Elbit Systems (ESLT) Q4 2021 Earnings Call Transcript

Elbit Systems (ESLT -0.03%)
Q4 2021 Earnings Call
Mar 29, 2022, 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' fourth quarter 2021 results conference call. All participants are present and 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 Myerson, Elbit Systems' investor relations director. Please go ahead.

Rami Myerson -- Investor Relations Director

Thank you, operator. Good day, everyone, and welcome to our fourth quarter and year-end 2021 earnings call. On the call with me today, are Butzi Machlis, our president and CEO; Yossi Gaspar, our chief financial officer; and Kobi Kagan will take over from Yossi on April 1st. Before we begin, I would like to point out that the Safe Harbor statement and the company's press release issued earlier today also offers the contents 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 details to help understand the performance of the ongoing business. You can find all the detailed GAAP financial data, as well as the non-GAAP information, and the reconciliation in today's press release. Yossi we'll 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. Earlier today, we hosted an investor conference at the Tel Aviv Stock Exchange. Recording of the event will be available in the Investor Relations section of our website www.elbitsystems.com. Investors and analysts who wish to ask questions related to topics discussed in the press conference are welcome to present their questions during the Q&A session of the call.

With that, I would like now to turn the call over to Yossi. Yossi, please. 

Yossi Gaspar -- Chief Financial Officer

Thank you, Rami. Hello everyone, thank you for joining us today. As Rami mentioned, on April 1st, Kobi Kagan will take over as chief financial officer. I will continue as senior executive vice president-business management and will retain among other corporate life duties and responsibility for capital markets and investor relations, working together with Rami.

I look forward to introducing Kobi to the investors and analysts over the coming weeks and months. I would like to take this opportunity to wish Kobi good luck and success in his new role. The 2021 annual results reflect the very positive transformation of Elbit over the last few years, during which we successfully move up the value chain from a provider of products and systems to a provider of comprehensive solutions. The Hellenic Flight School contract is a good example of a comprehensive contract, as a result of this transformation, as well as supports the growth in all of backlog and revenues, that indicates the strong demand for our systems and solutions.

We continue to implement mitigation plans to limit the impact of the strengthened Israeli shekel, and the competition for [Inaudible]. in the short term, these include the adoption of rolling currency hedge policy and efficiency measures. Over the longer term, we plan to expand our engineering and infection footprint in high-quality, low-cost countries, to better balance our currency exposure and reduce risk. The introduction of a companywide ERP system will support these efforts.

I will now highlight and discuss some of the key figures and trends in our financial results. Fourth quarter revenues were $1 billion and $494 million and increased by 8.5% year over year. For 2021 as a whole, our revenues were $5.3 billion versus $4.7 billion last year, representing a growth of 13%. A major part of the growth was organic, in addition to the contribution from Sparton, which we acquired in the second quarter of 2021.

In terms of annual revenue breakdown across all areas of operation, Airborne systems accounted for 38% of total annual revenues and increased year over year, mainly due to airborne precision guided munitions seats. That system sales accounted for 24% of total revenues, a similar level of revenues to 2020. C4ISR at 26% of revenues increased year over year, primarily due to the acquisition of Sparton, and unmanned systems sales. Electro Optics accounted for 9% of total sales, and other sales with 4% of revenues and increase year over year, mainly due to the growth of our English Medical Instrumentation subsidiary.

Our diverse geographic revenue base is important to the long-term sustainability of our business. In 2021, North America contributed to 31% of all revenues, Asia Pacific 27%, Israel was 21%, and Europe 17%. The growth in US was mainly due to the spike in acquisition and sales of commercial medical instrumentation. Asia Pacific revenues increased mainly due to the sales of precision guided munitions and unmanned airborne systems.

The growth in European revenues was primarily through training and simulation sales. Elbit has always viewed Europe as a strategically imported market with significant potential. We have made significant investments to expand our positions across the continents. Since 2014, our European revenues increased by more than 90%, significantly faster than the growth of the European Mayco member defense budgets in the same period.

Almost all of this growth was organic. Following many years of investment, we believe Elbit is well-positioned to benefit from the planned increase in the European defense spending. Compared with the fourth quarter last year, we saw strong growth in Asia Pacific, and more than offset lower sales in certain other markets. This reflects the phasing of programs and trends to fluctuate from quarter to quarter.

We believe the longer-term trends are more representative of our business. The non-GAAP gross margin for the fourth quarter was 25.5%, compared with the fourth quarter of 2020 its 26.3%. For the full year of 2021, non-GAAP gross margin was 26.2% compared with 26.7% last year. Non-GAAP gross margin 2021 reflects an unfavorable program mix, as well as the impact of the strong shekel versus the US dollar compared to 2020.

GAAP gross margin in the fourth quarter of 2021 was 25.1% of revenues, compared with 26% in the fourth quarter of 2020. GAAP gross margin in 2021 was 25.7%, compared with 25% in 2020. GAAP gross profit in 2020 included expenses of approximately $60 million, as a result of a non-cash expense related to inventory write-offs, and asset impairment, mainly in our commercial aviation activities due to the impact of the COVID-19. The fourth quarter non-GAAP operating income was $120 million or 8% of revenues, compared with $113.8 million or 8.2% of revenues last year, but has declined slightly year over year due to lower gross margins and higher journey expenses in the quarter.

GAAP operating income in the fourth quarter was $107.3 million versus $104.6 million in the fourth quarter of 2020. Non-GAAP operating income in 2021 was $451 million or 8.5% of revenues, compared with $390 million or 8.4% of revenues last year. GAAP operating income was $419 million versus $326 million last year. The operating expense breakdown in 2021 was as follows.

Niqdar expenses were 7.5% of revenues versus 7.7% in 2020. Marketing and selling expenses declined to 5.5% of revenues versus 6.2% last year. G&A expenses were 5.1% of revenues compared with 4.8% last year. The increase in the G&A expenses was mainly related to the spike in acquisition.

Why we do not provide forward guidance, I would note that the recent rise in the share price could lead to an increase in expenses in 2021 and are related to share price leading compensation plans. Financial expenses were $20 million in the fourth quarter, compared with $33 million in 2020. The low level of financial expenses were mainly due to exchange rate differences related to the reevaluation of lease liabilities in the quarter. Financial expenses in 2021 with $40 million compared to $71 million last year.

We recorded the tax expense of $92.3 million in the fourth quarter, compared with $1.9 million in 2020. Taxes on income in the fourth quarter included a one-time expense of approximately $80 million related to the release of exempt earnings [Inaudible] published on 22nd of February this year. We have excluded this expense from our non-GAAP net income due to the non-recurring nature of this expense. Including this extraordinary expense, the effective tax rate in 2021 was 34.8%, compared with 13.9% in 2020.

Our non-GAAP diluted earnings per share was $2.14 in the fourth quarter and $8.30 for the full year of 2021. GAAP diluted EPS was $0.18 for the fourth quarter and $6.20 for the full year of 2021. Our backlog of orders as of December 31st, 2021 was $13.7 billion, $2.6 billion higher than the backlog at the end of 2020. Approximately 60% of the current backlog is scheduled to be performed during 2022 and 2023, and the rest is scheduled for 2024 and beyond.

The percentage of the short term backlog decline in recent years, following the receipt of long term contracts improving our visibility for the future revenues. Operating cash flow for the fourth quarter was $260 million, compared with $172 million in the same quarter last year. For 2021 as a whole, we reported $417 million operating cash versus $279 million in 2020. Operating cash flow benefited from receipts of delayed payments from the Israeli Ministry of Defense in the fourth quarter, as well as growth in advance payments on contract by customers.

The Board of directors declared a dividend of $0.50 per share for the fourth quarter of 2021. I will now turn the call over to Mr. Machlis. Butzi, please. 

Butzi Machlis -- President and Chief Executive Officer

Thank you, Yossi. I would also like to wish Kobi and Yossi good luck in the new awards. I look forward to continue walking with both of you. 2021 was a solid year for Elbit, and the growth in revenues and bitlocker reflect our strategy that combines strong market positions around the world, and a broad portfolio, and technological capabilities that we leverage to [Inaudible] market, leading relevant and cost-effective solutions for our customers.

At the investors' conference today, we discussed this property and investment we made in the past, and continue to make to grow both these market positions and disruptive technologies. We continue to see good momentum across almost all our end markets, in recent weeks, we have all heard European in [Inaudible] announced plans to dramatically increase defense spending. Elbit Systems has established subsidiaries in countries across Europe, as part of our strategy to build a global multi-domestic company. Only European subsidiaries employ hundreds of employees, creating local jobs, and supporting domestic supply chain.

They provide engineering, manufacturing, and support services for domestic and export customers. Elbit Systems has invested a lot more just capital to develop these subsidiaries. We have transferred technologies IP, business practices, and provided new subsidiaries with benefits of Elbits' global sales force and footprint. Our investment in Europe had already generated good returns.

Our European revenue have a grown significantly faster than European defense budget in recent years, providing an encouraging indication of both our market position and the demand for solutions. Sweden, provides another example of our strategy. In 2021, we open Elbit systems Sweden following a number of commercial successes. This includes avionics for the group of fighter, radios ammunition for the army, and combat management system for the Royal Swedish Navy.

The Swedish prime minister recently announced plans to increase defense spending to 2% of GDP. I believe as this system Sweden can provide the Swedish military with a broad range of additional advanced and relevant technologies capabilities to help address the increasing's threat environment. This is also [Inaudible] for additional European countries with Elbit Systems subsidiaries that have also announced plans to increase defense spending, including Germany, Belgium, and Romania. In 2021, we open our subsidiary in the United Arab Emirates, and in January this year, Elbit System Emirates received its first contract to supply philcom in electronic warfare self-protection system for the UAE Air Force Airbus A330 Multi-Role Tanker Transport aircraft.

I am optimistic about the potential for Elbit Systems in the UAE in additional countries that were part of the historic Abraham Accords. It's all Investor Day in 2020, we presented [Inaudible] to market as one of Elbits' growth drivers, and the investment we have made to develop a range of solutions for this growing market. Following the progress made over the last 12 months, we decided to highlight our activities in the maritime market at today's 2020 Investor Day. This progress includes the acquisition of Sparton in the US, a contract for our neighbor [Inaudible] system, as well as contact of our civil unmanned naval vessels.

The $100 million Royal Navy Electronic Warfare contract, our UK subsidiary Elbit Systems UK received in November, was a significant achievement for both our UK subsidiary and our maritime activities. As part of this contract, Elbit System UK will design and manufacture maritime EW suits comprised of digital full-spectrum Radar Electronic Support Measures and EW Command and Control system. These latest-generation technologies will enhance the situation awareness and anti-ship missile defense of the Royal Navy ships, improving the capability to exploit the electromagnetic environment. I believe there is significant potential for cooperation across Elbit subsidiaries that operates in the maritime market.

Following the acquisition of duty in Canada in 2018, the Sparton is a US in 2021. Elbit Systems today is a supplier to the US Navy, the Canadian Navy, and the British Norway Navy. These three countries are members of the Five Eyes alliances with Australia and New Zealand. I am optimistic about Elbit's potential in the maritime market following the progress we delivered in 2021.

In summary, I believe as the system's investments to build a significant market position around the world, and the leading portfolio of new technological capabilities will enable us to benefit from future growth in defense budget. And with that, I would be happy to take your questions. Operator.

Questions & 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 Pete Skibitski of Alembic Global. Please go ahead. 

Pete Skibitski -- Alembic Global -- Analyst

Yes, hello, Butzi, Yossi, Kobi, and Rami, and good afternoon. Maybe we could start out talking about backlog. Backlog in the quarter was fairly flat versus the third quarter. But I'm wondering how the continuing resolution in the United States impacted that.

Because that was on, the CR was ongoing through the entire December quarter, and really ongoing until only a few weeks ago. So I was just wondering if you saw some order headwinds from the CR in the fourth quarter, and maybe you expect that to continue through the first quarter given the length of that. 

Yossi Gaspar -- Chief Financial Officer

Hi, Pete, this is Yossi. No, I cannot confirm that we have seen any headwinds. As you know, we have increased significantly about $2.5 billion the backlog in this year. A significant part of that came also from the US.

There are fluctuations in these income orders. However, we are very optimistic. When we heard today that the Biden administration has proposed an increase of 4% of over $30 billion in the recommended budget for next year. That will definitely be something very positive for us as well. 

Pete Skibitski -- Alembic Global -- Analyst

Yeah, well, and that kind of is a segue way into my next question, and you guys alluded to that in your opening commentary. We're seeing certainly higher defense spending in the US now, certainly in Europe. Pretty sizable increases, it sounds like. If we put that all together, maybe it's too early? But how are you guys now thinking of your organic revenue growth outlook maybe through the midterm, given this pretty strong kind of macro environment we're seeing out there.

Butzi Machlis -- President and Chief Executive Officer

Hi, this is Butzi.  We see a lot of interest in our portfolio, and we see the funnel, the potential new business opportunities that we are emerging right now has increased a lot. We also got some immediate orders already. We just published last week, and that contract we got from Sweden to provide [Inaudible]. So I'm quite optimistic that this funnel would be transformed to growing backlog in the near future, as well as the [Inaudible] future.

Pete Skibitski -- Alembic Global -- Analyst

Sure. Makes sense. One last one for me, if I could, on the gross margin in the fourth quarter. Can you say, which was more of a headwind in the fourth quarter gross margin? Was it the program mix or was it affects headwind? And maybe you could give us a sense of reverse those had wins in 2022. 

Yossi Gaspar -- Chief Financial Officer

Yeah, well, it's a combination of both. And we, as you know, we're working very hard to mitigate these headwinds on our future planning. We have a very extensive long-term plan to improve profitability in our business, and we are working hard to implement that. The one company Elbit mentioned earlier, one of them, the reorganization that we did, the synergies that we are building between the various parts of the organization to reduce cost and overheads.

All of that is underway with the long-term planning. We hope to see some improvement in the mid-term future.

Pete Skibitski -- Alembic Global -- Analyst

I won't ask any more questions, but let me just say congrats on the free cash flow performance this year. It turned out to be over 90%, one of the best years, I think over five years or so for all us. Great job there, and thanks for the time, guys.

Operator

The next question is from Dina Korshunov of Leader Capital Markets. Please go ahead. 

Dina Korshunov -- Leader Capital Markets -- Analyst

Hi, guys. Great talking to you again today, and I have a couple of questions. My first question is regarding the war in Ukraine. Can you please detail what are the immediate and long-term effects regarding the supply change and ongoing operation, and can it escalate us to a significant rise in costs or disruption in activity? This is my first question you can answer, then I will ask the other questions.

Butzi Machlis -- President and Chief Executive Officer

Hi, Dina. I don't see any effect on supply chains. There is an effect on supply because of Covid, and which we found some ways to handle. But I don't see any immediate effect on supply chain, and other cost drivers which might affect our performance in the future.

I don't see actually, I see more, I see many opportunities related to Ukraine war, and new business for the company.

Dina Korshunov -- Leader Capital Markets -- Analyst

I understand. Thank you. And the second question, what are your estimations regarding the future trends in defense budgets? The medium and long-term. Maybe not in the next year, but in couple of years? 

Butzi Machlis -- President and Chief Executive Officer

No. I think that we will see increase in defense spending in this year as well as in the future. Actually, it looks like this war was a wake-up call to NATO, and there is a decision to increase defense spending in native countries to 2% of EDP. And just yesterday, it was announced that increase in the defense budget to 4% might take place, which is about a certain additional $30 billion.

We also see an additional growing defense spending also in Asia Pacific, not just in the two countries. So I believe that this year, as well as in the coming years, we will see growing and defense spending all over the globe.

Dina Korshunov -- Leader Capital Markets -- Analyst

I understand. I mean the long term maybe, I don't know, in five, ten years, want to stop at some point in time?

Butzi Machlis -- President and Chief Executive Officer

It's quite difficult to predict what would be in 5 to 6 years. But it looks like many countries in Europe took a strategic decision to build a strong local defense industries, and to support the industries. And we heard that Germany, for example, will invest 100 billion euros this year in defense. And we also see a trend to invest most of the budget locally and hope it is very well positioned via our subsidiaries in Europe, as well as all around the globe to take benefits of just growing investments.

Dina Korshunov -- Leader Capital Markets -- Analyst

Great. Thank you. And my last questions. What does the main programs or a segment that's expected to rise in the US budgets in 2023 proposal that can influence you the most or vice versa? 

Butzi Machlis -- President and Chief Executive Officer

We see additional investment in the naval domain. And therefore the growing investment in the naval domain, this was one of the reasons for this strategic decision to invest in this domain, and that is one of the reasons to acquire Sparton, which supplies [inaudible] to the US Navy. And we also see an increasing defense, increasing spending, and for urban platforms, and the army I assume that is based on the last conflict in Ukraine, we see also increase in the army budget this year, as well as in the near future.

Dina Korshunov -- Leader Capital Markets -- Analyst

I understand. Thank you. Great. Great answer.

Good luck

Operator

The next question is from Alan Spence of Jefferies. Please go ahead.

Sheila Kahyaoglu -- Jefferies -- Analyst

Hi. Good morning, guys. It's actually Sheila on the line. I wanted to follow up on some of Pete's questions actually with regards to Europe.

Can you remind us the largest exposures there in terms of on a country basis? I know you mentioned some specific opportunities, but if you could give us a breakdown. 

Butzi Machlis -- President and Chief Executive Officer

Can you repeat, please?

Sheila Kahyaoglu -- Jefferies -- Analyst

Sorry about the background noise. In Europe, can you remind us of your exposure on a country basis, and how we think about the opportunities actually being of creative [inaudible] In terms of timing? Countries. Sorry. Revenue exposure in terms of countries.

Sorry.

Yossi Gaspar -- Chief Financial Officer

Well, our subsidiaries, our major subsidiaries in European countries, we have, starting with the UK, we have actually under Elbit UK, we have got five various plants that are operating in the various business areas that we work on, and do business in. We have hundreds of people in these operations. The other one that's worth mentioning is, of course, Germany. We have two operations there, again, so there are hundreds of people operating in Germany.

When I say operating, then I would say it's manufacturing, it's engineering work, customer relations, customer support, and everything's related with the business that we have performing in that country. We have in Belgium, we have in Belgium several hundred people operating in the Electro Optic systems, again, developing and manufacturing equipment. We have a relatively significant base in Romania, which is high quality, low-cost territory. We're manufacturing over there, quite a lot of mechanical and electronic assemblies, parts and assemblies, and of course we have as well some software capability to develop software and related with all the engineering work that we are doing, that's in Romania.

We have several hundred people over there. We have in Hungary, we have in Hungary a subsidiary that is operating in the advanced, the RF business, including radar systems, we have quite a lot of people over there. We have a subsidiary in Sweden, which we established about a year and a half ago, but already received significant contract for the Swedish Ministry of Defense. And we have the people on site doing performing these contracts.

Austria is another base of ours. It did start in the past with command control systems, but it developed in many other areas as well like fire control systems, and unmanned [inaudible], and control systems, and so on, and communication. Everything that I mentioned is just a part of it. We, of course, have subsidiaries.

Maybe it's a little bit lower scale in France. We're doing over there commercial avionics, supporting the local commercial industry. And we also have subsidiaries in Italy, and other places as well. Quite a lot of spreads in total, I would say in Europe, we are close.

So probably over a thousand people that are working for our subsidiaries in this continent. 

Sheila Kahyaoglu -- Jefferies -- Analyst

OK. Great. Thank you for all that color. And then maybe I wanted to ask about free cash flow.

Once again, we get conversion on strategic percent on adjusted net income and 83 or so on that. I think it suggests that there's still customer payments outstanding. You need to remind us of those?

Yossi Gaspar -- Chief Financial Officer

Oh, yeah. Well, we had a short period of time during which there was no stability in the budget of the whole budget of the country of Israel. With the establishment of the new government, the budget stabilized was approved. And as part of that budget, the budget for the Ministry of Defense here in Israel was approved, and they have actually paid up all their debt to us, and actually continuing on a normal, regular basis to pay whatever they have to pay to us.

So, I would not look at them as any debt holders for for Elbit. [Inaudible]

Sheila Kahyaoglu -- Jefferies -- Analyst

It was customer payments. But you could talk about inventory and [Inaudible]

Yossi Gaspar -- Chief Financial Officer

OK. Thank you very much.

Sheila Kahyaoglu -- Jefferies -- Analyst

Thank you.

Operator

[Operator instructions] There are no further questions at this time. Before I ask Mr. Machlis to go ahead with his closing statement, I like to remind participants that a replay of this call will be available 2 hours after the conference end. [Operator instructions] A replay of this call also be available on the company's website www.elbitsystem.com.

Mr. Machlis, would you like to make your closing statement?

Butzi Machlis -- President and Chief Executive Officer

Thank you. I would like to thank all our employees again for their 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.

Operator

[Operator signoff]

Duration: 36 minutes

Call participants:

Rami Myerson -- Investor Relations Director

Yossi Gaspar -- Chief Financial Officer

Butzi Machlis -- President and Chief Executive Officer

Pete Skibitski -- Alembic Global -- Analyst

Dina Korshunov -- Leader Capital Markets -- Analyst

Sheila Kahyaoglu -- Jefferies -- Analyst

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