Thales SA

PAR:HO

Earnings Call Transcript 2022-Q2

[Operator]

Good morning, ladies and gentlemen and thank you for standing by. Welcome to today's Thales H1 2022 Results Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today. I would now like to hand the call over to Mr. Patrice Caine, Chairman and CEO. Please go ahead, sir.

[Bertrand Delcaire, Head of Investor Relations]

Yes, actually. No, good morning. I'm Bertrand Delcaire, the Head of Investor Relations at Thales. Welcome and thank you for joining us for the presentation of Thales' H1 2022 results. So, with me today are Patrice Caine, Chairman and CEO; and Pascal Bouchiat, our CFO. As usual, the presentation will be in English and followed by a Q&A session. It is webcast live at thalesgroup.com where the slides, press release, and consolidated financial statements are also available for download. A replay of the call will as usual be available in a few hours.

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

[Patrice Caine, Chairman and Chief Executive Officer]

So, good morning, everyone. Let's begin with Slide number 2. As usual the highlights of our H1 2022 results, which were undoubtedly strong. First, we achieved a new record order intake, driven by our strong commercial dynamics combined with the coming into force of the Rafale order from UAE. Our backlog reached as well a new record €38 billion at the end of June, which further increased our long-term visibility.

Second, in spite of several operational challenges, and especially supply chain tensions and the end of our Aerospace sales to Russia sales grew organically above 5%. It's included, in particular, a strong performance at DIS, which has now recorded three quarters in a row of double-digit organic sales growth.

Third, both EBIT margin and our free operating cash flow were ahead of plan increasing our confidence over the full-year. Considering our year to date performance, we have decided to upgrade our full-year guidance for both order intake and sales. And I will come back on this at the end of the presentation.

Finally, thinking about our priority for H2, we will work on two levels. On the one hand, we need to focus on short-term operational issues that are limiting our growth and thinking of supply chain and recruitment. On the other hand, we continue to execute on the five strategic priorities that I outlined back in March. But first, let me comment on our key financial metrics and I'm now on Slide number 3.

At €11.2 billion order intake reached a new record 46% above last year. Sales grew by 5.4% on an organic basis and 7.7% on a reported basis, both EBIT and adjusted net income were up 23%. At 10.8% EBIT margin gained 140 basis points. This progression is clearly ahead of our full-year guidance, which corresponds to 60 basis points to 90 basis points increase compared to 2021.

Free operating cash flow now reached €820 million, almost double last year. It benefited from both the record order intake and the team's increased focus on cash management. In consequence, net debt at the end of June was only slightly higher than at the beginning of the year.

[Pascal Bouchiat, Chief Financial Officer]

Okay. Thank you, Patrice, and good morning to everyone. I'm now on Slide 4. So, starting with our order intake dynamics. As Patrice mentioned, we achieved again a very strong order intake in H1 2022 with already €11.2 billion, up 43% organically and a book-to-bill of 1.36. This [indiscernible] performance is clearly boosted, but in general Rafale orders from the UAE.

However, it is important to highlight that the performance was also very strong on top of that one specific contract. Indeed, we booked no less than 10 large orders in Q2. True contract related to space. The new tranche of the CO2M project, which will play an important role in the fight against global warming. And one more space inspire telecommunications satellite for the Saudi operator our [subsets] [ph].

Also eight large orders in Defense and Security. On top of the UAE jumbo contract I've just mentioned, we booked two contracts with the French Armed Forces. Two with the Greek Armed Forces, one with Australia, one with the Middle East country [emerging] [ph] and one with an undisclosed customer. Interestingly, small orders below €10 million were up by 11%, thanks to the ongoing recovery in the civil aero aftermarkets. And also the strong demand for Passport in our biometric business, also rebounding post-sanitary crisis.

The smart cards also continuing to be up, mostly thanks to a pricing effect. Geographically speaking, the dynamics were strong in Australia, France, U.K., and North America for the mature markets. Obviously, emerging countries were exceptionally strong, driven by the jumbo Rafale orders from the UAE. So, overall, another very solid performance in 2022. In regards to order intake, pushing up our consolidated backlog to a new record €38 billion.

Moving on now to Slide 6, looking at sales. The currency effect was again positive during Q2 at 2.5% of sales. Over the first half, it added 2.1 points of growth or €157 million. There was no significant scope effect during H1 2022. However, it will be a bit more matured during H2 after the consolidation of RUAG simulation and training and once we close on the other acquisitions we announced recently.

Turning to organic growth. At 7.8%, the second quarter was clearly an acceleration of 2.7% in Q1 with different dynamics within our three segments. First, our DIS sales remain particularly strong, up double-digit for the third quarter in a row. Our Defense and Security sales achieved a solid high-single-digit organic growth catching up after a small negative organic growth in Q1.

And then our Aerospace sales were up low-single-digits driven by strong double-digit growth in our civil aero aftermarket business. And I will of course come back in greater details on the three segments in the next slides.

So, now moving on to the EBIT bridge, now on Slide 6. Looking at the drivers of the change in our EBIT between H1 2021 and H1 2022. Before going into the details of this bridge, let me point out that in the period, we booked two one-off items that almost entirely balance each other. On the one hand, and this was recorded in the gross margin, a negative impact coming from the economic and trade sanctions imposed in Russia, which represented €62 million of non-recurring expenses.

On the other hand, the EBIT contribution of Naval Group was boosted by the compensation agreement related to the Australian submarines. This item represents an income of €50 million. On that note, we expect a reversal of around €10 million during H2 and this Naval Group positive one-off, hence, the total positive impact is estimated around €40 million for the full-year.

In the EBIT bridge, we have put aside this to one-off all the way to the right. So, what were the other drivers behind the EBIT increase? The mechanical impact scope, currency, and pension represented a positive €17 million, mostly thanks to currency. Excluding the one-off, you can see the quite solid progressions of our gross margin by €174 million or 80 basis points moving organically from 26.8% to 27.5% of sales.

You can also see that indirect costs are increased. However, less than our sales by 150 basis points. Our 3.9% [indiscernible] sales up 5.4%. However, this was partly driven by H1, H2 phasing effects, so don't expect this performance to extend over the full-year. Both restructuring and equity affiliates contributed to strengthen our EBIT as you can see on the right of the chart.

And finally, the one-off offset each other in the periods. So, all-in-all, as you understood, the EBIT margin was a bit ahead of full-year plan, thanks to the improvement of gross margin and also the phasing of indirect costs. Now, looking briefly at each segment one-by-one. I'm now on Slide 7 for Aerospace. Orders were down by 18% organically, mostly through [icons] [ph]. You remember how last year we booked the jumbo order relating to the new generation of Galileo satellites.

Now, the underlying commercial dynamics remain strong for the [state business] [ph] with four contracts above €100 million, one with the European Space Agency and four relating to new space inspired satellites. [Avionic orders] [ph] were also up versus H1 2021 despite [indiscernible] our original equipment still weak, but with a strong dynamic coming from civil aero aftermarkets up at double-digits.

Sales were up by 2.9% organically. Several factors were behind this logo. First, the loss of sales to Russia was mostly recorded in this segment. Second, both space and microwave tubes were facing [indiscernible]. And third, Avionic was a bit contrasted. As expected, civil aftermarket continued to rebound strongly at a double-digit growth, but the original equipment activities were still recovering slowly in particular on the widebody side.

While avionics should accelerate in H2, we expect that some of this issue and more broadly supply chain and equipment challenges will continue to weigh on growth in the Space business at least for a few months. Without, of course, changing the mid-term outlook. EBIT continued to recover over H1 with EBIT margin up from 3.3% to 4.4%, but it was slowed down by the one-off I mentioned earlier. Correcting for this one-off, the EBIT margin would have been around 6.2%, i.e. 3 points higher than last year.

Turning now to Slide 8, looking at the Defense and Security. Order intake was exceptionally high over H1, thanks to the Rafale orders from the UAE coming into force. However, it's important to note that on top of the jumbo contract, the commercial dynamics was also excellent with a total of eight contracts over €100 million versus [only four] [ph] during H1 2021.

These segments order booked reached €29 billion, a new all-time record representing nearly €3.4 of sales. As expected, organic sales growth was up at high-single-digit in Q2 after a soft Q1 confirming the positive trends across most business lines.

Let me stress here that we don't expect an immediate significant positive impact on our sales from the recent [European] [ph] announcements. In Q2, discussion with our customers confirmed that we are talking about a mid-term impact here, not immediate impact and Patrice will come back on the subject during his presentation. The 40 basis points EBIT margin increase was mostly due to H1, H2 phasing of expenses. So please don't assume we can carry it over the full-year.

Turning now to Slide 9, looking at our last segment, Digital Identity and Security. As you can see from now on we have decided to stop showing order intake on the slide as they are structurally aligned with sales. At €1.6 billion our sales were up by an impressive 13.1% organically and almost 20% on a reported basis. The strong Q1 performance expanded in Q2 in-spite of ongoing supply chain challenges.

Cyber security continued to deliver robust growth at double digits organically in H1. It is also expected to remain strong over the full-year. Biometrics has continued to recover with an ongoing growth in passport demands and even bottlenecks, hence double-digit organic growth over H1. Please remember that the rebound in biometrics started during Q4 2021, hence an organic growth expected to be lower at H2 this year due to higher comps.

And finally, the smart card businesses are performing strongly, mostly due pricing effect on top of some precautionary buying. EBIT margin benefited from the operating leverage on this robust sales growth. It is very encouraging to see that this business is already almost at the low end of the 2020 swing EBIT margin target we had set back in 2019 before COVID. It illustrates once again the quality of this asset and the hard works of the team.

Turning now to Slide 10, looking at items below the EBIT. First, taxes. As you can see, the effective tax rate is up to a normalized rate 19.7% [as a 14%] [p] during 2021 resulted from two one-off items from UK and in particular Italy. We now expect the effective tax rate to be in the 20% range over the full-year.

Second, adjusted net income from discontinued operations. This is of course the contribution of transfers, which is stable on an adjusted basis. Finally, minorities are strongly down. You'll find here the negative one-off impact related to Russia and Thales Alenia Space profitability. All-in-all, this drove an adjusted net income group share of €726 million and an adjusted EPS of €3.41, strongly up by 23% versus adjusted EPS at H1 2021.

Finishing up with two slides and cash flow. I'm now on Slide 11 first. As you know, our working capital is usually negative in the first half of the year, mostly due to a strong seasonality. However, during the first six months of 2022, our operational free cash flow has reached an exceptional €820 million, coming from a higher EBIT, but also clearly from a much stronger working capital performance.

From this working capital performance, you will find the very strong commercial activity and the level of orders booked during the first six months with, of course, a significant positive impact resulting from the done payments associated with the Rafale order from the UAE. You will also find the [result] [ph] from the ongoing efforts, the group places on cash managements, like the reduction of [overdue balances] [ph], and also part of negotiations with both customers and suppliers in order to obtain more favorable payment terms whenever possible.

Finally, moving on to Slide 12, with a quick look at the evolutions of our net debt position. You will notice here how our capital deployment is gaining momentum with €141 million related to acquisitions. The final dividends of [€416 million] [ph] and also the €127 million corresponding to the first few months of the share buyback program.

A final comments on an important long-term liability that is not on this slide, pensions. As you will see in Note 8 of our financial statements, the higher discount rate drives a very metal reduction more than €1 billion in our net pension liability over the first half. And that's the end of the financial review.

I'm now turning over the call back to Patrice.

[Patrice Caine, Chairman and Chief Executive Officer]

Thank you, Pascal. I'm now on Slide 13, turning to our strategy and outlook. This morning, I wanted to briefly share some perspectives on our market positions and provide an update on the five strategic priorities that I presented back in March. First of all, and I’m now on Slide 14. First of all, the invasion of Ukraine by Russia has been driving major political moves in Europe. Such as the decision by Finland and Sweden to join NATO or the €100 billion defense fund that was announced by the German Chancellor.

Most European countries have committed to substantially increase their defense expenditures in the coming years. As you can see on the right, this is starting to show in independent forecasts. Jane’s now expects European defense budgets to grow at 5% per year over a quite a long period between now and 2030. However, we need to be all aware that these increases in spending will take several years to materialize.

Our two largest customers in Europe, France, and the U.K. have only recently initiated their own discussions on the topic. In June, the UK government talked about targeting 2.5% of GDP by the end of the decade, which would imply 6% annual growth over the period. However, nobody knows who will be the next Prime Minister and this target has not yet been made in [indiscernible].

Last week, in France, President Macron announced that his government would submit to parliament a new military programming law, covering the period from 2024 to 2030. So, be aware it is too early to confirm the exact budget trajectory. While these new budget dynamics are yet to unfold, let me stress that we are convinced it will drive an extension of our mid-single digit sales growth outlook over a long period of time not just for the next three years, but for another 5 years to 10 years, if not more. This is because we are positioned on faster growing market segments.

As we often stress, electronic equipment, sensors, and communication systems, are essential enablers for modern armed forces. In addition, thanks to our ongoing commercial successors, our backlog is at its highest ever EUR29 billion for the sole Defense and Security segment. This explains why, as you can see on the bottom of the slide, over the coming years, our growth guidance is at the high end of the forecasted growth by large U.S. and European defense companies.

Turning now to Slide 15 to our predominantly civil businesses, Aerospace and DIS, Digital Identity and Security. Starting first with Aerospace. After two years that were heavily disrupted by COVID-19, the civil aero industry is only at the beginning of a major rebound in air traffic and aircraft deliveries. I have previously showed the chart on the left. Last year, air traffic represented only 40% of the 2019 level.

While the range of uncertainty remains large, IATA now expects traffic to double this year and to further recover strongly until the end at least 2025. Aircraft deliveries have been as well very depressed in the past two years. This was particularly striking for wide body aircraft, which were more than 60% lower last year than in 2019, including 90% for the Boeing 787. Here as well, while the ramp up will require several years, the room for post-COVID-19 recovery is considerable.

Turning to the space side. On top of the long-term growth of institutional space budgets, Thales Alenia Space can count on the strength of its backlog, which it further increased in the first half. In consequence, our expectation for this business is unchanged. We see it’s delivering 5% annual growth at least until 2024.

Moving to DIS, Digital Identity and Security. Well, we've showed previously this sort of chart showing the growth of its TAM, its Total Addressable Market. With its exposure, to data protection, identity and access managements or biometrics, its TAM is set to grow at more than 10% per year over the coming years.

On top of these growth platforms, DIS will benefit from the cyclical recovery of passport demand following the COVID-19 crisis. As you understand, altogether, the medium-term perspective are particularly robust across all our markets.

Moving now to our strategic priorities. Slide 16 is just a reminder of the five strategic priorities that I presented back in March. Slide 16 shows where we stand on each of these initiatives. First priority portfolio management. During H1, we progressed well on the disposal of our Transport business. The formal agreement with Hitachi was signed in February and we have now obtained more than half of the required regulatory authorizations.

The teams are now working full speed on the carve outs of the business from the rest of Thales in particular on the IT side. And we are fully on track to grow this transaction according to the initial calendar i.e. by the end of 2022 or early 2023. In parallel, we keep on developing revenue synergies between DIS and the rest of the group. In H1 2022, we won 64 revenue synergy projects.

Our flagship project is since the JV we are setting up with Google Cloud to offer a so-called trusted Cloud Solution in France. On a standalone basis, neither Thales nor Gemalto would have been able to seize this opportunity worth several hundred million euros of sales in a few years.

Second priority, technology leadership. To illustrate the impact of our increased investments in technology here are two remarkable commercial successes we booked this year. On the civil aero side, I'm referring to the selection of our new flight management system by Airbus. We have been developing this connector and cybersecurity solution over the past five years. And it's down selection by Airbus on all its commercial platforms is a major demonstration of our leadership in this domain.

On the military side, we are very proud of having been selected by the U.S. Navy to supply sonars for the new Constellation class frigates. Captas-4 is our leading variable depth towed sonar. For these U.S. ships, the sonars will be built by AAC, the joint venture we had with Leonardo and DRS and that we are taking full control of this year.

Third, a strategic priority taking our sustainability performance to the next level. First, we have completely stopped the production of [smoke shells] [ph] containing White Phosphorous. The last batch was delivered to the French Army at the end of June, fully in-line with the commitment we took back in 2019. The end of this production will allow a few investors to invest in our share.

Second, and this was another commitment we took, we have submitted our emission reduction targets to the science based target initiative as BTI. We expect to hear back from them in Q4. You remember how we have a constant flow of initiatives to improve operational efficiency. And this is the fourth priority I listed at full-year results.

At that time, I had talked about some of our key projects, such are the transformation of our [indiscernible] assumption, or the development of sales and operating planning, S&OP. This morning, let me zoom on one crucial support function in the current period, talent acquisition. To deliver on growth, we are targeting to hire 11,000 employees in 2022, a 25% increase compared to 2021.

To address these recruitment needs, while gaining efficiency, we decided to reorganize and scale-up our current acquisition function. To achieve this, we are implementing a new global model concentrating the teams on five geographical platforms and deploying new IT tools to simplify administrative processes. In parallel, we continue to work hard to adapt our fixed cost structure to the new ship of the group after the disposal of the transport business.

Finally, as planned, we have stepped up our capital deployment actions. Since January 2022, we have implemented four bolt-on acquisitions, two in defense, two in cybersecurity. In defense, first, the acquisition of RUAG training and simulation is a [indiscernible] will allow us to create the open leader in the niche segment of simulation and training solutions for armed forces.

And second, the acquisition of the 50% that we did not own in [AAC] [ph], the joint venture I've mentioned earlier, which will help us serve better the U.S. defense market. And I said to in cybersecurity, first, a pair of companies that are specialized in cybersecurity consulting and managed services. This transaction will give us scale in this area moving from 6 to 9 cybersecurity operation centers and increasing the number of experts by 25%.

And second, OneWelcome. OneWelcome is a European leader in customer identity and access management, CIAM. And this acquisition will allow us to offer the most comprehensive identity platform on the market. Our base scenario is to close on all these acquisitions by the end of the year, which will represent the capital deployment of slightly more than €400 million.

In parallel, as announced in March, we have started implementing the share buyback program Pascal mentioned the figure earlier over H1, we spent €130 million to carry 15% of the program.

Moving now to slide 18 and discussing our H2 2022 outlook. Starting with the business environment assumptions on the left of the slide. As I demonstrated earlier and you saw in the results that Pascal presented, market demand is robust across the portfolio. At the same time, challenges are mounting. Global supply chains remain under tension, especially on semiconductors.

Inflation is soaring in our main markets as well. At least, the weakening of the euro is positive for an exporting company like us. This context leads us to focus on three key priorities for the coming months. Number one, addressing your personal bottlenecks that are impairing growth, staffing, and supply chain. Second, even if we benefit from some protection against inflation, we are far from being fully immune to it. So, we will focus on maximizing the path through of inflation to our customers.

Finally, of course, will continue to execute on the five strategic priorities, I've just described, which brings me to our financial objectives of 2022, considering our H1 performance, and the business environment and priorities that I just described. So, now I'm on Slide 19. As you understood, considering the strength of our order intake and sales year to date, we have decided to upgrade our full-year guidance on both KPIs.

For sales considering the material currency impact we expect over the full-year, close to 2 points, we have decided to guide on organic growth. We now expect an organic growth of 3.5% to 5.5%. On the basis of the July 2022 scope and foreign exchange rates. This corresponds to €17.1 billion to €17.5 billion. We keep unchanged the EBIT margin guidance 10.8% to 11.1%, which will represent a significant improvement over last year.

Let me finish with a quick summary, and I'm now on Slide 20. The portfolio is now refocused on three leading businesses with strong growth prospects. As you understood, while we focus on addressing short-term growth bottlenecks we continue to execute full speed on our strategic levels, investing in R&D reinforcing our performance culture. We continue to implement both disciplined M&A and cash returns to shareholders.

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

[Operator]

Thank you. [Operator Instructions] The first question is from George Zhao with Bernstein. Please go ahead.

[George Zhao, Bernstein]

Hi, good morning everyone. First on the recent series of the cyber both-on acquisitions. You had noted that these businesses are growing pretty strongly, but what about on profitability? how do they compare versus margins for your existing commercial cyber businesses? And second question, somewhat related, on capital deployment, would you still stick to the commitment of only looking for deals up to 500 million in enterprise value? If the landscape of potential available assets in their cybersecurity space changes from when you first provided this commitment back in March? Thanks.

[Pascal Bouchiat, Chief Financial Officer]

Hello George. I will take the first one about, I mean your questions relating to cybersecurity. I mean, growth and profitability, quite very good questions, George. What is very important to consider is those small size acquisitions, on one side, I mean, the potential for growth. And then what it means in terms of profitability, and in particular, I mean the leverage aspect that we can account on this type of acquisitions.

At this time, we are talking about small size companies, and probably one welcome that we have [just announced] [ph] is a good example, quite small size companies, but really I mean fast growing business, which means that at this point profitability is not that much an issue. It's not that much a priority of this type of very small sized business. It's more about, I mean, growing, taking market share. And then in the second step, I would say, balancing between as a level of investments in particular in terms of sales and marketing and the level of profitability.

So, at this point, it's more to consider that the first priority is to keep those small sized companies to go. Investing the right level of sales and marketing and R&D also. I mean, in order to fuel, I mean, the product policy and making sure that the technology will continue to be ahead of the competitions.

In the [second step] [ph], probably in a few years, we will consider probably arbitrating a bit of investments in other than probably to balance between a bit less growth and getting really, I mean the right level of profitability. So, this is basically I mean the plan, which means that, of course, I mean, those two small sized companies that today quite a low level of profitability. And of course, have nothing to do with, I mean, the cybersecurity that we already own at Thales, but of course, which are going much less than those two acquisitions.

I mean, one welcome is probably a good example. It is a business with a level of sales, which is slightly above €10 million, but going 30% per year, and our top priority is to keep one welcome, one welcome to keep going and even faster than that, benefiting from the overall commercial network of Thales. About capital deployment, maybe I will let Patrice to talk about, I mean, the size of acquisition and what it means.

[Patrice Caine, Chairman and Chief Executive Officer]

Good morning, George. Perhaps I should just report however, that our main focus, number one focus is really organic growth. I do understand that investors, of course, interesting about capital allocation, but clearly the day-to-day business for us is really to deliver our projects and you have understood that we have a few challenges, if I may say, those were delivering our projects and customer satisfaction.

So, having said so, indeed, we do not exclude of course to also, I would say, trigger the M&A lever to grow even faster or to increase profitability or both. Our, clearly priority is really to focus on the three main pillars that we have now enhanced, defense integrity, Aerospace and space and DIS, excluding – totally excluding any kind of diversification, number two.

Number three, and I'm coming to the size of the acquisition, but to make sure that everyone has the right, I would say, parameters in mind. What are we looking for? I would say, two things: either to reinforce our technological leadership [in some] [ph] domains, related to defense security, Aerospace space and DIS, or and or our footprint in a given country because localization is really key in the eyes of most of our customers.

Now, in terms of size of acquisition, we have tried to answer to the best we could when we were asked this question a while ago so we give a figure, not a magic figure, but it's great to give you a kind of, I would say, feeding of our main focus and clearly our main focus is bolt-on acquisitions. So, we said no more €500 million EV. That's a range or that's to give you a figure, and clearly that's our main focus.

Now, we remain pragmatic, of course, if something bigger, I would say, becomes clearly a variable and which really would really make sense for us in terms of price, evaluation, synergies and so on and so forth, how could we exclude it by principle? So, it's not contractually with what I said on bolt-on, but at the same time, we are pragmatic. Hope it helps George.

[George Zhao, Bernstein]

That's helpful. Thank you.

[Operator]

The next question is from Ben Heelan with Bank of America. Please go ahead.

[Ben Heelan, Bank of America]

Yes. Good morning. Thanks for the questions. So, the first question I had was on the comments you made, Patrice, around the mid-term outlook you highlighted, kind of that mid-single digit is the right level of growth that we should be thinking about, but the time period has been extended, the visibility has been extended, is there a chance we could go through a period where that mid-single-digit is actually going to be higher than mid-single-digit for a couple of years as these budgets start coming through, I'm thinking 24%, 25%. So, obviously, you've given us some color around the extension of visibility, how do we think about the potential for that mid-single-digit to be higher for a period of time? That would be the first one. And then the second one, you mentioned you're not totally immune from inflation, you're focused on passing through as much as you can, could you give us maybe a bit more color around that? How should we think about the businesses that are exposed to inflation and more risk than others? And then obviously from an energy cost perspective, huge amount of inflation, could you talk about your ability to pass that on and also your exposure to gas, right? And whether you have significant gas exposure and whether you see any risks there? Thank you.

[Patrice Caine, Chairman and Chief Executive Officer]

Thank you, Ben, and good morning. Perhaps I will take the first one and we'll let the second one for Pascal. So, we’ll share the answer. In terms of growth, and I think that your question is related to defense, when I said that the new geopolitical context gives us much better visibility or much longer visibility, it's just one conviction that clearly defense as enter or reenter, in particular for Europe, into a long period of steady growth in defense investments.

Honestly, I think mid-single-digit is the best or good, best proxy that we can take in terms of growth looking forward. Now, if we can do better or if the market, sorry, does better, we will be very pleased to observe that the market will go faster than that, but for the moment, I think this mid-single-digit is probably the best proxy for everybody.

Now, our growth is of course the combination of the market growth and our own performance and I'm referring to the quality of our portfolio. I am convinced that we are in the right sweet spot, if I may say, in terms of solutions, products or services, really to grab the full potential of this growth.

In the past, and it's not [contrary] [ph] to what I said, but in the past, we are regularly over performed in the market, the growth of the defense market. Clearly, that's our ambition to continue to over perform, thanks to the quality of our portfolio. Now we will see, of course, but globally speaking, putting all these factors together, which is very positive for the Defense and Security business of Thales. Pascal on the second…

[Pascal Bouchiat, Chief Financial Officer]

Yes. I mean, your second question was about, I mean, first inflation, and what does it mean for us to be able to transfer higher input cost to our clients? I probably indeed to go a bit more in detail in our three segments. Of course, as you can imagine, I mean, we have a number of contracts with different type of contracts. So, I will make it as simple as possible for you. So, let's start with overall, I mean, Defense, as you know, I mean, our largest business.

So, in Defense, in most cases, I mean, we benefit from a specific variation of price escalation mechanism in the contract, which takes into account, I mean inflation on salaries or inflation in material. So, this is how it works. And here I mean the majority of our contract and they take the benefit from this type of, what’s probably something like 75%, 80% of our contract. benefit from this version of price close.

Second is, if I take now more of civil businesses, here it might vary across our two segments. Starting with DIS in the DIS and I guess what happened in H1 is probably the best demonstration of what it means to be able to transfer high input cost to our clients. Even though we don't benefit from contractual closes on this matter, I mean, the balance between [offline demand] [ph] is such that basically, we can really exercise pricing power on this matter.

And even when you look at DIS figures in H1, probably some kind of expansion of margin. As of course, I mean, we don't increase below gross margin cost at the same rate as we increase our level of sales. So, we benefit from some kind of leverage effect in terms of EBIT margin, in terms of percentage. So here, I mean, well, a very good level of [projections] [ph] where I mean, we're more exposed is in our Aerospace business.

Starting with our Space business, here, I mean, in most cases, not in all cases, but in most cases, we don't benefit from this type of mechanism. So, this is where we need to come back to our clients and to negotiate with them and in some kind of increase in prices to reflect higher input cost. Avionics is a bit different with some kind of protections. It's more about, however, I mean, the [indiscernible] of this growth, which will [cause one] [ph] some kind of negotiations with some of our clients.

So, this is overall, I mean, the overall picture. As you see on our H1 figures, I mean, and overall, our level of EBIT margin shows that we're able to manage this type of situations. Your question about energy and gas, probably gas, your question was more about what does it mean if we wouldn't get a wide level of supply in particular Europe? So first, I mean, what we consume in terms of gas is quite minimal. There are only one sites where I mean we use quite large amount of gas. It is located in Australia.

So, I don't expect that the – and it's not supplied from Russia. So, I mean, no specific issue on this matter. Overall, I mean, by the way, on top of getting the right level of supply, your question was probably also about inflation is true that we have seen the cost of energy is going through the roof. Now what is good at Thales is that overall, out of the overall €8 billion of [materials] [ph] that we buy from the [merchant services] [ph], whatever we buy from our supply chain, overall, we buy around [€100 million or €200 million] [ph] of energy. So, you see €100 million of energy as compared to overall €8 billion of supply. It is insignificant.

So, even though, of course, we had to face with a price of energies going through the roof, overall because we consume just a small amount of overall energy, which basically is used I mean to hit our buildings. I mean, the impact on the bottom line overall for Thales is insignificant.

[Ben Heelan, Bank of America]

Very clear. Thank you, guys.

[Pascal Bouchiat, Chief Financial Officer]

Thank you very much, Ben.

[Operator]

The next question comes from the line of Andrew Humphrey with Morgan Stanley. Please go ahead.

[Andrew Humphrey, Morgan Stanley]

Hi there. Thank you very much for taking my questions. I've got just a couple. Clearly, there was a very strong cash performance in the quarter. We obviously knew about the UAE order, but even allowing for the prepayment associated with that, it seemed like a much stronger cash performance. Can you talk about the level of prepayments associated with orders that maybe, kind of weren't in expectations until fairly late in the quarter on whether there were significant prepayments attached to those? And my second question is, I wanted to ask if you have a perspective on the current state of [FCAS] [ph] in the light of developments in future fighter jet programs over the last week or so? Clearly, FCAS remains somewhat stalled, there's a discussion about project leads. I’d be very interested in your perspective on it.

[Pascal Bouchiat, Chief Financial Officer]

Okay. Good morning, Andrew. So, I will take maybe the first question and let Patrice to answer the second one. About cash flow, sorry for that, but I will not detail. I mean, the level of down payment that we get from UAE Rafale contract, this is, of course sensitive information. Of course, I mean, this level is quite significant.

I mean, it's also important to consider that we got them not just on this specific large sized [general export] [ph] contract, but as you have seen overall level of order intake in H1 was quite strong. And of course, in general, the more we get order intake the more in general, we can get down payment. So overall, I mean, all of that was pretty positive. Maybe probably a good positive for me to discuss probably bit more about what does it mean for, I mean, the full-year 2022 level of cash flow generations.

First, I guess it's important for you guys to realize that we have worked in such a way that as opposed to what was the case at Thales in [indiscernible], getting a more balanced level of cash flow between H1 and [not show] [ph] with something that we are looking for. And this is basically what we got in the last two years and we will strive to make sure that this will continue in the next few years. So, a bit more balance between the two semesters.

Second point, I mean, our run rate in the trend from me gives confidence about our full-year guidance, which is a 100% [conversion ratio] [ph] from net income, net adjusted income to free cash flow generations. And I can really confirm that, I mean, this is what we'll get in 2022.

Overall, I mean, if I look at the level of consensus on net adjusted income something around €1.5 billion, so confirming a level of cash flow generation at this level, I'm quite confident with that. I've seen that, I mean, the cash flow generations consensus is slightly above this level. I think it's around €1.6 billion, and I'm also quite confident with this level of growth.

More importantly also, I mean, a good opportunity to confirm that when it comes to 2023, where we've also mentioned a few months ago as we released our 2021 figure that we are contemplating also a level of conversions ratio in 2023, around 100% I can also confirm that this is still our view today for [2023] [ph]. So, really, I mean to make a long story short, H1, good level of cash flow, good balance between H1 and H2, happy and in-line with the overall guidance, comfortable with current level of consensus, and confirming that 2023 should continue to show that Thales will continue to generate a very strong level of cash flow, which in [indiscernible] also play a good illustration of the quality of our earnings.

Patrice, maybe on certain points.

[Patrice Caine, Chairman and Chief Executive Officer]

Yes, good morning, Andrew. So, on FCAS, as you know, there are [pillars] [ph] involved in system of system project. We are informed as main partners in two of them, combat cloud with [indiscernible] being the leader in the leading seat or in the leading position. And the pillar named sensors were in the – is in the living seat and as well, main partner, so called main partner for this second pillar.

Now the – and we have an agreement on those two pillars. As you know, the one which is still under discussion is the [period name, NGF] [ph]. And clearly, I'm not going to comment because I'm not the better place to comment it. So, you should raise the question or the question to [indiscernible]. That's the two where we say. The two guys I would say involved in this pillar and let them give their view on this [one] [ph].

[Andrew Humphrey, Morgan Stanley]

Much appreciated. Thank you.

[Patrice Caine, Chairman and Chief Executive Officer]

Thank you.

[Operator]

The next question comes from the line of [indiscernible] with Jefferies. Please go ahead.

[Unidentified Analyst]

Yes, good morning. Thank you for taking my question. I have first one on DIS actually on the mid-term potential. You mentioned the total addressable market would grow at least 10% by 2025. And also you would benefit from revenue synergies, what should we take as the right target for DIS in terms of growth by that timeframe? And within that, what would be the revenue synergy potential that you expect? And then I'd have actually a clarification on the free cash flow. If I recall well, at the end of 2021, you had 400 million of timing benefits within your free cash flow, could you tell us how much of these have reversed in H1 and what we could expect for H2? Thank you.

[Pascal Bouchiat, Chief Financial Officer]

Good morning, [indiscernible]. Maybe I will start with the questions. Yes, I mean, of course, we've got the reversal of this €400 million in H1. What I think to H2 is at this point quite a bit difficult. Of course, we anticipate, I mean, a bit difficult. I mean, first, to assess today, I mean, the cut off between the very end of December and what might be paid in January 2023. So cut off is always a bit difficult to anticipate. [Indiscernible] shows that we are quite [indiscernible].

We took advantage in December last year of advance payments from some of our clients including some large prime contractors. At this point, of course, a bit difficult for me to anticipate what might come in from some customers deciding or not to pay in advance in the very last days of December this year.

About [Multiple Speakers]

[Patrice Caine, Chairman and Chief Executive Officer]

Yes. Good morning. You're referring to Slide 15 as where we showed – by the potential of the market. So take it as an illustration of the potential of the market this so-called 10%. By the way, it's a mix of different, I would say, market segments. So, it's an aggregate of, I would say, several underlying growth depending on do we speak of EMV? Do we speak of data protection, data management, or whatsoever?

Clearly, our commitment, if you remember well, on DIS, is to grow at mid-single-digit and mid-single-digit in the medium-term, this is still the best assumption that you can take probably too early to [grade it] [ph] or to modify it. So we will see. Now the fact that in 2022, for instance, we are able to – or confident to be in the range of high single digits showed that this potential is not a theoretical.

So, still if we keep the guidance for the mid-term, it gives you – should give you confidence, looking at the potential of the market and looking also at what we can achieve in a given year such as 2022.

Now in terms of synergies, we said a while ago that we would reach between €300 million to €500 million of synergies by 2020 as [fee] [ph], if I remember well. So, it's coming soon. Now, we are on track looking at 2022 and what we should achieve by the end of the year. Fully on track to post this level of synergies by next year.

[Pascal Bouchiat, Chief Financial Officer]

Maybe two points of additional comments, if you – Patrice I mean, first, [indiscernible], you're saying it, I mean, on the first part of the questions about the mid-single-digit top-line growth that we expect in the overall DIS business, we need also to consider the balance between more mature businesses like the [small count] [ph] businesses, and the most fast growing businesses. And in particular, I mean of cybersecurity business and also our biometric business will be, of course, I mean booster in terms of growth as compared to more mature smart care businesses, on which of course, I mean the growth will be much more limited.

Maybe a second point on these synergies, you probably remind that we mentioned that significant part of the synergies growth in other businesses, in particular, our Defense and Security business, in particular in our secure and communication system businesses. So, which means that when looking at the overall synergies, I mean, we need to consider on one side the growth of DIS plus also the growth in other businesses, in particular, at our Defense and Security business.

[Unidentified Analyst]

Okay. Thank you very much.

[Operator]

The next question comes from the line of Milan [indiscernible] with Barclays. Please go ahead.

[Unidentified Analyst]

Yes, thank you for taking my question. I have one on indirect cost. Can you help us understand the sequential breach for the R&D to marketing expense and the restructuring cost that is implied by your guidance? What kind of scale of those costs will be in the second half of the year compared to H1? Thank you.

[Pascal Bouchiat, Chief Financial Officer]

Good to hear you again, Milan. Good morning. So, yes, it's true that we had some phasing effect in terms of below gross margin costs. And it is a case in particular on self-funded R&D, but also on sales and marketing. So, here, we're talking about a few tens of million euros. I'm not talking about figures that are quite large with maybe I mean, two underlying points that you need to have in mind.

First, and this is in particular the case in R&D. I mean it’s true that the challenge that we face in terms of equipment has also an impact on the overall level of R&D. And you have understood overall that we are scaling up talent acquisitions, overall organizations. So, this of course, we'll have a positive impact in our ability to get more people and more engineers that will support our overall self-funded R&D program.

A certain point, this time, probably more on G&A and self-marketing. I guess it's quite obvious for everybody that we are, sort of working in a global context, which is a bit shaky. And of course, I mean here and there, I mean, was put in place some kind of savings as compared to our initial trajectory. And we see, of course, in H2, as we release some constraints in terms of permitting resources, on those two materials.

So, overall, I mean, it's not that large a few tens of billion euros within particular R&D equipment challenges and also a bit some kind of precautions of overall, yes being a bit cautious considering, I mean, some challenges and uncertainties that we keep facing today, in particular when it comes to supply chain challenges and also inflation.

[Unidentified Analyst]

Very clear. Thank you, Pascal.

[Operator]

The next question is from Christophe Menard with Deutsche Bank. Please go ahead.

[Christophe Menard, Deutsche Bank]

Yes. Good morning. Thank you for taking my question. I had actually three left. The first one was on – coming back on the working cap, the cash program was actually very – also very efficient in H1. You mentioned that you were negotiating proactive, I mean, proactively negotiating payment terms with, I mean with your, I would say, probably clients and suppliers. Do you think it's still possible to do further improvements on that cash program considering inflation and the cost pressure?

So, it's just more about the potential of cash – net cash program going on. The second question is around the economy of war as depicted by President Macron. I just – I was wondering it's another question, but what does it mean for you? I mean, you talked about also making things more, probably more cost effective? I mean, does it mean there is a trade-off between sales growth and margin? And the final question is on Microwave. I think, correct me if I'm wrong, but it's the second quarter where we have microwave a bit weak apparently.

Is there a plan or is it a transitory period? Because usually, it has always been seen as a very stable solid business. So, just wondering what's happening?

[Pascal Bouchiat, Chief Financial Officer]

Okay. Christophe, good morning. So, I will start on cash. Of course, there's always ways to do better. Now, I mean my view is that when it comes to accounts receivable and accounts payable is probably a bit difficult now to consider but still a significant additional improvements and obvious additional improvements that we could get in the next few quarters.

Where I think that we've got still today, I mean opportunities to do better is overall – in the overall management of our stocks, and maybe I've commented on previous calls that we have launched, I mean, last year, across the board, I mean, initiatives on S&OP, sales and operations planning, where we – with the intend to have a much better integrated way of working from, I mean, sales forecast, management of demand, productions planning, and supply chains, orders, and commitments and walking in a more integrated way, which by the way we see in other sectors is probably, I mean, where we can do better overall at risk.

And I think that it is very important that we keep working on this matter because at the same time, it shows that we feel the need, I mean, to be here and there. Some, I would say, safety stocks, I mean, to handle what we see in terms of challenges on supply chain with what we commented about the shortage on specific components in particular like 20 components. So, we know that probably in the next few quarters, we need to invest probably a bit of working capital in additional stocks on some critical components in order to build probably a bit more safety stocks. And to compensate for that, we need to keep working on this overall S&OP program where we see I mean quite significant opportunities for us to keep doing better.

Equity of …

[Patrice Caine, Chairman and Chief Executive Officer]

I can say a few words on this [economy] [ph]. First of all, sales [indiscernible] confirm the plus €3 billion of additional investments for next year for 2023. So, this is the first, I would say, positive announcement for the industry and of course for Thales. Number one, number two, also announced this LPM for some low. On a period of time, which won the debate, by the way, before this announcement.

So clearly, he chose a long period of time, 2024, 2023, 2030 sorry, he could have chosen another opposite time frame, a shorter timeframe, but he did choose the longest one, 2024 to 2030. So, this is a circuit that we say very positive and tangible. I would say sign or message that was conveyed during his speech on the day before the 14 of July. So this year, I would say clear signs of robust, [the world] [ph] continues trajectory in terms of defense investment in France. So for me, all of this is very positive.

Now, it is quite, I would say, classical as a customer by the way, that he asked for our competitive solutions products, so it's not a surprise. I'm not expecting any customer to say that we are not, I would say, that we are to – that we should be more [expensive] [ph] and when I look, I would say, at all the competition on the [indiscernible] where Thales clearly with all these others, its full competition, thanks to the quality of our portfolio, as I said, and thanks to the competitiveness as well of our portfolio.

All of this make us very confident to largely benefit from this very positive trend on the long run. Yes, the other one Pascal.

[Pascal Bouchiat, Chief Financial Officer]

Yes, good morning. So your first question is about microwave, no specific concern, I mean, maybe I mean for everybody, you need to have in mind that this is a €500 million sales business on buyers, serving buyers industries in particular, I mean, the space business. It's true that last year, I mean, we benefited from quite large space order, which generated in 2021 quite large level of revenues. And which is less the case in 2022. So, no specific concern, I think that it's not a strong growing business. It's more, I mean, some kind of pretty stable type of business overall.

So, no specific concern and it's more, I mean, I mean, the 2021 [icons] [ph] that shows this apparent level of softness that's what we've wanted in H1 2022.

[Christophe Menard, Deutsche Bank]

Thank you very much. Thank you very much.

[Pascal Bouchiat, Chief Financial Officer]

Thank you, Christophe.

[Operator]

The next question is from Tristan Sanson with BNP. Please go ahead.

[Tristan Sanson, BNP]

Yes, good morning Patrice, Pascal, Bertrand. Thanks for taking my questions. And three quick ones, a bit [indiscernible] for that, but the first one is on FX. So, you already mark to market your guidance for the current spot. So, probably 2% to 3% of our currency tailwind to revenues. At the EBIT level, can you remind us a few elements on your currency [substitivities] [ph], especially if we focus on the euro dollar? What is today your net transaction exposure? What is your hedge rate for 2022? And what is the shape of your hedge book for the years to come? So basically, when are we going to start to really seize a benefit from the result of this appreciation of the developments in the Euro?

The second question is a quick follow-up on the inflationary pressures. I guess for you, the topic is more a topic of labor cost than anything given your specific cost structure, compared to peers more exposed to labor, not sure that's your business model. What is today's – what are today's in terms of the debate that you have with unions on cost inflation? Do you have a – reach a good level of consensus about what you are for 2022, 2023 are there significant requests for further salary increases as we can see at some of your competitors? Some color here would be interesting. And the last one is a quick one. I just wanted to – we stand today on the [indiscernible] consolidation program, [36] [ph].

[Pascal Bouchiat, Chief Financial Officer]

Okay. Good morning, Tristan. So maybe I will start with a technical question about [ForEx] [ph]. I guess your question was more about the transactional exposure overall of Thales. Overall, I mean, a level of transactional exposure, net transactional exposure between €600 million and €650 million, which is almost equally split between aerospace and in particular, organic business, and DIS business. Of course, as you know, I mean our policy is to hedge our positions a few years in advance.

So, overall, of course, I mean, the bulk of our exposure is covered in 2022. Overall, the weight, which we hedge, our exposure for 2022 is 1.13. Also, I mean the bulk of our 2023 exposure is already hedged at around 1.08. Now, when it comes to 2024, at this point, I mean, we're a bit less than half of our exposure, which is hedged, today at a level, which is also in-line with our 2023 average rate, and 2025 just a very small proportion of our 2025 exposure, which is hedged today, which means that of course, I mean, we will continue to progressively hedge in particular in 2024, and of course, I mean in the next few months, we'll keep increasing by 2025 exposure.

On inflation, maybe…

[Patrice Caine, Chairman and Chief Executive Officer]

Tristan, perhaps, first, it's a good question because clearly our proportion of our internal salary in our internal cost is significant, which it's a very legitimate and valid question. One additional remark is the fact that half of our staff is in France. And as France for the moment has chosen to compensate on a nationwide basis, I mean, part of the inflation related to energy, structurally the inflation in France is, let's say, two, a bit more of two to three points below other – compared to other countries – other European countries.

So, it gives in a way, it gives France kind of a competitive advantage if I must say, compared to other countries and this is important for us as we are 50% of our staff in France. Now, of course, we'll have this, as you heard, the early discussions on, I would say, salary increase with this, I would say inflation, I would say environment or landscape. Now, what I observed by the way, it's – we have always had and it is the case currently. I will say mature and good quality discussions with our units everywhere in France, but not only in France.

Good quality discussions and quite responsible discussion. We all understand that there is a balance to be found between, I would say, recognizing efforts or inflation or the economic, I would say, macro environment. And the fact that on the long run, there is also the question of the competitiveness of the group. So, altogether, I'm sure we'll find the right balance with our unions in all the countries in which we operate. It will be probably a mix between core salary increase, but as well as [indiscernible] in France, participation in [indiscernible] extra hours in tax – free of tax, we see it under discussion in the House of Parliament in France and so on and so forth.

Now, at the end of the day, and that was the point of Pascal earlier. The ultimate, I would say, goal is clearly to pass through all these cost increase into our price or in terms of price increase. And this is, I would say, the remedy or the solution. To this, I would say, new situation. That was the case by the way 15 or 20 years ago or even before. When we are used to operate under an inflationary economic environment. So, we need to adapt our own I would say, software, to this new environment, but we used to run 20 years ago.

And on this last point, I think Pascal has been [directing] [ph] how can we pass through this cost increase depending on the type of customer, depending on the business model and so on and so forth. Pascal?

[Pascal Bouchiat, Chief Financial Officer]

Yes, maybe before talking about [indiscernible], just to compliment my answer about, I mean, [ForEx], I mean, what I share with you is, I mean, this overall mechanical, conductional exposure. Of course, this is good for pallets overall, I mean to operate in a global environment where I mean the U.S. dollar is stronger, overall this is positive because, of course, on top of this mechanical transactional exposure, it is also the question about the overall level of competitiveness. And it's true that when we face in particular U.S. competitors, in some of our markets, in particular, abroad in some countries like, I don't know, Asia, the Middle East.

Of course, I mean, we take advantage from, I would say, a better overall cost competitiveness, even though of course, I mean, cost is not the only part of the equation when it comes to selling in this type of control, but overall, this is quite positive. On Telesat, I mean, of course, I mean, it's, of course, a bit difficult for us, I mean, to discuss about this opportunity. As – I mean, it's – of course, I mean, the responsibility of Telesat to indicate where they stand on this matter.

What I can share with you however, is that we keep working very hard with Telesat. On this constellation project, we think that was made quite good progress. Of course, as you can imagine, an inflationary environment requires a bit of adjustments of course, in particular, in the way we, as a supplier, need to be protected on this type of exposure. So, of course, we had discussions with our clients about how to protect Thales in this inflationary environment, also making sure that the component – electronic components is also well under control. This is what we have done in the last few months.

And now it's more about Telesat coming back to the market and explaining where this stands in terms of putting together the overall, I would say, funding package, which of course will be absolutely critical I mean to strike a project on which we keep being quite excited once again. So, a bit difficult for me, I mean, to tell you Tristan, when this could materialize in terms of order intake.

At this point, on our side, I tend to believe that we have done everything that we had to do from a supplier standpoint and in particular on the two aspect that I've just mentioned. Now, it's really up to Telesat I mean to finalize the overall funding so that we can launch the project.

[Patrice Caine, Chairman and Chief Executive Officer]

And you remember, Tristan, this is not factored in our 5% yearly growth rate in 2024. So, this is a regular pure opportunity, which would come on top in addition to what we have already shared with you on.

[Tristan Sanson, BNP]

That seems to be quite optimistic about [indiscernible]. So hopefully, we'll talk about it again on Q3 sales growth. We’ll see. Thanks very much for your comprehensive answers. It was very useful.

[Operator]

The next question comes from the line of [indiscernible]. Please go ahead.

[Unidentified Analyst]

Yes. Good morning, everyone. So, just to left. The first one on [AISC] [ph] orders are quite weak. So, how are you thinking about the outlook there when those [indiscernible] will return to growth? And as the COVID crisis change, I would say the strategic vision or ambition you had for this activity? And the last one is on, I would say, on strategy. A few days ago, Alessandro Profumo, Leonardo CEO, said in the near term that he wanted to create a kind of European competence center for electronics and [indiscernible] both, added that he wasn't – not close to new partners and that an alliance may also include the stake in [indiscernible]. So, what's your take on these comments?

[Pascal Bouchiat, Chief Financial Officer]

So, honestly, I was not aware of Alessandro’s interview or statement. If any type of initiative I would say, materialize. So far, we have had no discussion with Leonardo on this particular topic. By the way, I'm not sure I tell you this, [anyway] [ph] it means, so sorry not to be more precise. Looking at Thales, honestly, and it's not that we see a sign of being I would say to consider, but I'm not sure we need any kind of European electronic competence center to be stronger in Europe or elsewhere.

I mean, we are working hand to – I would say develop our own product solution of whatsoever and to win many, many competitions on internal markets, as I said earlier, when we discuss the defense growth and defense market. So, sorry again, we will investigate what – as some was in mind there with more clarity. I think nothing specific. I mean…

[Patrice Caine, Chairman and Chief Executive Officer]

No, I mean, maybe, again, we have seen, I mean, some question on IFE. About, I mean, single aisle new aircraft in particular, the famous A321, in particular the A321XLR taking a stake in the overall long haul type of flight. And whether or not, I mean, this type of aircraft would be equipped with IFE. And the answer, yes. I mean, today is true that our IFE business is essentially a wide body, I mean, a type of business because today, wide body means long haul flight if tomorrow we see more single aisle taking market share on long haul flights.

Of course, I mean, those aircraft would be equipped with – by the way, this is a case on large size contracts that we booked with American Airlines, which orders and in A321, etcetera. So, it's probably a good demonstration that this this potential move in the market about single-aid taking market share on the long haul flights. This will not impact our IFE.

Now, it's also to recognize that at this point today, IFE is quite soft. We start seeing a, probably more request for proposal today. By the way, we signed a few days ago a large size project with the Middle East airlines. So, this is positive, but of course, it is taking time as we see airlines starting to emerge. Continuing now, I mean, new [ISP] [ph] as they are emerging from the equities. Of course, all of that will have to be confirmed in the next few months.

Maybe a last question from David Perry, if I understand well.

[Operator]

Yes. The next question is from David Perry with JPMorgan. Please go ahead.

[David Perry, JPMorgan]

Yes. Thanks for squeezing me in. So two, the first one is, the pension you mentioned, the deficits dropped because of higher discount rates. I just wonder how you thought about that in your capital allocation. I mean there may be a great window of opportunity here to remove the overhang of the pension deficit, the 100 million a year you have to put in to fund the UK. So, I just wondered whether you had any plans to capitalize on that? The second question is something I wouldn't normally ask about. I'm a bit confused by Naval Group, is if I take out – if I ignore the 50 million, the exceptional, the sales are very, very strong, but that doesn't look like any progress on the margin. Can you just tell us how we think about the underlying Naval Group performance and maybe how that's going to evolve going forward? Thank you.

[Pascal Bouchiat, Chief Financial Officer]

First, good morning, David. On pension, probably the first time that I get questions on the call about pension, which is good. So, what does it mean? I mean, how we should be thinking about capital allocation? By the way, I would be pleased, I mean to get input from investors on this front. Now, I mean, one thing is capital allocations, another thing is also, I mean, to consider hedging part of our exposure and to go maybe a bit further in terms of hedging, for instance, I mean, interest rates, potentially also I mean long-term inflations, which remains quite low today.

So, I think that what is happening today on the market with, at this point, increasing interest rate, at the same time is still long-term inflations. Where we're thinking about is increasing overall our level of hedges based on the current situations. The second question..

[David Perry, JPMorgan]

Naval Group.

[Pascal Bouchiat, Chief Financial Officer]

Oh, yes, Naval Group, so I mean, no, I mean, overall, so Naval Group is doing pretty well. One thing is, I mean, overall one-off elements coming from the signature of this deed of settlement with the Australian government. Now, if you put this aside, I mean, the level of margin at another – overall in terms of EBIT, if I take 2022, should be around 7%. This is overall, I mean what are in mind. So, I don't have the exact figures and of June, but overall, a level of EBIT margin from Naval Group at one-seven of 7% plus is what we can expect for the full-year 2020 and 2022.

[David Perry, JPMorgan]

So just to clarify, so the 7% margin without the focus payment?

[Pascal Bouchiat, Chief Financial Officer]

Without the – I mean, the net effect of the focus, I mean, settlement agreements. No, maybe there's a bit of confusion between the amount of cash that never got from the Australian government and the net bottom line effect this represents in terms of EBIT. As of course, against what they've got in terms of cash. You've got, of course, I mean, cost and you need to consider, I mean, the net effect.

[David Perry, JPMorgan]

Maybe I'll follow-up with the question. All right. Thank you very much.

[Pascal Bouchiat, Chief Financial Officer]

Thank you, David.

[Patrice Caine, Chairman and Chief Executive Officer]

Okay. I think this was the last question, Bertrand.

[Bertrand Delcaire, Head of Investor Relations]

Yes, yes.

[Patrice Caine, Chairman and Chief Executive Officer]

Indeed, okay. So just – thank you. Thank you, all of you. Just a few words of conclusion. So, our H1 2022 financial performance was really strong as you have seen, and we've had good progress on all our strategic priorities and the five ones that we have shared with you. It's also for me always [indiscernible] to reiterate my thanks to the team, to the 80,000, say, people of Thales for their mobilization to serve our customers.

And lastly, of course, you can count on us to remain focused on the execution of our profitable growth strategy going forward. And with Pascal, we are looking forward to seeing you or meeting you soon in the upcoming investor virtual’s or conferences. So, have a good summer and looking forward to meeting you very soon. Goodbye.

[Bertrand Delcaire, Head of Investor Relations]

Thank you very much. Bye, bye.

[Operator]

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