Ehud Helft - GK Investor Relations Joseph Gaspar - Executive Vice President and Chief Financial Officer Bezhalel Machlis - President and Chief Executive Officer

Gilad Alper - Excellence Yoav Burgan - Poalim Sahar Liat Glazer - Excellence

Ladies and gentlemen, thank you for standing by. Welcome to Elbit Systems second quarter 2016 results conference call. All participants are at present in 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. If you have not received it, please contact Elbit's investor relations team at GK Investor Relations or view it in the News section of the company's website, www.elbitsystems.com. I would now turn the call over to Mr. Ehud Helft of GK Investor Relations. Ehud, please begin.

Thank you, operator and good day to everybody. On behalf of all the investors, I would like to thank Elbit's management for hosting this call. Joining us on the call today are Mr. Butzi Machlis, Elbit's President and CEO and Mr. Joseph Gaspar, Elbit's Chief Financial Officer. Joseph will begin by providing a discussion of the financial results of the second quarter of 2016, followed by Butzi who will talk about some of the significant events during the quarter and beyond. We will then turn over the call to the question-and-answer session. Before we begin, I would like to point out the Safe Harbor statement in the company's press release issued earlier today also refers to the content of this conference call. With that, I would now like to hand over the call to Joseph. Joseph, please.

Thank you Ehud. Hello everyone and thank you for joining us today. As we do every quarter, we would like to provide you with both our regular GAAP financial data as well as certain supplemental non-GAAP information. You can find all the detailed GAAP financial data as well as the non-GAAP information and a reconciliation in today's press release. Overall, we are pleased with our performance in the second quarter, in particular with the growth in revenues and backlog while delivering improved bottomline. I will now highlight and discuss some of the key figures and trends. Our second quarter of 2016 revenues were $804.5 million, a solid increase of 7.3% compared with $749.6 million reported in the second quarter of last year. In terms of revenue breakdown across our areas of operation in the quarter, airborne systems was 39%, C4ISR was 38%, land systems was 11%, electro-optics was 9% and the rest was approximately 3%. Compared with the second quarter of last year, C4ISR was substantially up while land systems were down. In terms of geographic breakdown for the quarter, Israel was 22% of revenues, North America 27%, Europe 18%, Asia-Pacific was 26% and Latin America 4% and the rest of the world was 3%. Compared with the second quarter of last year, we primarily saw increased contribution from Europe and Israel and a lower contribution from Latin America. For the second quarter, the non-GAAP gross margin was 30.3% versus 30% in the second quarter of last year. Our GAAP gross margin was 29.4% versus 29.2% in second quarter of last year. The second quarter non-GAAP operating income increased by approximately 7% to $80.5 million or 10% of revenues compared with $75.4 million or 10.1% of revenues last year. Our GAAP operating income increased by 7% to $69.9 million or 8.7% of revenues compared with $65.5 million or 8.7% of revenues last year. In terms of our expenses for the quarter, total operating expenses were 20.7% of revenues compared with 20.5% of revenues in the second quarter of last year. The breakdown was net R&D expenses at 8.4% of revenues versus 7.7% last year, marketing and selling expenses at 7.5% of revenues versus 8.1% last year and the G&A expenses at 4.8% of revenues at a similar percentage to that of the second quarter last year. Financial expenses for the second quarter of 2016 were $5.5 million compared with financial expenses of $6.2 million in the second quarter of last year. Our share in affiliates for the quarter was an income of $4.4 million compared with $366,000 loss at last year. The primary reason for the increase in our share in affiliates was due to our joint venture for the military flight training school project in the United Kingdom. The project is progressing successfully and we achieved a number of milestones that allowed us to recognize a relatively high level of increase of income from the project in the second quarter. For the second quarter, non-GAAP net income grew 18% to $62.9 million or a net margin of 7.8% versus $53.5 million or a net margin of 7.1% last year. Non-GAAP diluted earnings per share were $1.47 compared with $1.25 last year. On a GAAP basis, consolidated second quarter net income grew 19% to $54.1 million and the net margin was 6.7% versus $45.3 million and a net margin of 6% last year. GAAP net income per diluted share was $1.27 compared with $1.06 last year. Our backlog of orders at quarter end was $6.8 billion, $513 million higher than the backlog at the end of the second quarter of last year. Approximately 59% of the current backlog is scheduled to be performed during 2016 and 2017. This figure is slightly below the proportion of the backlog scheduled to be performed in the upcoming two years compared to that at the same time last year which stood at 60%. This is due to the fact that our current backlog includes a slightly increased proportion of longer term projects. Operating cash flow for the quarter was negative $39.6 million compared with a positive of $32.6 million cash flow in the same quarter last year. The Board of Directors declared a dividend of $0.40 per share for the second quarter of 2016. That ends my summary and I shall now turn the call over Mr. Machlis. Butzi, please go.

Thank you, Joseph. We are encouraged by our second quarter financial results with revenues growing by over 7% compared to last year as well as improved gross margins. Additionally, we continue to remain pleased with our solid growth of 8% in backlog on a year-over-year basis. This is a good sign for the future as our backlog provides us with revenue visibility over the long term. Additionally, our backlog increasingly includes some long term projects. Another important off-take of our results is a gradual trend over the past few years of improving gross margins. In 2014, our gross margin was just under 28%. In 2015, it was just under 29%. And in the first half of 2016, it has been 29.4%. This represents the fruits of an ongoing effort we have taken to ensure we continue to operate efficiently, improve internal processes, while harvesting synergies across our various businesses' units. Our operating expenses were somewhat higher than those of the second quarter of last year. This was mainly due to an increase in R&D expenses. Part of the reason is that in some of our markets, we see some interesting opportunities that we wish to attack while maintaining our leading competitive position in the electronic defense arena. As always, a strong growth in backlog demonstrates we have been very successful over the years in remaining competitive and maintaining our technological lead, which will benefit us for the years to come. Our strategy of diversifying our revenue across many markets and products is proving itself. Latin America has been slow in recent quarters and Asia-Pacific and North America has been consistently strong and relatively stable. Also, Europe and Israel have grown and more than compensated the other markets. Just to highlight some of our recent momentum. In Europe, a region which had shown strong growth in the past year, we won a $30 million one-year contract to supply advanced thermal imaging observation system. The system will serve all army command levels from the dismounted soldier to the headquarters. In May, we were awarded a $40 million contract from another European country for the supply of advanced tactical communications system over the coming years. This communications system will allow tactical dominance, better situation awareness and groundbreaking interoperability between combat vehicles and dismounted soldiers. In summary, our businesses continued to perform well. We are pleased with the development, particularly our growth in revenues driven by a continued increase in backlog. Our businesses remains well diversified, built on broad spectrum of technologies and products we serve into many countries and regions. I believe we continue to remain well positioned in the right areas and the geographical markets of the defense industry and that we have the potential to continue to experience growth over the coming years. With that, I will be happy to take your questions.

[Operator Instructions]. The first question is from Gilad Alper of Excellence. Please go ahead.

Hi. Thanks for taking my call. Two question, if I may. The first one is on the new way that U.S. military aid might be arriving to Israel, as far as I understand from reading the papers, it's possible that this time around none of the aid is going to be able for the Israel government to buy from the Israel market. Everything is going to come from the U.S. market. So can you speak about how that might impact you because, at least in theory, we are talking about few hundreds of millions of dollars that existed in previous years and won't be here anymore? And the second question is about Europe. You mentioned the growth there. Is that you are seeing something that’s more of a cycle? Basically, we had some weakness from Europe in the last five years or so. And now we are just seeing some of that weakness coming back? Or actually going away, so there's a lot of pent-up demand? Or do you think there is something more fundamental here with the way Europe is dealing with its own problems? In which case, I guess the implication is that growth is actually going to continue, not 50% per year like you had in this quarter, but we are still going to see more growth and then we might actually go to a level of revenues in Europe much higher than we had, let's say, five years ago or 10 years ago? Thanks.

With regard to the first question, with regards to the American to the U.S. aid, I just want to remind all of us that we have activities we have here in Israel as well as in the U.S., we have Elbit Systems of America. So we can utilize the U.S. aids either here or in the U.S. So I don't really believe this will affect or this will have an impact on Elbit. So for Elbit, it might be even an opportunity. So I don't really see the changes in the U.S. aid affecting Elbit. With regard to Europe, I believe it's not just a one-time phenomenon. I believe it's a trend which shall continue. We see an increase in defense spending in Europe. There is a decision to invest 2% of the GDP in defense. The investment today is much lower than that. And it's a strategic decision of NATO and we see many countries adopting this decision right now. And as a result of that, we see many opportunities relevant to us. I just also want also to remind this that we have subsidiaries almost all over Europe. So in Europe, we are domestic and we have the ability to bring Israeli technologies to the Europe market by our subsidiaries. And we have subsidiaries all over the continent. The homeland security market is also growing in Europe and that's because of the refugees and because of the terrorist activities, which take place in Europe and that’s also an big opportunity for Elbit. One of the reasons for the increase in defense spending is Russia. Many countries saw what happened in Ukraine and are investing more in defense and there are many more reasons why I believe Europe will continue to increase its investment in defense and that's a big opportunity for Elbit in the future.

Okay. Thanks.

The next question is from Yoav Burgan of Poalim Sahar. Please go ahead.

Hi Butzi. Hi Joseph. First of all congratulations on an impressive quarter. I have two questions. One is on the backlog. I see that if I look at the backlog at the end of June and I compare it to March end, it seems to have stagnated. And this is after two quarters, I mean in Q4 of 2015 and Q1 of this year that you had a pretty impressive growth rate of about 3%, something like that. I am just wondering, is this something seasonal? Or how confident are you in expecting a renewal of the backlog growth?

Well, the thing that we are looking at all the time is the funnel of the business opportunities relating to the proposals that we are turning into our customers, relating to the marketing activities that we are performing, request of interest by our customers and so on. From that point of view, I would say that we are optimistic looking into the future as to the potential of the incoming new business in future periods. Backlog, we record, as you will probably know, front-ended orders in our backlog and these might fluctuate a little bit between quarters. It depends when the contract is signed and they are fully approved. So this is the process and these are the expectations. Regarding the history, I think we have seen an increase of about 8% in the last year in our backlog, about over $0.5 billion. I think that was due to increased marketing activities and the development of the defense market worldwide. As Butzi mentioned earlier, Europe is one of the lead territories. So looking into the future, I think we can remain optimistic about keeping the backlog growing. We might see fluctuations from quarter-to-quarter according to the specific developments.

Okay. Fair enough. And my second question, Joseph, obviously it's for you. It's specifically on the P&L. On the equity net earnings of affiliate companies this quarter, actually you gave an explanation that the relatively high level, about $4.5 million, is mainly due to the recognition or the beginning of the operations of your U.K. affiliate. I just want to understand, because I think I didn't see it in the previous quarter, when exactly did this affiliate started its operations?

The affiliate was established actually about over a year ago when we started the contract. And if you remember, that affiliate received contract of over $730 million, which by the way is not in our backlog because we are not consolidating the financial statements of the affiliates because we own only 50%,. But we start recognizing revenues in the affiliates once we meet specific milestones that are defined by the contract with our customer. And this quarter, some major milestones were achieved. So we could recognize the revenue and as a result, we could recognize the profit included in that revenue and we took our share, which is 50% of that profit to the equity line. And that number, by the way, includes other affiliates as well, as you probably know, but the big change in this quarter was in regards with that specific subsidiary that we have for the flight school.

Okay. So I just want to make sure that I fully understand. So this is not necessarily a one-time gain? This could be a run rate for the near term future, correct?

It is not a one-time gain definitely. However, I would expect to have a slightly lower run rate for the next quarters. That whole program goes over 18 years. So the expectation is that the future quarters may fluctuate, may have sometimes a higher or a lower number. This time, I would define that as a little bit on the higher side.

Okay. Good. Great. Thank you very much, Joseph and Butzi.

Okay.

[Operator Instructions]. The next question is a follow-up from Gilad Alper. Please go ahead.

Hi. It's actually Liat Glazer. Just quick two questions on the cash flow actually. First one is on CapEx which came in a little bit high this quarter. Just wondering if there is anything to read into this? And the second thing is days receivables. If my calculation is correct, then in 2016 days receivables were around 110 and they jumped in Q1 and also now in Q2 to 130 days. So I am just wondering if there is anything to read into that? Any change in business pattern? Extending more credits or whatever? Thanks.

Regarding the cash flow, yes, you know that we are a company that are operating under project oriented contracts and the cash flow is dependent on receivables from customer meeting deliveries and receiving it according to contract. So we do see fluctuations in the cash flow and quarterly cash flow really doesn't give a lot of information for what's going on. However when you look on a yearly basis, you will see the cash flow generated is probably very close and even higher than the reported net profit. So I would like to remind you, by the end of last year in 2015 we generated cash flow of about $430 million, which was essentially also, that did include some advances on contracts and some early cash receipts for future milestones. So especially with our Ministry of Defense in Israel, but also other customers. So that is the cash flow. Our expectation on a yearly or definitely on a multi-year basis, you will see our cash flow coming back and being generated on the right positive level. That was the history that's going to be in the future as well. Regarding the CapEx, yes, we had some little bit higher capital expenses this quarter and we might have little bit higher expenses next quarter. This is related with, I would say, a one-time significant investment that we did in establishing one of the consolidated branch of Elisra that they are moving to one place. We expect some improvements in expenses due to that, but that movement that was planned now for several years is taking place. We have completed. We are actually very close to completing all the building activities and the people are moving into the new facilities, which would improve significantly the life of the employees on one hand, but also the conditions and also we expect some improvement in effectiveness and reduction of cost. So this is the extraordinary CapEx that we see this quarter and maybe a little bit next quarter. Regarding the receivables, I go back to the cash flow discussion that I had earlier. This is fluctuating periodically. It very much depends on the specific contracts that we have. It could fluctuate from 100 to 120, 130. It very much depends, but we have a strong balance sheet. And yes, you are right. We are using our strong balance sheet in working with our customers to help them in some financial requirements that they have in their budgeting cycle for contracts with us.

Okay. So the DSOs coming up to 130 is not necessarily something wide across the market that you can identify as fundamental and need from most of your clients for more credit or competition getting tougher or anything like that?

No.

Okay. Good. Thank you.

There are no further questions at this time. Before I ask Mr. Machlis to go ahead with his closing statements, I would like to remind the participants that a replay of this call will be available two hours after the conference ends. In the U.S., please call 1-888-295-2634. In Israel, please call 03-925-5900 and internationally, please call 972-3-925-5900. A replay of the call will also be available on the company's website, www.elbitsystems.com. Mr. Machlis, would you like to make your concluding statement?

I would like to thank all of our employees for their continued hard work. 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.

Thank you. This concludes Elbit Systems Ltd. second quarter 2016 results conference call. Thank you for your participation. You may go ahead and disconnect.