Elbit Systems Ltd. (ESLT) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to the conference call to discuss Elbit Systems 2022 Annual Report. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to hand over the call to Rami Myerson, Elbit Systems Investor Relations Director. Rami, please go ahead.

Thank you, Joni. Good day, everyone, and welcome to the call today to discuss our 2022 annual report that includes disclosure on the segmental reporting structure. On the call with me today are Butzi Machlis, President and CEO; Kobi Kagan, our CFO; and Yossi Gaspar, Senior EVP, Business Management. Before we begin, I would like to point out that the safe harbor statement in the company's annual report on Form 20-F filed on 1 May 2023, also refers to the contents of this conference call. As we do on our regular quarterly conference calls, 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 the annual report. On this call, we will only discuss our financial results as of 31 December 2022. We plan to report Q1 2023 results to end of May. We reported our earnings for 2022 on 28 March 2023 in our 2022 annual results press release. There are no changes to the financial information we disclosed in our 2022 annual. However, we would like to highlight our segment financial information included in the annual report, which we will report going forward. Butzi will begin with the presentation of Elbit Systems 5 segments, followed by Kobi, who will provide information on the financial results of the segment. 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 Butzi. Butzi, please?

Thank you, Rami. The annual report that we filed today includes new information on the segmental reporting structure that Elbit has adopted and plan to disclose going forward. I would like to provide some background on our decision to update our disclosures. At our investor conference on 28th March, we presented the transformation that Elbit is implementing from a company with revenues of around $3.5 billion a few years ago to a company with infrastructure in place to support annual revenues of $6 billion to $7 billion with improved profitability and cash innovation. This follows the strong growth in our backlog to a record level of more than $15 billion, approximately 2.8x our 2022 revenues. As part of our regular processes, and the operational transformation that also includes changes to our internal reporting as well as correspondence with our regulator, we decided to adopt the way we disclose our operations to the market. This is also an opportunity to provide additional transparency to investors and analysts. Elbit Systems [ import ] segment information in five segments, beginning with the year ended December 31, 2022. The 2022 financial information we reported from each segment is compared retrospectively to the financial performance of each segment in 2021 and 2020. The segments are organized by a combination of the nature of products and services offered together with [ Aerospace ] based segment [ Elbit System of America ] or ESA reflecting a way management manages the company. The U.S. is the largest defense market, and we believe this structure is suitable to maximize the significant potential. The five reportable segment of aerospace, which provides products and systems for urban platforms, unmanned air solutions, precision guidance munition or PGM sensors, [indiscernible], training and simulator systems as well as commercial aviation system. C4I and Cyber provide C4I systems, data links and radio communication systems and equipment, cyber intelligence, autonomous and homeland security solutions. ISTAR and EW provide a wide range of electro-optics and laser systems as well as a range of electronic warfare and seeking systems. Land provides land-based systems for armed, armored and other military vehicles, artillery and motor systems, ammunition for land, air and three applications, including PGM, armed vehicle and other platforms mobility and protection systems. Elbit Systems of America, or ESA, provides products and system solutions, principally to the U.S. military, foreign ministry service, homeland security, medical instrumentation and commercial aviation customers. Management encourages the segment to cooperate on a range of common projects performed by the company. It is common for the segment to provide the products to the same customers, either from joint projects or by marketing and offering combined and integrated solutions containing variety of capabilities, products and technologies of the company's portfolio from various businesses or subsidiaries all tailored to satisfy the customers or project-specific requirements. Management also remains focused on the consolidated results as an important measure of performance, particularly given the high level of cooperation among the segments. I will now hand over the call to Kobi to discuss the financial results of each segment for 2022. Kobi, please?

Thank you, Butzi. Hello, everyone, and thank you for joining us today. I would like to reiterate Ramin's comments that there are no changes to the consolidated financial results we reported on the 28th March in the annual report filed today. I will start my review with some of the highlights of our consolidated 2022 financial results and will then elaborate on the financial information of each segment. Our consolidated revenues increased by 4% to $5.5 billion in 2022 from $5.3 billion in 2021. GAAP Operating income was $368 million versus $419 million in 2021. Non-GAAP operating income in 2022 was $357 million or 6.5% of revenues compared was $451 million or 8.5% of revenues in 2021. As a reminder, GAAP and non-GAAP operating income in 2022 included expenses of approximately $62 million related to stock price linked compensation plans. I will now review the financial results of each segment as we note that our segmented disclosure of operational income is provided on a GAAP basis. Aerospace revenue increased by 9% to $1.73 billion in 2022 from $1.58 billion in 2021, mainly due to training and simulation and UAS sales. Aerospace operating income in 2022 was $106.8 million and 6.2% of Aerospace segment revenues compared to $129.2 million and 8.2% of segment revenues in 2021. The $22.5 million decrease in operating income was mainly due to increased employee compensation expenses and negative program mix. C4I and Cyber revenues increased by 8% to $678 million in 2022 from $625 million in 2021, mainly due to growth in radio-enabled command and control system sales. C4I and Cyber operating income in 2022 was $49 million and 7.2% of C4I and Cyber segment revenues compared to $44.4 million and 7.1% of segment revenues in 2021. The $4.6 million increase in operating income was mainly due to the increase in revenues partially offset by increased employee compensation expenses. ISTAR and EW revenues increased by 2% to $1.05 billion in 2022 from $1.03 billion -- [ million ] 2021, mainly due to armored vehicles, night vision and target acquisition system sales. ISTAR and EW operating income in 2022 was $49.1 million and 4.7% of ISTAR and EW segment revenues compared to $66 million and 6.4% of segment revenues in 2021. The $16.9 million decrease in operating income was mainly due to increased employee compensation expenses and negative program mix. Land revenues increased 5% to $1.17 billion in 2022 from $1.12 billion in 2021, mainly due to airborne precision munition sales. Land operating income in 2022 was $28.6 million and 2.4% of Land segment revenues compared to $35.6 million and 3.2% of segment revenues in '21, the $7 million decrease in operating income was mainly due to increased employee compensation expenses. ESA revenues decreased by 2% to $1.46 billion in '22 from $1.49 billion in 2021, mainly due to lower medical instrumentation and military avionics sales, partially offset by growth of night vision sales and one additional quarter of Sparton sales compared to 2021. ESA operating income in 2022 was $75 million and 5.1% of ESA segment revenues compared to $124.3 million and 8.3% of segment revenues in 2021. The $49.3 million decrease in operating income was mainly due to the decrease in COVID-19, medical instrumentation sales that peaked in 2021, supply chain disruptions and negative program mix. Other operating income was $68.9 million in 2022 compared to $14.7 million in 2021 and included capital gains related to the sales of building and investments by subsidiaries in Israel and the U.K. as well [ finite ] evacuation rent received by subsidiary in Israel. Going forward, we plan to continue to report revenues and operating income of each segment in our annual report. In our press release for the first, second and third quarter, we will provide revenues by segment, which reflect the way we manage our business. Revenues by segment in our press releases for the first, second and third quarter will replace revenues by areas of operations that were previously provided. The revenue split by geographical revenues and areas of operations were also disclosed in our annual report. The areas of operations are a capability or a platform-based classification that cross over the different segments. An example of this our EW systems provided to the U.S. and customers through our ESA segment for installation on the U.S. Air National Guard F-16 aircraft. These are included in the airborne systems area of operations, and they are reported as intersegment sales by the ISTAR and EW segment and a third-party sales by the ASA segment. And with that, we will be happy to take your questions. Operator?

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

Guys, do you expect any cost savings or any revenue synergies from this new alignment? Butzi, maybe you could give us more color on how you think things could change as a result of this.

As you know, Pete, we organized the company in a different structure recently. And just we combined the UAV division with the Airborne division, and we combined EW and the electrooptic activities together under another division. And it's part of the transformation we are performing in the company in order to gain more synergies to reduce overheads and to be more effective and proactive to the market. And as I said, this is part of the transformation process. The company is activating right now in order to reach the -- the revenue level of between $6 billion to $7 billion in the coming years and to improve profitability and cash generation.

That's great. Very helpful. And then you may have touched on this at the beginning. But in terms of the segment heads and their annual incentive compensation, how are you guys incenting them? Is it sales growth, margin growth? Anything else? I wasn't sure about that.

Pete, this is Yossi. Regarding the incentive program, we have for each individual starting from the highest level, executive level and down to our program managers and below defined goals that vary from a function to function that includes for example, cash generation that include profitability that includes revenues, new business, quality criteria and so on. Every year, we define major highlights that are important for the company. And accordingly, we assign for each function, the goals and we measure them, of course, quarterly, and we compensate them by year-end usually with an advance by midyear.

Okay. Okay. Very helpful. And just last one for me. A question about the U.S. segment. I think you guys mentioned it was a 5.1% operating margin in 2022 which 5.1%, I would say, is below U.S. peers. And I know you guys have built ESA up over decades, kind of one piece at a time, small pieces initially to get a foothold. But so my question is, do you guys expect to consider maybe some portfolio reshaping, maybe some portfolio pruning in the U.S.? Because I imagine there are some big margin differences among the businesses in ESA for you. I imagine there's some lower margin businesses and some much higher margin businesses, and it strikes me that maybe there's an opportunity there longer term?

Pete, we see all our activities in the U.S. and core activities. We always adapt here and there in some of the activities. But in general, we -- all the activities we have in the U.S. the company in the U.S. is very important. That's the largest market for Elbit today, and we see it's a strategic market for us. It's true that in 2022, [indiscernible] or the profit was impacted by stock price linked compensation expenses as well as lower medical infra instrumentation sales and by supply chain disruptions and the increase of electronic components. I also want to remind all of us that we went live with the new ERP system in the U.S., which was not an easy task as well. But all of it -- and of course, project mix as usual. So all of it is -- most of it is behind us, and I expect our numbers in the U.S. to improve.

The next question is from Ellen Page of Jefferies.

Just following Pete's question on margins. If we look across the segment, you're in kind of the mid- to high single-digit range across segments. Where do you see the most opportunity for margin expansion? You used to talk about a 10% total company target long term. Just as we think about margin improvement across the businesses to get there?

I would expect all segments to grow to the neighborhood of 10%. That's a strategic -- or even above that, that's a strategic goal we have placed to the management and the things that are there to go to this direction. And the beauty of that is the wide portfolio, the wide portfolio we have on one hand and the vertical spread on the other hand. And the combination of these two creates stability. So altogether, I do -- all together, I think the company will reach the 10% quite soon. And as we've mentioned in the conference, which was held a month ago, 2022 was a year of transformation. We are investing hundreds of million dollars in new facilities in Israel as well as in the U.S., in Germany, in the U.K. in order to convert the backlog to revenues and to profits we are going to conclude implementation of new [ Elbit system ] mid this year. And after that, we will all operate on 1 ERP, based on one standard system, which will help us also to create -- to be more effective and more efficient. And we reorganized the company recently in order to be to be more relevant to the market and more effective as well -- but this is true for all the segments.