Thales SA

PAR:HO

Earnings Call Transcript 2018-Q1

[Operator]

Ladies and gentlemen, welcome to the Thales Order Intake and Sales on the 3rd of May 2018 Conference Call.I now hand over to Mr. Pascal Bouchiat, Chief Financial Officer. Sir, please go ahead.

[Bertrand Delcaire, Head of Investor Relations and Vice President]

Actually, yes. Good morning. Welcome and thank you for joining us for the presentation of Thales Q1 2018 order intake and sales. I'm Bertrand Delcaire, the Head of Investor Relations at Thales. With me today is Pascal Bouchiat, our CFO.As usual, the presentation will be in English and followed by a Q&A session. It is audio webcast live on our website at thalesgroup.com, where the slides and press release are also available for download. A replay of the call will be available as from tomorrow morning.And with that, I'd like to turn over the call to Pascal.

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Thank you, Bertrand. Hello and good morning, everyone. So before moving on to the number as usual, I wanted to highlight a few recent events.First, I wanted to mention 2 interesting orders that we booked in Q1. In February, we've been awarded the so-called OneSky contract by Australia. It's a pretty unique contract considering the amount of airspace covered, 11% of the world, and the tasks at hand. We will not only modernize the old infrastructure, but also integrate both civil and military air traffic management. Its value of AUD 1.2 billion, i.e., around EUR 800 million, makes it a jumbo contract according to our definition. And of course it's a testimony of our global leadership in this field.The second contract I wanted to highlight, even if it's slightly under EUR 100 million, is the one we received from Norway to deploy country-wide what is called a traffic management system, which is a software at the heart of a rail network. And this project will add digital features, including cyber security to the software solution that were already deployed in 17 countries, including Germany and the U.K.A few day after the end of the quarter, we signed another quite unique contract coming from Eutelsat for a satellite system called KONNECT VHTS. This is one of the most powerful telecom satellites every ordered and it will incorporate our latest digital payload innovations. Of course this is only one contract and one satellite, but it shows that -- especially ones that we innovated and cost effective -- some of the largest telecom satellite operators remain willing to commit to large new projects.Last point I wanted to mention in this highlight; we're making good progress on our projected Gemalto acquisition. The offer was formally launched on the Dutch stock market at the end of March and we have now finalized its financing. To be precise, this financing was carried in 3 tranches of EUR 500 million, a fixed rate bond in January, followed by a combination of fixed rate and floating rate notes in April. And the cost of this financing is significantly under 1%, around 0.6% to 0.7%, depending on the evolutions of the weight in the next 2 years.So turning now to Slide 3, which summarizes our key figures for the first quarter. New orders amounted to EUR 3.03 billion, strongly up on both reported and on organic basis. As you will see in a minute, order intake was boosted by the booking of several large contracts in the quarter.Sales were up by 4.1% and reached EUR 3.41 billion. Organic growth was significantly higher at 7.2%. Obviously, this level of organic sales growth is ahead of our full year target and puts us on a good footing for the rest of 2018.Moving now to Slide 4 to go a bit more into details on the order intake. Q1 2018 order intake was strongly up on Q1 2017, plus 34%. As you can see on the right, this solid dynamics was driven by large contracts, the ones with a unit value of more than EUR 100 million. Last year we have booked only one such contract for a satellite, while this year we have booked 3.Besides the OneSky contract in Australia that I've already highlighted, we booked the renovation of the signaling system on the main East-West railways crossing Poland and the contracts related to the 12 additional Rafael aircraft ordered by Qatar. Order of low unit value were down, but this is simply due to the quarter-to-quarter phasing effects.Turning now to Slide 5, looking at sales growth. Let me first say a word on currency impact, which are a bit higher than usual, around 3% of sales. As a reminder, our top exposure relate to the U.S. dollar and the pound, around 10% of sales each, followed by the Australian dollar, so around 6% of sales. All other currency exposures are in this journey under 2% of sales.This quarter the euro transcend by 9% to 15% against most currencies and by 3% against the pound, which explain this higher than usual negative currency impact. Putting aside this currency impact, Q1 sales were organically up 7.2%, driven, as you can see on the right, by both mature and emerging markets.Now, looking briefly at each segment one by one. I'm now on Slide 6. In Airspace, orders were down compared with Q1 2017 at EUR 751 million against EUR 925 million in Q1 2017. The main explanation is that Q1 2017 included the booking of a satellite contract which was not the case in Q1 2018. Sales were organically flat against high comps in 2017, especially in in-flight entertainment and space.Now, moving on to Slide 7 with Transport. Transport orders were strongly up in Q1 2017, with the 2 significant contracts I already mentioned in Norway with the train management service -- train management system and in Poland. Sales were strongly up, driven by the delivery of the last contracts we won in 2015 and in 2016 as well and an acceleration of our mainline signaling business. Let me stress that growth in this segment will normalize over the rest of the year as the comps will become much tougher.Turning to Slide 8, now looking at the Defence & Security Segment. Defence & Security orders amounted to EUR 1.78 billion, up 60% year-on-year. No need to come back on the driver for this high number. Sales were up 9.5% and reached EUR 173 billion. Many business units contributed to this strong performance. I could mention surface radar, naval systems, combat aircraft, but also military telecommunication and networks and civil cyber security. So as in previous quarters, a broad-based sales growth in Defence & Security.Slide 9 is just a reminder of our 2018 financial objectives. All-in-all, Q1 represents a solid start of the year, in line with our expectations, which naturally lead us to confirm our financial objective for 2018.Let me conclude with another reminder on Slide 10. We will hold our Capital Market Day on June the 6th in one of our largest facilities a few kilometers north of Paris. I'm told that registrations are closing soon. So if you have not done so, please go to the registration website, and if you have any questions, please contact the IR team, Bertrand, [Bruno] or [ Henri ].So this concludes my brief presentation. Many thanks for your attention. And I will now be pleased to take your questions.

[Operator]

[Operator Instructions] We have a question from Olivier Brochet from Crédit Suisse.

[Olivier Brochet, Research Analyst]

I will have 3 questions in fact. The first one on transport. If you could provide a bit more granularity around the mainline rail signaling acceleration that you've seen? Is it linked to Deutsche Bahn reinvesting? Is it linked to something different? Or can you provide a bit of color around that? The second question is on satellites. With the KONNECT order, how should we think of the turnover for space in '18-19? You were expecting some softness, has that changed? And the third question is on Gemalto and the progress that you are making. What approvals have you received already and what key authorizations are you still needing please?

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Okay. Good morning, Olivier. So first on Transport. So overall the momentum is there. It's true that we're today slowing down and executing contracts that we booked in 2015 and 2016. You probably have in mind in particular our large size contract to upgrade the London underground network. We're also executing a large size project in the Middle East. Those 2 contracts relate to our urban business. Now, it's also true that we see today also a good level of sales with regard our mainline business, as I pointed out. No specific driver on this front. Deutsche Bahn is, as you know, Olivier, quite an important customer to Thales. I don't want to pinpoint any specific country, but the demand is there in countries like Germany. Spain I would say is speeding up. And we're also today executing in particular a project that we booked a few years ago in Norway. So those are the key underlying contracts that we're today executing in our mainline business. Space; I guess this is a comment that I've already made in previous meeting or discussion or call about what we are expecting at least with regard 2018 with regard our space business. What I keep saying is that after quite a steady growth in space over the last 2 years, we are expecting a level of sales for space for the full year 2018 to be stable as compared to 2017 overall. So stability in terms of top line growth for space. Going forward, it's probably a bit too early. Today we anticipate some kind of stability or very moderate growth as we speak now. This is my view. But on this particular aspect, I will be able to provide you with more, I will say, forward-looking information at our Capital Market Day. This stability about our sales in space 2018 is really consistent with the overall guidance that we have provided to you, which is on 2018 to deliver an inorganic growth which will be between 4% and 5%. So this 4% to 5% range is consistent with some kind of stability in terms of top line with regard to our space business. Gemalto, I don't want to be too much specific. We have to file and in particular antitrust authorizations in 10 jurisdictions. I don't want to at this point in time to give you more detail on where we stand today. But overall the process is developing as expected. And with regard -- I mean, for our investments, we have to submit authorizations in 4 countries. And here again what we see is -- I would say is a normal [indiscernible]. So nothing to highlight today and we are absolutely in line with what we told you the last time we shared information about Gemalto acquisition, which is about a transaction that in our view should be completed, should be closed in H2 2018.

[Operator]

The next question is from Harry Breach from Raymond James.

[Harry William Freeman Breach, Aerospace Analyst]

Morning, Pascal Bouchiat. Can you hear me?

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Yes, absolutely, Harry. Good morning.

[Harry William Freeman Breach, Aerospace Analyst]

Morning. Just 3 if I can. Firstly, maybe a different aspect from Olivier about Gemalto, Pascal. When you discuss with Gemalto management their business planning and the current pace of revenue and order activity of the EMV card and the SIM card business, are you comfortable that we have definitely got a sustainable plan there going forward and there's no more negative surprises? Second question was over on to Aerospace. We've seen I would say over the last couple of quarters sort of a reasonable aftermarket pickup for some of the avionics names. Can you give us a bit of a feel for how avionics aftermarket is doing at Aerospace? And then final question also on Aerospace. I'm looking at the IFE business or IFEC I should say. Can you give us a little comment -- I did read something somewhere about JetBlue connectivity and whether they had perhaps not renewed a contract with Thales relating to the old live TV business. Is that material for you or is it frankly no?

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Okay. Harry, thanks for your 3 questions. So starting with Gemalto. So Gemalto released its sales figures a few days ago with regard to Q1 performance and -- I mean, for me -- I mean, we are showing figures with Gemalto getting back to positive organic growth which was in Q1 around plus 3% and with the confirmations of what Gemalto management has mentioned at the end of 2017 when they released their 2017 figures with in particular with regard EMV -- I mean, some kind of stabilization, normalizations in terms of level of business in the U.S. with a confirmation that the destocking in the EMV business in U.S. should be completed at the end of 2018. And by the way, Q1 a drop in level of sales in the U.S., which was much more moderate than it was back a year ago. So overall, stabilizations of the situations in EMV and in particular concerning this destocking that should be finalized by the end of 2018 in the U.S. And the SIM business is very much also in line with our own projections. So, yes, we know pressure on prices and the intent and the willingness of Gemalto to exit some, I would say, low margin markets and focusing on those markets where the level of prices is much better. Last point on Gemalto, we've also noticed, as you have done I'm sure, the very good progress and the very nice growth coming from the 3 fast-growing businesses, which are the IoT; machine-to-machine business; the data encryptions of the overall -- I mean, enterprise security business, which also reported quite a nice growth in Q1 2018; and finally also the biometry or enterprise business, which was, you'll see, pretty good. So all-in-all, a good confirmations of our view in term of momentum on those 5 businesses. Aerospace and your comments and a question about aftermarket picking up, you know aftermarket is very much linked in terms of dynamics to the overall level of traffic and at this point in time we keep seeing a good level of air traffic. And because of that, overall the level of activity in aftermarket is in my view satisfactory. IFE; I don't want to comment on any specific project or contract or discussion with any of our customer of course. What I could share with you is that today we are developing our connectivity business with the first, and this is a large contract, with North American Airlines, where we're finalizing the, I would say, overall qualifications of our end-to-end system. And this is quite important for us at -- it will open doors to develop our businesses at some other large sized airlines we're targeting today.

[Operator]

The next question is from Tristan Sanson from Exane BNP Paribas.

[Tristan Marie Raphael Yvan Sanson]

So a few question on my side. The first one would be on your pipeline for large orders, so above EUR 100 million in Q2, Q3. You already mentioned one. But can you maybe qualify, do you think it's very active or reasonably active and are there any very large tenders we should be aware of over these 2 quarters? The second question is on the payment terms of export orders, especially on defense market versus 5 years ago. Some of your peers have commented that today they are less favorable or there's a bit of a change in paradigm due to the large military export contracts. I'm not referring specifically to the additional tranche of Qatar Rafale fighter, but overall can you comment whether the payment terms indeed are less favorable for you than it used to be? Third question is about the FCAS program, so the future European fighter aircraft program. Today you have 25% stake on the Rafale. Can you tell broadly what is your ambition for this program and would it be realistic to consider that you can seal target for 15% to 20% stake on that program or this would be very soon?

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Okay. Thank you, Tristan. Good morning. So our internal large size orders and what could you expect in the next quarters to come, it's a bit difficult for me. I mean, this is -- so it's an ongoing commercial developments. So that -- I mentioned our large size satellite that was signed a few days ago that should be booked within Q2 -- at the end of Q2 or beginning of Q3. Of course we're pursuing many other projects. I would say the level of demand and discussion and a number of contracts I would say is as it should be, pretty much in line with what we have in mind for the full year. Today I see a level of commercial activity which confirm our guidance in term of order intake for the full year 2018. Nothing more specific to highlight. Payment terms; I mean, for years I get. I mean, this I would say is a recurring question about are we seeing deteriorations in payment terms. This is of course something on which you're quite vigilant. At this point in time, I would say that I don't see any deteriorations in term of payment terms in the, I would say, contract that we're signing. I'm not saying that customers are not willing pressure on that, but at this point in time -- and we are very vigilant on this aspect. I mean, I keep saying no compromise on payment terms at Thales. This is part of financial discipline that we want to keep pursuing. At this point in time, my view is that overall the situation is quite balanced and very much under control. I don't see excessive pressure. And it's also true in countries which suffered in particular from the drop in the oil price and in particular the Middle East, where we keep having payment terms that are in line with what we have seen in the past in these regions. FCAS; so FCAS -- I mean, we absolutely need to understand that this is a very long-term project and we have to understand that what has been announced last week is the first of many steps of what is -- this is quite clearly a very exciting project for the industry and in particular for Thales. I'm not going to give you any specific figures in term of what should be our part in the development of this project. Now, just to give you a bit of color, we need to understand that FCAS is not just a single system. FCAS is a system of system, encompassing of course the new or the future aircraft that should be replacing the Rafale and the Eurofighters. But it will be much more ambitious than just replacing an existing combat aircraft. FCAS will encompass also the management of drones, the management of a swarm of drones, the management of this new combat aircraft, together with also having to manage the existing type of aircrafts that will carry on post 2014. And all of that in a global network. And we can understand that it's going to be quite a complex system of systems, where in particular connectivity, sharing of informations, electronic warfare, all of that will be absolutely essential and in an environment that will be much more complex as it is today. So it's going to be more, I would say, even network management than just having to manage various pieces of equipments. So because of that, we're quite optimistic of what this could represent for Thales. Of course as soon as we discuss about connectivity, as soon as we discuss about having to manage a complex network, as soon as we need to discuss about cyber security, electronic warfare, those are areas where of course Thales will be able to play quite an important role.

[Operator]

We have questions from Celine Fornaro from UBS.

[Celine Fornaro]

[Foreign Language] If I could just ask 2 questions please. My first one would be just on your comments regarding Gemalto. So just to be clear, Pascal, you said you -- the time table at your end is still in line with what you thought initially because the CEO of Gemalto on the call on Friday said potentially the deal would happen later, second half of the year. And I thought that -- from the full year call we thought maybe this would be moving a little bit more forward. And my second question on Gemalto is, how do you think about your credit rating and how the agencies are now thinking of this credit rating post the acquisition as there is potentially a risk of a downgrade and how can you manage for this not to happen? Or if that happens, what are the implications for the business? What does it really mean?

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Okay. Good morning, Celine. First, in term of timing to complete or to finalize Gemalto acquisition, we keep saying that it will take place in H2 2018. We cannot be more specific at this point in time because of what I mentioned at the previous questions about the number of jurisdictions in which we need to submit both our antitrust and foreign investments authorizations. So, yes -- so H2, but here again very much in line with what we have said in formal discussions. In term of credit ratings, a bit -- today a bit too early to anticipate. What we can share with you is that we have met with rating agencies, by the way, when we announced the transaction and we have also met with them in the last week. And overall, I see a level of reactions, which, in my view, are quite positive and it's my understanding that rating agencies have now fully understood the merits of this acquisition. It's true that Gemalto was not weighted by rating agencies, which means that we had to go through some kind of data graphic presentations to the rating agencies. That's being done. And probably a bit too early to anticipate. Will we be able to keep our existing level of ratings? This is what we would like it to be. Will we have to go through a one notch downgrade? I don't know. But my view, it's going to be in this ballpark with some kind of stability and keeping a quite good rating today. Or will they consider that they will move down to a one notch degradation. But -- so overall, my view is that it's quite positive. Should we have to go through a one notch deterioration, that will not have any implication in terms of financing cost for Thales. So there won't be anything. Our reasons and the reasons for which we have decided to move ahead -- to move on quite early in term of completing the financing of the transactions is because of more anticipations in term of increasing long-term interest rates. Also this is the reason why we have decided to move on securing this financing. So it has been done, as I mentioned, through those 3 tranches of EUR 500 million, with overall a level of rates which is in my view quite positive. I mentioned overall level of interest rates that will be between 0.6% and 0.7%.And of course -- this of course will contribute to what we mentioned when we announced the transactions. Quite a significant positive EPS accretions. We mentioned between 15% and 20%-plus synergies. And basically we are very much in this ballpark in terms of EPS accretions.

[Operator]

We have no other question for the moment. [Operator Instructions]

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Okay.

[Operator]

We have another question from Olivier Brochet from Crédit Suisse.

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Olivier, [Foreign Language]

[Olivier Brochet, Research Analyst]

[Foreign Language], Pascal. [Foreign Language], madam. [Foreign Language]

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

English please.

[Olivier Brochet, Research Analyst]

Sorry for that. Brain not working this morning. So on the tube activity, if you could tell us how you see the business, if satellite is doing a bit better? And the second is, can you update us on the Watchkeeper program in the U.K. because there is a bit of question marks around its progress there?

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Okay. So on the -- on your first question, Olivier, on the electronic tube business, I will say the level of activity is still today quite -- I would say, it's quite depressed. I mean, 2017 was quite overall low in term of activity in this business. We are expecting probably some kind of slight increase in 2018. But our view is that it would still be quite under pressure in term of overall level of volume. Once again, this is fully embedded in our overall guidance for 2018. Watchkeeper; I mean, I don't have anything in mind specific on Watchkeeper in term of development of this project. I mean, I would say it's developing as expected. I mean, nothing to highlight on it now.

[Olivier Brochet, Research Analyst]

Okay. Thank you.

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Thank you, Olivier. So...

[Operator]

We have another question.

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Okay.

[Operator]

So we have a question from Zafar Khan from Société Générale.

[Zafar Ayub Khan, Equity Analyst]

Just a simple one on the Gemalto acquisition. Pascal, could you just help us in terms of what your thinking is on when you may be able to create positive value from the acquisition, i.e., where the return is higher than your WACC, just in terms of the timeframe on that? And what WACC you would be using in that?

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Okay. Zafar, good morning. With regard on value creations on Gemalto acquisition, we mentioned when we announced the transactions in December that we're expecting a return on capital employed on this acquisitions to be a growth of our WACC in 2021 -- and of course post synergies, a return on capital employed. And this on the basis of a WACC which should be between 8% and 8.5% -- of course post tax, average cost of capital for Thales 8% to 8.5%. This WACC, by the way, being more based on the existing capital structure of Thales. I mean, of course, and I guess it is obvious for others, our balance sheet will be much more effective after the acquisitions. I mean, for years you kept telling me that we have accumulated cash on the balance sheet and it's true that is providing 0 return. So here -- I mean, if I take Gemalto 2017 figures, their profit from operations was a bit in excess of EUR 300 million. And I overall mentioned a level of financing cost which will be quite moderate. So of course overall a capital structure that will be probably much more effective and overall the WACC of Thales, which in my view should be probably below 8% post the acquisitions. But keeping the existing WACC of Thales and quite, I'll say, well-shared valuation of our WACC between 8% and 8.5%, we are expecting our Gemalto acquisition to be value accretive for us on 2021.

[Zafar Ayub Khan, Equity Analyst]

That's very good. Thank you for that.

[Pascal Bouchiat, Chief Finance Officer and Senior Executive Vice]

Okay, if there are no further questions -- so let me conclude this call by stressing that as you understood, this Q1 is fully in line with our expectation and we remain focused on the delivery of our financial objective, of course the deployment of all our Ambition 10 initiatives, and as we have commented, the execution of the Gemalto acquisition.Next event for us will be our General Assembly Meeting on May the 23rd in Paris and then our Capital Market Day on June the 6th, where I am looking forward to seeing many of you in person.Have a good day. Thank you very much and bye-bye.

[Operator]

Ladies and gentlemen, this concludes the conference call. Thank you all for your participation. You may now disconnect.