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Edited Transcript of HO.PA earnings conference call or presentation 26-Feb-20 7:30am GMT

Full Year 2019 Thales SA Earnings Call

Paris Mar 9, 2020 (Thomson StreetEvents) -- Edited Transcript of Thales SA earnings conference call or presentation Wednesday, February 26, 2020 at 7:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Bertrand Delcaire

Thales S.A. - Head of IR & VP

* Pascal Bouchiat

Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems

* Patrice Caine

Thales S.A. - Chairman & CEO

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Conference Call Participants

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* Andrew Edward Humphrey

Morgan Stanley, Research Division - VP

* Celine Fornaro

UBS Investment Bank, Research Division - Head of EMEA Industrials Research

* Harry William Freeman Breach

MainFirst Bank AG, Research Division - Research Analyst

* Malini Chauhan

Redburn (Europe) Limited, Research Division - Analyst

* Olivier Brochet

Crédit Suisse AG, Research Division - Research Analyst

* Tristan Sanson

Exane BNP Paribas, Research Division - Head of Aerospace & Defence and Equities Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and thank you for standing by. Welcome to today's Thales 2019 Annual Results Conference call. (Operator Instructions) I must advise you, this conference is being recorded today.

I would like now to hand the conference over to Mr. Bertrand Delcaire, VP, Head of Investor Relations. Please go ahead, sir.

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Bertrand Delcaire, Thales S.A. - Head of IR & VP [2]

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Yes, hello. Good morning. Welcome, and thank you for joining us for the presentation of Thales 2019 full year results. I'm Bertrand Delcaire, the Head of Investor Relations here at Thales. And with me today are Patrice Caine, Chairman and CEO; and Pascal Bouchiat, CFO of Thales.

As usual, the presentation will be in English and followed by a Q&A session. It is webcast live on our website at thalesgroup.com where the slides, press release and consolidated financial statements are also available for download. A replay of the call will be available in a few hours.

With that, I would like to turn over the call to Patrice Caine.

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Patrice Caine, Thales S.A. - Chairman & CEO [3]

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Good morning, everyone. So let's start with Slide #2 on the highlights of 2019. Starting first with the commercial perspective where last year, we achieved a strong performance in terms of order intake, more than EUR 1 billion above our guidance, thanks to a record Q4, which included great successes in commercial satellites and in the naval domain.

Secondly, organic sales growth is in line with the revised target of around 1%. As previously stressed, this sales level reflects the impact of the slowdown of Space and a high basis of comparison in Transport after several years of exceptional growth. Even with the lower-than-expected sales growth, EBIT is slightly above our initial target, demonstrating the resilience of our business model.

Final point of satisfaction from a financial point of view, the group delivered a strong cash flow performance. Last but not least, we have been consolidating Gemalto since the 1st of April. And the integration has been completed, fully in line with the plan.

Let's move now to Slide #3. So as usual, our key figures in a few charts. At EUR 19.1 billion, order intake is up 4% on an organic basis and up 19% after the consolidation of Gemalto. This is significantly above our target for the year, which we had set at EUR 19 billion. Book-to-bill is clearly above 1, 1.04 to be exact.

Sales benefited as well from the integration of Gemalto. They grew by more than 16%, reaching EUR 18.4 billion. EBIT is slightly above the EUR 2 billion mark, EUR 2.008 billion to be exact. At 10.9%, EBIT margin is once again progressing in part because we are consolidating Gemalto on its 9 most profitable months.

At EUR 1,405 million, adjusted net income is strongly up as well by 19%. Free operating cash flow amounts to EUR 1,372 million. This strong performance includes the negative one-offs that we had previously flagged, but also some positive one-offs. And Pascal will, of course, explain them in more detail in a few minutes.

Last chart on this slide, the dividend. The full year of strong financial performance has led our Board to decide to increase the payout ratio to 40%, leading us to propose a 27% increase in the dividend to the next AGM at EUR 2.65 per share.

So after this rapid introduction, I now hand over to Pascal who will comment our financial results in greater details.

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [4]

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Thank you, Patrice, and good morning to everyone. So I'm now on Slide 4. So starting with our order intake dynamics, as Patrice mentioned, which is a very solid order intake in 2019, EUR 19.1 billion, 19% above 2018 and 4% up organically. The plus 19% is obviously resulting from the consolidation of Gemalto with an addition of EUR 2.4 billion of orders recorded in 2019. With 21 orders and EUR 4.5 billion, we maintained a strong performance in terms of orders of over EUR 100 million. As you remember, our 2018 order intake included the jumbo order, OneSKY in Australia for EUR 855 million.

Q4 was a very strong quarter with 12 large orders, including 3 commercial telco satellites: Eutelsat 10B, NileSat-301 and Amazonas Nexus; 2 large orders in Transport, in Chile and in London; 6 large orders in Defence & Security, including several major programs such as the mission system and the U.K. Type 31 frigates or the strategic airborne intelligence program of the French armed forces, a project called Archange.

Orders with a unit value of less than EUR 100 million were up 28% compared to 2018, plus 8% at constant scope, in particular, with a sharp increase in orders with a unit value of between EUR 10 million and EUR 100 million, plus 18% at constant scope.

The dynamics were strong in both emerging and mature markets, with an organic increase of 19% from emerging markets and 9% from Europe. This drove a book-to-bill of 1.04 and even 1.05 if we exclude DIS businesses, whose book-to-bill is structurally equal to 1. So overall, a very strong performance in 2019 in regard to order intake.

Moving on to Slide 5, now looking at sales. Here as well, the reported growth of 16% is, of course, driven by the consolidation of Gemalto. The currency effects remained slightly positive for a little under 1% of sales over the period, a EUR 118 million positive impact, mostly due to the stronger U.S. dollar.

Excluding scope and currency, organic growth was just below 1% for 2019 and quite contrasted from a geographic perspective. Mature markets confirmed their growth profile with an organic growth of 4.7% while emerging markets were down by 7.7% versus 2018. As you can see on the chart on the right, this negative growth in emerging markets comes after a long and uninterrupted period of outperformance.

Moving on now to Slide 6, looking at the adjusted P&L from sales to EBIT. Here, we have the usual presentation of our adjusted P&L, which is a bit difficult to analyze considering the significant scope effect. As mentioned already, EBIT is up 19% year-on-year and 4% organically. And the EBIT margin continues its progressions, increasing by another 30 basis points, from 10.6% in 2018 to 10.9% in 2019.

Let me point out that this level benefits from the consolidation of Gemalto over its 3 best quarters of the year. If we had consolidated Gemalto since January 1, 2018, EBIT margin would have been 10.6% in 2019 compared to 10% in 2018.

We'll have a look at the driver of this performance in a minute, but looking at the key items of the P&L, let me point out that, first, gross margin increased by 170 basis points from 25.8% to 27.5%. Organically, it was up 70 basis points, demonstrating that our efforts to improve this crucial KPI keep delivering.

Indirect costs were up by 1.5%, growing only slightly faster than sales. As planned, we continued to ramp up R&D expenses, up 3.2%, while controlling marketing and sales. We also kept working hard to reduce G&A, down by 2.7%, while absorbing salary inflation.

Third, restructuring costs were a bit lower than expected, EUR 106 million, despite the significant adjustments implemented within Space and Transport and the addition of Gemalto. So overall, good control of the restructuring costs. Finally, Naval Group delivered a slightly better contribution to our EBIT, EUR 65 million in 2019.

Slide 7, now looking at the usual -- into greater details of the drivers of the change in our EBIT between 2018 and 2019. Starting with 2018, our EBIT amounted to EUR 1,685 million. The mechanical impact, scope, currency and pensions were, of course, very material this year following the consolidation of Gemalto. The small positive currency impact was offset by a negative pension impact, which will, by the way, continue to weigh in 2020.

At EUR 156 million, our organic operational performance remained strong, demonstrating that our Ambition 10 initiatives, growth, value-based pricing, procurement, product policy, support functions competitiveness, project executions, all of that continuing to deliver. In parallel, we invested part of this operational improvement into R&D, organically up EUR 29 million, as you can see on the right side of the chart.

Slide 8, now looking at our Aerospace segment in more details. Starting with orders. At EUR 4.8 billion, the order intake was down by 11% organically compared to 2018. This change reflects the drop in order intake in Space and in-flight entertainment. As I already mentioned, Space and had strong Q4 performance, winning 3 out of the 4 tenders we mentioned in October.

At EUR 5.6 billion, sales were up 4.2% organically. This trend is due to the 13% decline in Space sales, in line with our revised guidance, while our Avionics business kept growing. EBIT amounted to EUR 521 million or 9.3% of sales. The 0.7 point margin decline reflects the decline in Space sales, the increase in restructuring charges, combined with the step-up in the R&D investments.

Now moving on to Slide 9 with Transport. Market dynamics in this segment remain solid. The small decline in order intake simply reflects the phasing of large contract awards. Sales were organically down by 5.8%, but it is important to remember that this segment is facing exceptional comps. Over the 2015-2018 period, it grew organically by more than 45%, including plus 18% in 2018 when it reached peak workload on 4 major urban rail signaling contracts. Excluding these 4 contracts, 2019 sales were actually organically up by 5%.

Profitability was down with EBIT at EUR 56 million. As explained previously, the underlying margin improvement is masked by the recognition in the first half of 2019 of 2 one-off charges totaling around EUR 60 million: the restructuring charge related to our engineering transformation plan in Germany and cost overruns in the executions on the very specific urban rail signaling project. Corrected for these one-offs, margin was around 6%, continuing to increase in line with the midterm target.

Now moving on to Slide 10, Defence & Security. Order intake amounted to EUR 9.9 billion, up 17%, benefiting again from robust orders in many areas. The book-to-bill was strong at 1.2, and the order book for this segment reached a new record of EUR 21.8 billion. Interestingly, many of these orders were multiyear and will underpin long-term growth.

Sales amounted to EUR 8.3 billion, up 6.4% organically, slightly above our midterm target. Many business units contributed to this momentum: air traffic control, optronics, systems for fighter aircraft, system and services for ships, military radio communications, cybersecurity and many other examples.

As expected, EBIT margin reached a record 14%. This exceptional level was driven by several positive factors: strong revenue growth, our competitiveness initiatives, good project executions, very low restructuring costs, but also the one-off provision release of around EUR 40 million booked in May 2019.

Last segments on Slide 11 with DIS, Digital Identity & Security. Let me first stress that overall, integration is progressing fully in line with our expectations. At EUR 2.6 billion, order intake is aligned with sales as the majority of business units in the segment operates on short cycles.

Sales were in line with the full year target we had set in June, a margin growth between 0% and 2%. This low growth reflects different moving parts: quite strong performances in EMV payment cards driven by the reissue cycle in the U.S., the impact of the reorganizations of the adjacent businesses and the continued decline in sales of traditional SIM cards, very much in line with expectations.

At EUR 264 million, EBIT was slightly above the upper range of the target set in June 2019, EUR 240 million to EUR 260 million. This reflects lower than integrated (sic) [expected] integration costs, partially offset by the negative impacts of the re-org of the HSM business.

Turning now to Slide 12, a few comments on items below the EBIT. The cost of net financial debt and the other financial results was up by EUR 40 million. This is mostly due to the impact of the new IFRS 16 standard, which represented EUR 27 million; and also because in 2018, we benefited from a EUR 9 million positive one-off. It means that the additional interest cost linked to the funding of the Gemalto acquisition is overall not material.

Finance costs on pensions was stable, and so was our effective tax rate, just slightly down at 26.3%. Minority interests were down compared to last year on the back of the lower profitability in Space, leading to an adjusted net income group share of EUR 1.4 billion and an adjusted EPS of EUR 6.61, boosted by 19%.

Moving on now to Slide #13, let's have a look at the conversions of EBIT into free operating cash flow. The usual written items were up versus 2018. Financial interest increasing from EUR 2 million to EUR 37 million in 2019, mostly because of IFRS 16. Income tax paid, EUR 154 million in 2019 versus EUR 91 million in 2018. Equity affiliates, which correspond to the gap between our share in the net income and the actual dividends we receive from them, represented a negative EUR 60 million.

We remain very selective with CapEx projects, resulting in a global balance between CapEx and D&A. Once again, the swing factor was a change in working capital requirements, which represented a EUR 341 million headwind in 2019. It included positive and negative one-offs that I'm going to describe in a minute. Other cash items, not including the EBIT, such as ForEx, items related to Gemalto acquisition and IFRS 16 lease depreciations, amounted to a negative EUR 39 million.

Now on Slide 14, with 2 charts to help you qualify -- quantify this strong free cash flow performance. On the left side, you see our reported cash conversions at 107% on average over the 2014-2018 period, which [connected] from a favorable down payment sequence. You also see the 98% cash conversions in 2019 that I've just showed you.

On the right side, you see the same comparison based on amounts before one-offs, exactly as I presented as -- exactly as I presented them back in October during our last Capital Market Day. The 2019 underlying cash conversions is at 105%, significantly above the guidance of 95% on average over 2019-2023.

The cash action plan we put in place in 2019 has clearly allowed us to over-deliver on cash flow performance. Adjusting for the IFRS 16 impact on both adjusted net income and free cash flow, this underlying cash conversion comes to 91%, which is above the 2014-2018 average as well.

To help you track these one-off effects, we have added a slide in the appendix on the subject. In short, these one-off effects are smaller than expected, thanks to a positive EUR 300 million related to cut-off effects advanced payments, which will obviously reverse going forward.

Let me finish on this topic by stressing that the unwinding of exceptional down payments will continue in 2020. There are roughly EUR 400 million left of exceptional down payments on the balance sheet at the end of 2019, and a significant portion of them should unwind this year. So in a nutshell, a solid 2019 cash conversion, ahead of our 2019-2023 guidance and some material reversal of down payments are to be expected in 2020.

Moving on to Slide 15 with a quick look at the evolution of our cash position. As expected, 2 major items take our net cash position from EUR 3.2 billion at the end of 2018 down to a net debt of EUR 3.3 billion at the end of 2019: the acquisition of Gemalto and also the application of the IFRS 16 standard. Excluding the impact of IFRS 16, our net debt at the end of 2019 would be EUR 1.6 billion to be compared to a EUR 2.5 billion of EBITDA.

Interestingly, IFRS 16 adds some volatility to the net debt position, depending on the volume of leases that are renewed or extended. And in 2019, as we renewed and expanded some important leases, the new lease debt amounted to EUR 299 million, clearly above the [cost-cutting] position and impact on free cash flow.

And to finish, a word on the dividend on Slide 16. This year, the Board has decided to increase the payout ratio from 38% to 40%, which, combined with the significant EPS accretions, also driven by the Gemalto acquisition, pushes the dividend up by 27%. This adds one material step-up to the attractive growth trends you see on the chart. Adjusted EPS has been up 14% per year since 2015. And in parallel, dividend has grown faster, 18% per year.

So that's the end of this financial review. I'm now turning over the call to Patrice who will address our current strategy and guidance.

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Patrice Caine, Thales S.A. - Chairman & CEO [5]

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Thank you, Pascal. So now I'm on Slide 18, turning to our strategy and outlook. This slide, which I've shown before, is just here to remind you that our road map for the coming years remained structured around 5 key strategic priorities that we defined and explained back at the CMD in June 2018. Each of them represents a key contributor to the delivery of sustained and profitable growth.

So this morning, I thought it would be interesting, important to focus on this year's strategic priorities, and I'm on Slide 19. As you see, I've listed 3 key focus areas: first, growth; second, operational performance; and third, Space.

So let's start with growth, and moving to Slide 20. I've already mentioned how 2019 and, in particular, Q4 was quite strong from a commercial point of view. This was, in the end, clear for commercial Space where we won 3 of the 4 tenders we had mentioned back in October, Eutelsat 10B, NileSat and Amazonas Nexus.

Our performance on the defense side was also very robust, with major wins in both Europe and emerging markets. This was, in particular, the case in the naval domain with major projects, one in the U.K., such as Type 31; in Spain, with the sonar suite on the F110 frigates. Emerging market orders were up 19% after a slow 2018 with strong growth in every region.

Last but not least, France had another year of very good performance with a book-to-bill of 1.2, benefiting from the multiyear growth in the French defense budget. On top of these solid dynamics, we started to see the first revenue synergies with DIS with already more than 20 synergy projects won.

Turning to 2020, we will be able to capitalize on 3 drivers. First, while we always need to stay cautious on the timing of orders, of course, we see a robust pipeline of opportunities, including, in particular, the German MKS 180 frigates for which we have been selected, together with Damen and Blohm + Voss, and now await German parliamentary approval.

Second, we are accelerating our sales transformation project. In practice, we have decided to combine our European and international development organizations, which, on top of savings in terms of cost structure, will allow the teams to better focus on growth areas. In terms of sales organization, we are progressively moving to a strategic account management, SAM model, which supports a closer and more focused management of key strategic accounts. Also in line with our ambition in services, the teams will put an extra focus on targeting servicing opportunities on our installed base, which is sometimes very large.

And third, we will benefit from the further ramp-up of revenue synergies with DIS, which strongly enriches our digital positioning. So altogether, the solid order intake dynamics we have seen in 2019 and its expected continuation in 2020 pave the way to sales growth acceleration from 2021, in line with our medium-term guidance.

I'm now on Slide 21 with our second priority, operational performance. The development of a performance culture is at the heart of our strategic plan, Ambition 10. The chart on the left is a good illustration of what we have achieved on this topic in the past few years. It shows the improvement since 2015 in terms of both gross margin and G&A expenses as a percentage of sales. Since Gemalto comes with a higher gross margin than the rest of the group, the 2019 figures do not include it. Evidently, gross margin aggregates many drivers on top of operational performance, such as value pricing and increased project selectiveness. Still, these improvements, which totaled 2.9 points over 4 years, clearly show the material impact these operational performance initiatives has had on profitability.

Going forward, the teams continuously add new actions into the portfolio of initiatives. For example, looking at procurement performance, 2019 was the first full year of implementation of our new global procurement organization, which was launched in April 2018. This organization delivered clearly a step change in terms of procurement massification, with over 30% of the spend now concentrated on strategic suppliers compared to 5 or 10 before. Over 2018 and 2019, it carried more than 60 so-called product conventions in which cross-functional teams rigorously optimize the value of a given product.

Turning to engineering competitiveness. We are ramping up our engineering competency centers in Romania and India, targeting almost 2,000 engineers in these 2 centers by 2021 compared to less than 500 in 2018. And to accelerate the deployment of digital engineering best practices across the group, we have decided to put in place a single leadership for both the group engineering function and our so-called Digital Factories. Support function efficiency continues to benefit from additional platforming and the expansion of shared support services, such as in accounting. And finally, as mentioned by Pascal at the CMD in October last year, we have launched a group-wide CA$H! initiative as we felt that this key value creation driver was not getting sufficient attention from the operational teams.

Moving now to the final 2020 key priority, Space. Let me start with the commercial telecom side. In previous presentations, we have stressed how in 2017 and 2018, this market has faced a deep down cycle in terms of products, with a progressive recovery in 2019. This appears on the upper right chart and has been a key driver behind the decline in Space sales we experienced in 2019. Considering the solid, long-term growth prospects in this market, we decided to accelerate R&D investments while implementing the necessary adjustments to our cost base with, for example, headcount, including contractors, down around 11% over 2 years.

These R&D investments have led us to win significant market share in 2019. We had a 30% market share in terms of units and probably closer to 40% in value. As previously announced, we will further grow our R&D investments in 2020 to reinforce our product range with a new generation of fully flexible satellites called Space Inspire, which will strengthen our positioning in order to capture future market growth.

Moving to the institutional and military markets, which generates more than 2/3 of our Space sales. They continue to offer many domestic and export opportunities. In particular, last November, the European Space Agency Ministerial Council committed to its biggest-ever budget. 2019-2021 total subscriptions by member states are equivalent to a 6% per year growth in the European Space Agency budget, which will drive many opportunities for us.

Now moving on the outlook for 2020, and I'm on Slide 23. You can find on this slide some perspectives on each of our segments. In particular, we expect that both Space and Transport sales will continue to face negative growth in 2020 on the back of the progressive recovery in commercial Space and the ramping down of the 4 large urban rail contracts.

Let me stress here that while my view on the group's business environment remains clearly positive in the medium term, considering the unchanged, solid underlying trends in our markets, the global environment at the start of the year displayed several uncertainties. For example, the direct impact of the coronavirus outbreak on our market is currently low, but it is starting to cause difficulties to parts of our supply chain, especially for the DIS business.

So all this brings me to our financial objectives for 2020, considering the business environment that I just described very shortly, and I'm now on Slide 24. With respect to order intake, we expect another year of strong commercial performance, driving a book-to-bill ratio above 1. Based on February 2020 scope and foreign exchange rates, we expect sales to amount to between EUR 19 billion and EUR 19.5 billion. And thanks to the initiatives I presented earlier, we expect a further improvement in EBIT margin reaching between 10.8% and 11%. At constant scope, this corresponds to a 20 to 40 basis point margin expansion.

So this concludes our presentation. Many thanks for your attention. And together with Pascal, we are now pleased to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And the first question comes from the line of Olivier Brochet from Crédit Suisse.

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Olivier Brochet, Crédit Suisse AG, Research Division - Research Analyst [2]

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I would have first 3 quick ones, please. The first one is on the free cash flow for 2020, 2021, if you could give us a bit of more flesh around the moving parts and where we should be landing if there is anything you can share there?

Second one, on the R&D and restructuring levels that you have included in the 2020 guidance if you could also share some color.

And third, on the payout at 40%, is that the level that we should be using going forward that you would be advising the Board to serve to investors in the future?

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [3]

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Okay. Olivier, so first question about free cash, I mean there, the business (inaudible) time, I mean, to guiding under certain investments. Going back in 2019, our level of free cash was above target, above guidance. I mean, certainly, happy to report to you that, overall, our cash action plans delivered even better than expected. First point.

Second point. It's also true that the strong order intake in Q4 was a clear help in terms of free cash flow generation with also, as we mentioned, EUR 300 million, a positive impact of, I would say, the cut-off advanced payments from some customers.

And the last point, also, and as expected, back in 2019, as expected and in a progressive reversal of down payment that we cashed in a few years ago when we...

(technical difficulty)

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Operator [4]

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Yes, you can be heard.

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [5]

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No. I mean 2019, in terms of free cash flow and transitioning to a guidance for 2020. So first point and starting from, I would say, expected net income, which, if I follow the consensus, should be between EUR 1,450 million and EUR 1,500 million. So if we apply our typical conversion ratio, which is 95%...

(technical difficulty)

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Bertrand Delcaire, Thales S.A. - Head of IR & VP [6]

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So are we back on line here?

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Operator [7]

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I can hear you now.

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Bertrand Delcaire, Thales S.A. - Head of IR & VP [8]

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Okay. So I think it's back online. Sorry for the technical problems. I hope [next service]. And I guess, Pascal if you don't mind coming back and resuming your explanation on free cash flow, which is an important question.

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [9]

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Okay. I think everybody -- it was not made on purpose. So starting with the Q&A session and one bit of complex topic, which is cash flow. With this technical problem, it's probably not...

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Bertrand Delcaire, Thales S.A. - Head of IR & VP [10]

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As you were saying?

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [11]

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So hopefully, I mean, my explanation of the 2019 free cash flow was clear. So I was trying to move to the explanation on 2020 and starting from our net income, which, if I follow the today consensus, expected net income for 2020 is slightly below EUR 1,500 million. So if we apply 95% conversion ratio, it should be around EUR 1,400 million of underlying free cash flow generation.

Now what is important to consider is that we still have today on our balance sheet EUR 400 million of down payments related to a large export project that we signed a few years ago. And that should get, for the most part of it, get unwinded in 2020. So a significant part of those EUR 400 million should get unwinded in 2020.

Now last point, which creates a bit more uncertainty, is the reversal of the, what I mentioned, the EUR 300 million advanced payment cut-off effects. And this is where -- this is, of course, more uncertainty because, yes, there will be a reversal, but we might also have a positive also advanced payments end of 2020. So here, a bit of uncertainty. So overall, a level of free cash flow, if I put aside the reversal of the EUR 300 million, should be EUR 1 billion. It's probably a good guidance for all of you.

R&D and restructuring. So with regard to R&D, overall, I mean our intent is as planned, and our midterm target is to keep growing our R&D as a proportion of our revenues. It was the case in 2019 and will continue to be in 2020, driving us progressively to a level of [handling] as a proportion of sales. In the midterm, that should be around 6.3%. Restructuring, probably a good rule of thumb is to consider a level of restructuring that should be around EUR 100 million plus for 2020.

Payout ratio, Patrice?

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Patrice Caine, Thales S.A. - Chairman & CEO [12]

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Well, one word on the payout ratio. Clearly, when we tackle this topic at the Board level, looking at the, first, all year, I would say, a vast operational performance improvement. And looking ahead, the discussion was extremely smooth and easy to come to the conclusion to augment the payout ratio. It's also a clear sign of confidence from our Board about the future profit and cash [inertia] of the group, of course. So 40% now. For me, but I don't want to preempt future decision of the Board, of course, as you all know, but for me, it should constitute a new floor in terms of payout ratio looking forward.

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Operator [13]

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The next question comes from the line of Tristan Sanson.

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Tristan Sanson, Exane BNP Paribas, Research Division - Head of Aerospace & Defence and Equities Research Analyst [14]

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First question is a quick one of detail on the DIS. The net integration cost, you said that you had lower cost than initially expected, that you had higher cost on the divestment of HSM and you're talking about EUR 30 million of impact. I'm not sure what this EUR 30 million is. So if you could say that, that will be helpful.

Second on -- a follow-up on Olivier's question on R&D. I'm not sure if I understood exactly when you want to read the 6.3% of sales on the R&D to sales ratio. If you could refine the type of EBIT headwind we should get for 2020. So that would be useful.

And maybe a third one would be on the Naval Group. Maybe if you can give a bit of color on the debate around the Australian submarine execution. We know about the few weeks of delays on the first milestone. We heard comments about the political debates and the dispute around those contracts. How do you monitor yourself this execution risk in your portfolio?

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [15]

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Okay. Tristan, if I understood well, your first question was about some detail on the EUR 30 million of restructuring -- integration costs associated with the Gemalto acquisition, right?

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Tristan Sanson, Exane BNP Paribas, Research Division - Head of Aerospace & Defence and Equities Research Analyst [16]

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Yes, basically.

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [17]

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So I mean behind that, it's both. I mean a few integration costs like, for instance, IT costs, I mean, this type of thing, but also and primarily, I mean, restructuring costs in order for us to deliver on our synergies and essentially, I mean, labor cost-related restructuring costs. Overall, I mean, this level of restructuring cost is below our initial view, and the reason behind that is quite simple. We managed to re-class Gemalto managers within Thales, whose job was suppressed because of the integration and our synergies delivering. What is -- what was positive was the fact that us, Thales, is recruiting a large amount of employees on a yearly basis. We took take advantage of open positions within Thales to re-class a number of good-quality Gemalto managers.

Second question was about...

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Tristan Sanson, Exane BNP Paribas, Research Division - Head of Aerospace & Defence and Equities Research Analyst [18]

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If I may, just on the first one, to be clear, I just wanted to know whether this figure also included the reorganization of the HSM business following the Gemalto acquisition.

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [19]

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Of course, I mean, sometimes -- I mean the cost associated with the merger of the ex-Gemalto and ex-Thales, in particular, cybersecurity, HSM data encryption business, I mean those costs were part of the EUR 30 million that I've just [mentioned].

Now I mean with regards our level of R&D as a proportion of revenue, so first, if you take our 2019 R&D to revenue ratio, it was 6%. Now this was based on just 9 months of Gemalto. If we are taking into account 2019 pro forma, including 12 months of Gemalto, our level of R&D in 2019 will have been 6.1%. And you know, like I mentioned, what I recall was that overall, our view in the midterm is to reach a level of R&D representing a 1 -- or slightly above 6.3%. This, in the midterm. Now it means that for 2020, we believe that overall, our R&D expenses should represent between 6.1% and 6.2% of our sales.

Naval Group, Patrice?

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Patrice Caine, Thales S.A. - Chairman & CEO [20]

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I can take this one. Look, Naval Group is in charge, not like -- first. So several facts to have in mind regarding this contract. First, this contract is a complex, long-term and multiple one. That's a fact. It's not new, by the way, so nothing new. Complex because it's -- there is a relationship between Naval Group and Lockheed Martin, on one hand. Long term, it will be -- it will last several decades. What I said -- when I said multiple, it's because, first, you have to fulfill, I would say, operational capabilities, but also to fulfill what is called AIC, Australian Industrial Content (sic) [Australian Industry Capability] and (inaudible). This is a starting point, and this is not new. This is known from the very beginning.

Secondly, and this is a fact as well, the contract has not come in one single big contract. In fact, so far, Naval Group has booked, I would say, several small contracts, very small contracts to start the early phase of development. And the contractual mechanism is quite protective for Naval Group because it's quite similar to a cost-plus contract.

Third point, the management of Naval Group reports, let's say, regularly or several times per year to the Audit Committee of Naval Group Board the projects on this contract. And recently, they have told us that what you have heard from Australia had nothing to do with, I would say, technical difficulties or delays because a few weeks of delays further our contract for several decades. It's clearly not material or negligible; but more, I would say, a political, I would say, dispute in Australia. And that's what we have been reported by Naval Group management.

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Operator [21]

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And the next question comes from the line of Andrew Humphrey from Morgan Stanley.

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Andrew Edward Humphrey, Morgan Stanley, Research Division - VP [22]

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Just a couple, if I may. Firstly, can I get you to distinguish a bit between the GBP 400 million that you talked about being prepayments that you're expecting to unwind in 2020 -- or most of which you're expecting to unwind in 2020 and the additional GBP 300 million of cut-off items where there seems to be a little bit less clarity and a little bit less certainty? Can you talk about why that's the case and maybe talk in a bit more detail about what those cut-off items are?

And my second question is on Space. You talk about developing a new generation of flexible product in satellites. Can you talk about when that might be available? What it is that's led you to undertake that development? Were there concerns on market share or just a view on how the market is going? And what sort of -- how that will sit compared to your current product range?

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [23]

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Okay. So on your first question, so on one side, we have the reversal of down payments relating to a large-sized defense export project that was awarded, but in particular, in 2015. And we already communicated quite extensively on this matter, explaining that those large-sized defense export projects were very well funded with large down payments, but which, of course, reverse as we execute those projects. So here, of course, we have quite a clear visibility in terms of the sequence of reversal of those down payments. And of in 2019, we have here a remaining balance of EUR 400 million. So -- and this, I mean, we have quite a clear visibility.

And on top of that, we have more on cut-off of advance payments from some clients, which, by the way, is quite a good news with our clients, in some cases, deciding to pay us a bit ahead of the expected due time. So all of that is positive. Of course, but this is also our responsibility. When I was explaining our overall cash program in order to optimize cash flow generation at Thales, of course, we ask also our sales force, our sales guys to discuss with clients and to convince them to pay us as soon as possible.

Now all of that is probably a bit more difficult to anticipate in terms of the sequence of reversal of those, I mean, advance payments. And this is where I need to be a bit cautious because as opposed to what I mentioned on the large-sized export program down payments, where we have a clear visibility in terms of development, on those advanced payment cut-off, it's always a bit more difficult.

This is, by the way, why we also communicate on our free operating cash flow before one-off, which is reported on Page 31 of the presentation pack. And while you will see that year-after-year, we see a steady growth of our generations of free operating cash flow. Now yes, I need to analyze that because of the nature of our business with also down payments, but also, I mean, some cut-offs and advanced payments, we have some kind of volatility in the reported cash flow generation.

Now on a long period of time, I guess that you will agree with me, on overall, a level of conversions ratio which is overall pretty strong. And in 2019, once we put aside those, I would say, nonrecurring items, creating volatility, the underlying conversions ratio of 2019 have been overall pretty good, 105%. And if we adjust for the positive impact of IFRS 16, that's what we reported, by the way, as opposed to many other companies. So we provide you full transparency of the impact of IFRS 16. Our 2019 underlying cash flow generation, excluding IFRS 16, was slightly above 90%. So overall, a pretty good level of performance.

Patrice, Space Inspire?

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Patrice Caine, Thales S.A. - Chairman & CEO [24]

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For Space Inspire, so if you remember well, we announced the launch of this new generation of satellite back in September last year. So it's not a scoop. I mean it was disclosed during, I think, Euroconsult forum in September 2019. This constitutes a real breakthrough. This is really a new breed of satellite because this new generation will be fully flexible. What does it mean by fully flexible? It means that satellite operators will be able to reconfigure the mission of the satellite in orbit, which is so far absolutely impossible, and switching, given Space Inspire satellite, from a broadcast mission to a pure telecom mission, for instance.

So this satellite to be fully designed and developed will take a few years, as usual, in this domain. But of course, the sales and marketing campaigns have started already, has started already, and we have had many positive feedbacks and signs of interest from many satellite operators. And 2020 could be, I say could be, not will be, but could be -- could see, sorry, a first order of this Space Inspire new breed of satellite.

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [25]

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Okay. Andrew, does it answer your questions?

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Andrew Edward Humphrey, Morgan Stanley, Research Division - VP [26]

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Yes. That's great.

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Operator [27]

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And the next questions come from the line of Harry Breach from MainFirst.

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Harry William Freeman Breach, MainFirst Bank AG, Research Division - Research Analyst [28]

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Shall I ask maybe 3 slightly different ones? Firstly, just thinking about Defence & Security, I think in the second half of last year, which was maybe a slightly more normal picture, the EBIT margins there, about 13.4%. Is that a sort of reasonable sustainable margin rate you think for the business going forward?

Secondly, just wondering in terms of tax rate in France. Can you give us any sense of whether you expect overall for Thales Group, how you expect your tax rate to change this year and maybe going forward?

And then finally, just maybe on the Transport side, just if you can give us your thoughts about scale in that business given the Alstom-Bombardier transport transaction?

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [29]

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Okay. Harry, so on Defence & Security. So you have earned your mark, and we got 13.4% of EBIT margin in H2 2019. I have to confess that I have not made this calculation on my own, but I do trust your own calculation. So it is -- I mean this level of margin, the type of long-term recurring margin that we expect from our Defence & Security business, I will come back to what we shared with you a few months ago at our Capital Market Day where, if my recollection is correct, I guess, that we guided you more to a level that should be between 10%, 12% and 13%.

Now do we expect a level of 12% to 13% in 2020? The answer is no. We expect EBIT margin for Defence & Security in 2020 to be above this range. Will we be at the level that you mentioned? I guess this is maybe a bit opportunistic. But -- yes, and once again, 2019, as I said many times, all planets were fully aligned in our Defence & Security business. So of course, when we provide guidance, we need to be a bit more cautious. So my view, I mean, for 2020 that we should be at the upper part of the 12% to 13% range. Will it be 13% plus, 13% minus? At this point, a bit too early, but there's nothing negative I can report to you on our overall Defence & Security business in 2020. However, and considering that 2019 was great in terms of executions, let's be a bit cautious when we guide you.

Tax rate, it's quite simple in France. In 2020, for the first time, we'll benefit from a first reduction in the overall tax rate in France. That should move from 34.4% down to 32% in 2020. With a trend that -- which has to be confirmed year-after-year by the French government, that should lead us to a level of tax rate in France that should be between -- that would be at 28% in a few years' time. Now when we put, I mean, this drop in the tax rate in France and considering where we pay tax at Thales, overall, Harry, a good guidance for you in terms of tax rate for Thales in 2020 is probably something between 25% and 26%. So slightly below what it was in 2019.

Transport, Patrice?

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Patrice Caine, Thales S.A. - Chairman & CEO [30]

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Well, on Transport, a couple of thoughts on the -- on your question on Bombardier and Alstom, the potential merger that -- what they have announced. As you know, we are a pure signaling player at Thales. And Bombardier is not, at least in terms of size, a first-tier player. Their signaling business is roughly around 700 million euro or dollars, I don't remember, euros, EUR 7 million -- EUR 700 million, sorry, EUR 700 million in terms of sales. So it's not a big business. And as a consequence, the combination between this signaling business and the one of Alstom clearly does not constitute a game-changer. Let's remember that Thales is now the second-largest player worldwide in this signaling business with a level of sales of around EUR 2 billion. So clearly, we have no concern in terms of size in this business.

And perhaps, the last element you should always keep in mind is the fact that this signaling business belongs to a group worth EUR 19 billion, which brings a lot of technologies coming from outside the signaling -- the pure signaling business of Thales. And let me give you 2 examples. Cybersecurity, we leverage clearly cybersecurity expertise. It's a business of now EUR 1 billion at Thales. We leverage all this business, all this competence to the benefit of our signaling business. Second example, IoT coming from DIS acquisition. Rail IoT is clearly a future revolution for rail operators or ground transport operators. And clearly, our GTS business leverage IoT competencies coming from DIS.

Third one, and I will stop there, AI, artificial intelligence. We leverage AI R&D centers of competence coming from the wider Thales to position our signaling business, clearly, as a leading player in terms of autonomous train or autonomous controls. So in a nutshell, clearly, it's not a game-changer. And we are not -- I would say, we have no concern as a pure signaling player on this merger.

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Operator [31]

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And the next question comes from Malini Chauhan from Redburn.

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Malini Chauhan, Redburn (Europe) Limited, Research Division - Analyst [32]

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A couple of questions for me. Firstly, on the Transport division, what gives you confidence in kind of achieving the medium-term margin ambition? Is there any more risk of cost overruns? Or have you really derisked the contract portfolio there?

Two, on your growth expectations for the Defence & Security division in 2020. What's that looking like given the really strong order intake you had in 2019 here? And then, Space, just another quick question here on the order pipeline, what's that looking like for 2020?

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [33]

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Okay. Malini, so on your first question about Transport, so as we mentioned, our 2019 financials were impacted by, first, I mean what was more investments, which was our competitiveness plan to move a significant amount of our engineering base from Germany to Romania with a one-off restructuring cost that I put aside; and second, as we mentioned, on the very specific project, I mean a safety incident that resulted into this program being put on hold; and some other costs of the ones associated with this very specific project.

When we go through, I mean, various projects in terms of quality of executions, overall, it's pretty positive, which means that we are progressively putting the [finest] executions of difficult projects. We also see, I mean, a level of margin on new order intakes that are in line with our midterm target in terms of EBIT margin.

So in a nutshell, I mean, progressive one down, as expected, of previous contracts in which we had in Japan, some difficulties and that we are still running with a negative net margin. And second, so on those projects, overall level of execution that is in line with this 3 baselining. And second, overall, order intake is the level of margin and project execution, which is in line with what we expect in tough margins for the midterm.

Defence & Security, I have to say I have not fully understood your question. What was the growth -- what was our growth?

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Malini Chauhan, Redburn (Europe) Limited, Research Division - Analyst [34]

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Yes, what's your organic growth expectations, roughly, in 2020 because of the -- you had very strong order intake performance for that division this year?

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [35]

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Okay. So yes, I mean, a strong level of order intake, a book-to-bill which is significantly above 1. Also, and it is important, we signed in 2019 a few large-sized projects, with executions, will be on a long period of time. And in particular, we signed large-sized [aircraft] or maintenance projects that provide us quite a long-term visibility, but not resulting in the short-term goals.

So when we put all of that together, so you probably have in mind our midterm guidance for this business that we shared with you at our Capital Market Day, we said that it should be between 4% and 6% on average until 2023. We are clearly above this level in 2019 and with a level of organic growth that is in excess of 6%. So 2020 will be lower. It's a matter of fact.

Will it be, I mean, low- to mid-single-digit growth? I mean it's probably a good [question]. So we see that overall, I mean the momentum is there, a lot of demand from our customers, we're probably the only caveat in emerging countries. And in time, I mean, to [2020] to get contracts being awarded. And that's something that we shared with you in 2019. It's true that in emerging markets, we have seen a clear increase in order intake in 2019 and impacted in Q4. But still, we see, I mean, some of our customers taking time to strengthen -- I mean to make final decisions in terms of awarding contracts.

Space visibility in terms of order intake, so Patrice, overall, you can comment.

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Patrice Caine, Thales S.A. - Chairman & CEO [36]

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If you wish, Pascal. As I said during the course of my presentation, yes, definitely, looking at the institutional market, there is a, let's say, robust pipeline of opportunities. I should say -- or I could say the same looking at the commercial sector. Now you have always to stay a bit cautious because the pipe is one thing. The fact that -- and typically, in the civil business, separate operators take the decision, at the end of the day, to invest. It's another thing. So that's why we say on the mid to long term, we are staying positive on this business because the level of opportunities and the potential of this market is important, is significant. Now the timing, will it be in 2020 or a bit later? It's always difficult to predict. So yes on the pipe. Now you should be cautious in terms of decision in 2020 because it's 2 different things.

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Operator [37]

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And the next question comes from the line of Celine Fornaro from UBS.

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Celine Fornaro, UBS Investment Bank, Research Division - Head of EMEA Industrials Research [38]

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I have 2, please. The first one would be on the Transport division where the execution seems to finally come through in H2. And if I remember well, last year, you said that you were slowing down a little bit, the growth voluntarily, if I can say that way, just to get on with the restructuring. So how comfortable do you feel now? And what are you thinking in terms of the order intake for 2020? Can you be slightly more, I would say, adventurous on that one?

And my second question would be regarding the Asian exposure of the group. If you could just maybe run us through, given the coronavirus situation, from aviation to Gemalto exposure, which in Asia is probably 20% of the old portfolio, and also on the Transport division. And what are your thoughts there?

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [39]

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Celine, so on Transport, we remain quite vigilant in terms of order intake, which means that the new one -- it is not because we have improved quite significantly the quality of project execution that we are going to expose ourselves in countries where we believe that the level of risk is not acceptable. So we remain cautious. Now of course, I mean we analyze all the markets. We do our own analysis. We assess the level of risk, the level of competition, which is project by project, country by countries before making a meaningful decision.

So I'm not saying that we get a cost in this business. What I'm meaning is that we're quite vigilant because we don't want to get trapped in the difficulties that we had in the past. Part of those difficulties and we have been clear about that, was also, I mean, some deficiencies at Thales in international aviation, but part of the difficulties were also relating to a lack of maturity of some customers, some countries, with also some difficulties to get protected from a contractual standpoint. So overall, keep focus on profitability while I mean, of course, trying to develop this business, but very much monitoring the overall level of risk project by project.

Asia. So overall, I mean Asia, to a large extent, represents for Thales overall, 14% of Thales sales, but this is, I mean, the global Asia. Now when we did China, China is a small country for Thales in terms of countries by destinations. China represents only 2% of Thales revenue. So overall, it is not, I would say, the issue with regards the coronavirus. Where we are vigilant is more, let's say, the side effects. And probably there are 2 items that we are tracking. One is side effects, in particular, the overall aeronautics business, in particular, in terms of, of course, the impact of the drop in traffic on the aftermarket business. But with regard with the impact, it's quite obvious on our organic aero business.

Also, probably, we could consider that some airlines might decide to postpone investments, for instance, in terms of IoT connectivity business, considering, I mean, what they need to go through in terms of difficulties on their own business. And second side effect, and this is what Patrice started to mention about DIS business, some difficulties in the supply chain, in particular when it comes to providing some electronics modules or parts where we see today some, but at this point in time, quite limited disruptions in our supply chain.

So all of that to tell you that overall, probably in Thales as a group, it's probably one of the least exposed company to, I mean, the coronavirus difficulties and, in particular, because of our strong presence in defense. Having said that, what we're sharing with you today is, I mean, yes, our view of a limited impact of this crisis, but of course, all of that being based on the current situation.

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Celine Fornaro, UBS Investment Bank, Research Division - Head of EMEA Industrials Research [40]

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And sorry, if I may, but just want to follow up on the first question. So the book-to-bill for the year or the order intake for the year on Transport, you would still expect some decline there?

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [41]

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I don't want to be that specific, Celine. So we'll see. No, it's not, I mean, what I'm trying to [plug] into. No, I mean, I don't want to be more specific, but I'm not telling you that today, we believe that the book-to-bill for Transport will be below 1. So we'll see.

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Operator [42]

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And the next question comes from the line of [Milan Kerner].

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Unidentified Analyst, [43]

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I just have one, please. I wanted -- I mean could you tell us what's the impact of the lower wide-body production for your avionic and the in-flight entertainment business, medium term, please?

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [44]

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The impact of the rate -- lower rate...

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Patrice Caine, Thales S.A. - Chairman & CEO [45]

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Wide-body, Airbus wide-body.

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Unidentified Analyst, [46]

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Airbus and the 787, please, for the in-flight entertainment?

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [47]

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So overall, I mean, our IFE business is not directly connected to this production outlook of the narrow-body of the A350. No, I mean, I don't see a direct impact. Where we have seen in 2019 an impact and then which we have been a bit vigilant is, as you know, in some difficulties at Airbus to ramp up the production of the A321 expanding the long range of extending reach. So this is where we might have a bit of an impact. But I mean, the impact of the overall IFE business is, for me, not measurable. What I'm saying, where we are probably a bit more vigilant is to which extent the coronavirus could affect decision from airlines to invest in IFE, in the new generation of IFE in 2020, which is where we will need probably to be a bit more vigilant.

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Unidentified Analyst, [48]

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Okay. So I mean limited impact from A380, A330 and A350 production coming down on the commercial avionic in 2020 then?

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [49]

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So overall, no. Bertrand, you want...

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Bertrand Delcaire, Thales S.A. - Head of IR & VP [50]

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No, yes, well, I mean, of course, mechanically, if the wide-body production is revised down by Airbus, I mean it should take $1 million per ship set, I mean, let's say, an average value if you cut your forecast for production by $20 million, but I mean that's not very material.

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Operator [51]

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We have no further questions at this time. Please go ahead.

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Patrice Caine, Thales S.A. - Chairman & CEO [52]

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Okay. Okay. There are no further questions. So let me conclude then this quarter by stressing again that we remain focused, of course, on the implementation of our Ambition 10 strategic plan, which will continue to deliver profitable growth for the years to come. So we all look forward, Pascal and myself, to seeing you in our upcoming roadshows in Paris, London and in the U.S. Have a good day. Bye-bye.

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Pascal Bouchiat, Thales S.A. - CFO and Senior Executive VP of Finance & Information Systems [53]

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Thank you very much. See you. Bye-bye.

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Bertrand Delcaire, Thales S.A. - Head of IR & VP [54]

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Bye-bye.

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Operator [55]

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Thank you. Ladies and gentlemen, if you didn't have to ask a question on today's call, please do not hesitate to send your question to Thales Group Investor Relations at ir@thales.com, and we will get back to you as soon as possible. Thank you all for your participation. You may now disconnect.