Elbit Systems Ltd. (ESLT-NASDAQ) reported their third quarter 2017 results on Tuesday, November 14, 2017. In this piece we discuss how the timing of deals signed by Elbit impacted the quarter. We also provide a forecast for the upcoming quarter based partially on signed deal timing.
Q3/17 Results
Record gross margins helped make up for lower than expected revenue.
Source: Perspectec
Revenue was off a little – Elbit saw revenue come in about 2% below our estimates. Y/Y growth of about 3% was slightly below that of other defense contractors such as Lockheed Martin (5%) and Raytheon (4.5%).
Contract falls off – The miss we believe may be due to a 3-year, $80 million contract signed in 2014 coming to an end. The supply contract called for Elbit to supply C4ISR systems to a Latin American country. While Elbit continues to diversify its revenue base, they still suffer from customer concentration risks versus their larger peers who generally do not.
Revenue from elctro-optic contracts in other countries is being recognized quickly – Helping to balance this out we noticed that sales from contracts in “Other Countries” was up $30 million Y/Y. We believe this is likely due to electro-optic deals signed with Middle East / African countries earlier this year. These deals were said to be worth a total of $260 million over two years, and the early recognition of revenue here is a good sign that the deals have not fallen through.
Another positive contributor to sales was the recognition of sales from a 2015, 3-year, $27 million artillery deal with an APAC country.
Gross profit a big surprise – Gross profit of 31.3% materially beat our estimate of 29.5% and the 29.5% gross margin reported in Q3 of last year. Actually for the past six quarters ESLT has typically maintained a gross margin of 29.5%. The entire EBITDA beat of $10 million can be entirely explained by the gross margin beat.
The company noted the improving mix of their business was partially reflected in the gross margin. In addition in our discussions with Elbit, implementing Infor’s ERP solution, which is replacing a set of disparate systems is another factor aiding gross margin. Both factors are expected to help improve gross margin over time and we are adjusting our forecast accordingly.
Adjusted EPS beat – Elbit reported an adjusted EPS of $1.57, above our estimate of $1.44 for the quarter. Again this was driven by the gross margin beat.
Other material things that we noticed:
Lower backlog could mean higher growth the next few quarters – On the earnings call Elbit’s CFO Joseph Gaspar mentioned that for the next five quarters ESLT’s backlog are expected to grow 6% year over year. This is down from 12% Y/Y in Q3 despite a large amount of orders announced last quarter. Indirectly this could be hinting that backlog will translate to sales and that along with higher gross margins EPS could be in for a major beat in Q4.
Source: Perspectec
Some leverage in the coming quarters? Driving this growth in backlog is Elbit’s previous investments in R&D and S&M, both in absolute terms and as a percentage of revenue. We forecast both R&D and S&M expenses to account for 16.4% of revenue in 2017 and see this coming down slightly to 15.6% in 2018 as the company has done a lot of the heavy lifting in expanding their sales force Globally.
Technology solutions are seeing traction – Elbit mentioned that in many of their end markets they continue to see defense growth. In addition, they are trying to capitalize on the growth of electronic defense spending as a greater portion of overall spend. In our opinion, ESLT is well positioned in the electronic defense space with their past product offerings in cyber, C4ISR, as well combined products for border security.
Operating Cash Flow concerns – One of the noteworthy concerns we had from the Q3/17 results was the $142.6M in negative cash flow from operations for the quarter versus the $17.3M in negative cash flow from the year prior. Elbit mentioned that this is due to the longer term payment terms from some of their customers, but is in line with market trends and are expecting to collect the amounts outstanding in the coming quarters. This is something we will keep an eye out for in Q4.
Potential for better than expected revenue and EPS growth in Q4 – For Q4/17 we expect ESLT to announce year over year revenue growth of 3.9% to $991 million versus Q4/16 revenue of $953 million. There is a good chance Elbit reaches the $1 billion mark in revenue for the quarter for the first time as there are eight $100 million+ contracts signed earlier in 2017 that may begin to see some revenue recognized given that backlog is expected to only grow 6% Y/Y versus 12% last quarter. In 2016 there were only two $100 million+ agreements signed.
We forecast an adjusted EPS of $2.14, up from our prior estimate of $2.08 due primarily to higher gross margin offsetting slightly higher S&M and R&D costs.
Our full year forecasts can be seen below.
Source: Perspectec
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