Thales SA

PAR:HO

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, welcome to the Thales Conference Call. I now hand over to Bertrand Delcaire, Head of Investor Relations. Sir, please go ahead.

[Bertrand Delcaire, Head of Investor Relations & VP]

Yes, good morning. Welcome, and thank you for joining us for the presentation of Thales' 9 months 2018 order intake and sales. I'm Bertrand Delcaire, the Head of Investor Relations at Thales. With me today, Pascal Bouchiat, the CFO of Thales. As usual, this presentation is audio webcast live on our website at www.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.With that, I'd like to turn over the call to Pascal Bouchiat.

[Pascal Bouchiat, CFO and Senior Executive Vice]

Thank you, Bertrand, and good morning, everyone. Before moving onto the numbers, as usual, I wanted to highlight a few recent events.I'm now on Slide 2 of the presentation. First, I wanted to mention 2 important commercial successes we announced a few days ago with respect to the Grand Paris metro, which is the largest greenfield metro project in Europe.In consulting with Siemens, we'll deliver the signaling system for the 3 future metro lines of the Grand Paris Express, covering 125 kilometers and 50 stations. Separately, we will also deliver onboard passenger systems, such as CCTV cameras and interphones to equip more than 150 trains.Second, moving to our recent businesses. Current budget discussions in several countries are concerning the [satellite] trend we are starting to notice in the past 2 years. Just a few weeks ago, the French government presented its draft 2019 budget, which plans for the defense budget to grow by 5% in 2019. This is fully in line with the 5% annual growth that was approved in the -- in July as part of the LPM, the multi-years Military Programming Law until at least 2021.The defense budget in Australia, our second largest market, is expected to grow by 4% in the current fiscal year and in June 2019 and by 7% in the following year.In Germany, the draft 2019 budget calls for EUR 4 billion increase in defense spending next year, corresponding to a 10% increase. Of course, on the other end, visibility, we made limited in some other markets, such as U.K. or Italy, but the overall context for recent budgets remains solid.Third, a quick update on the acquisition of Gemalto. Since our H1 release in July, we have obtained a further 5 regulatory authorizations, including, in particular, the CFIUS approval in the U.S., and it was approved in China. As we announced last week, we've decided to propose a clear remedy to certain antitrust offering, the disposal of our General Purpose HSM business, which generated approximately EUR 90 million in sales last year. We believe that this remedy will address their concerns and lead us to rapidly secure the remaining approvals.Considering the remaining steps, we now expect to close the offer in the first quarter of 2019.Finally, I wanted to point out 2 recent recognitions of our leaderships in terms of sustainability.For the second year in a row, we were recognized by DJSI as the global aerospace and defense industry leader against 22 other companies in the sector. We are -- we were also assessed very positively by another influential sustainability rating agency, Sustainalytics, which ranked us second in the global aerospace and defense sector.Turning now to Slide 3, which summarizes our key figures for the third quarter and the first 9 months of the year. New orders during the first 9 months of 2018 amounted to EUR 9.47 billion, up by 7% on a reported basis. This level is in line with our expectations.As a reminder, our full year order intake guidance of EUR 15.5 billion implies a 4% increase compared to last year.Sales came to EUR 10.87 billion, 6.2% above last year. Organic growth was significantly higher at plus 7.9%. Obviously, the level of organic sales growth is ahead of our full year targets. As I will stress later, we expect a significant slowdown in growth in Q4, but this puts us on a very good footing to deliver on the upper range of our full year target.Looking into details at our order intake, I'm now on Slide 4. The chart on the right is pretty [explicit]. The order intake momentum is driven by large orders with a unit value over EUR 100 million.Over the first 9 months of 2018, we have booked such 10 large orders. Among these 10, we booked a so-called jumbo order, the OneSKY contract in Australia, whose value is around EUR 800 million.Looking at the list of large order book in Q3, you will notice that they're concentrated in Europe, which explain why our order intake in mature markets is significantly up while it is down in emerging markets.As expected, the base of small orders with a unit value below EUR 10 million increase significantly in Q3 at plus 20% versus Q3 in 2017.Over 9 months, it is now down only 3% on a reported basis and 1% organic growth.Moving on to Slide 5, looking at sales. Neither scope nor currency effects were material in Q3, which differs from H1 when several currencies, starting with the U.S. dollar and the Australian dollar, had significantly weakened against the euro.Once we put aside these effects, sales were organically up 7.9% as you can see on the chart on the right.Interestingly, our growth was geographically quite balanced with mature markets' sales accelerating and going even slightly faster than emerging markets in the period.Now looking briefly at each segment one by one. I'm now on Slide 6. In aerospace, order was stable compared with the first 9 months of 2017, a little above EUR 3 billion, which is an improvement compared to H1 once they were done [tenders].However, the main source of improvement in Q3 came from the [recovery] of Space orders from what was a low base last year.This morning, we announced the signature of a large contract, more than EUR 300 million, for the development and the deployment of the next versions of the grand portions of Galileo, the European global positioning system. By the end of the year, we expect to book several other space contracts, in particular, in the institutional market, which would help us deliver an improved book-to-bill ratio for our Space segment.Sales were organically up 3.4% over 9 months. At 8.8%, organic growth accelerated in Q3, but this is mainly due to phasing effect that we expect will be most revert in Q4.Considering the slowdown in the commercial telecom satellite market and the high comps we had last year in IFE, aerospace remains a segment with the lowest expected organic growth in 2018.Now moving on to Slide 7 with Transport. Transport order intake remained solid in Q3, up 38%. They were up 30% over the first 9 months of the year.After the booking of 2 significant mainline contract in Q1, we booked another 2 in Q3, this time in urban rail; the Grand Paris Express, which I mentioned earlier and also the extension of the radio system for the London subway.Sales remain also very dynamic in Q3, benefiting from both the delivery of the large urban rail contracts we won in 2015 and 2016 and the acceleration of our mainland signaling business.Let me stress here that the comps will be materially high in Q4, so that full year growth will be significantly lower than the 21% we achieved over the first 9 months.Turning to Slide 8, looking at the Defence & Security segment. Defence & Security orders amounted to EUR 5.1 billion, up 8% year-on-year. It was once again broad-based with significant orders in naval system, tactical radios, cybersecurity and various other activities.Sales were organically up 8.4% and which EUR 5.45 billion, many business units contributing to this strong performance. I could mentioned surface radars, combat aircrafts, naval systems but also military telecommunications and civil cybersecurity. So as in previous quarters, a broad-based sales growth in Defense & Security, with a similar word of caution with respect to Q4 when the comps will be stronger.So which brings me to the last slide, Slide 9, with our 2018 financial objectives. We are slightly upgrading our guidance on both full year sales and EBIT on the back of solid performance you have seen over the first 9 months and taking into account the higher comps we'll face in Q4. So we now expect to be in the upper range of our organic sales growth guidance, i.e. closer to 5%.Similarly, we expect to be in the upper range of our EBIT targets, i.e. closer to EUR 1,660,000,000, which corresponds to a level of margin never achieved before by the group. We still have a lot to do to deliver on these ambitious goals, but our strong 9 months performance and all our ongoing initiatives give us sufficient confidence that we can achieve these upgraded targets.So many, many thanks, again, for your attention, and I will now be pleased to take your questions.

[Operator]

[Operator Instructions] We have our first question from Mr. Olivier Brochet from Crédit Suisse.

[Olivier Brochet, Research Analyst]

I have a few questions, if I may. The first one is on Australia and the U.K. Just wanted to understand a bit the situation on that program, and whether we should expect delays in revenues there or costs for you or is it something that is an issue of the past. Second question would be on Transport. If you could provide a bit more color on the, I would say, the positive signals, sorry, for the pun, in mainline. And the third one is would you have any view on what consequences could be for you of the L3 and Harris announced merger?

[Pascal Bouchiat, CFO and Senior Executive Vice]

Okay. First, understand that -- your first question was about -- specifically on our Hawkei program in Australia?

[Olivier Brochet, Research Analyst]

That's right, yes.

[Pascal Bouchiat, CFO and Senior Executive Vice]

I mean, nothing special to report in this program. I mean, we had many ongoing programs in many, many countries. This is the case for this program in Hawkei, which is today in [one-time] an order. Today, I mean, starting the -- which is -- or completing the final design of the distributions with an expectations of, I would say, starting, I mean, the production ramp-up in the next month to come. I mean nothing special to report on this program. Your second question was about Transport and in particular, on mainline. So yes, I mean, we see today, I guess, it was obvious, which is a good momentum in term of our business or order intake. I mean, all of that was anticipated with -- in particular, I mean, a solid level of demands in mainline. I mean, we managed to book significant orders for our mainline business in countries like Poland, Romania, in particular. In Norway as well. So I mean, yes, the level of demand, which in our view, is today positive. So nothing more than that to report. Last question was about Harris and L3. So that'd be a bit too early, but I mean, I would be quite neutral on this transaction and the impact on Thales. As you know, I mean, those 2 companies are very much focused on the U.S. domestic markets and in particular, I mean, on the MOD. As you know, I mean, Thales is quite a small-sized player [ in this sense ] in the U.S., even though we have some nice niche markets, in particular, on tactical and other communications. Now we'd see -- we see that there might be some kind of significant rollup between the 2 companies. What does it mean? How will the -- our customers react to this merge? Does it mean that some assets would be available at this point in time? It's probably too early. So that's why, I mean, today, I'm quite neutral. But you have understood that because of this -- those 2 companies want much focus on the U.S. market. And I mean, today, I don't anticipate any material impact, and of course, we'll be quite diligent as we are in similar situations to see whether -- I mean, we could take advantage of some assets being put up for sale. But at this point in time, it's, I would say, a bit too early to provide more comments on this merge.

[Operator]

Next question from Romain Gourvil from Bank of America Merrill Lynch.

[Romain Gourvil, Associate]

I've got 3, please. The first one is on Gemalto. So you've said you are holding talks on the remedies. Just wondering what is nature of those and how material could it be related to the EUR 100 million of revenue overlap that you've flagged in the past. The second one is on Space. It looks like momentum is better. So should we expect this trend to continue into next year or visibility is still challenging here? And the third one is on the Panasonic and Inmarsat venture. How do you see this? It looks like [ ISAC ] may have become a bit more competitive, but I guess, it also validates your choice to go for the Ka technology. So happy to have your view on this.

[Pascal Bouchiat, CFO and Senior Executive Vice]

Okay. So on Gemalto, let me come back a bit on the remedy. It is quite simple. I mean, we have a business which is overlapping with Gemalto business, and I guess that we have been quite transparent on this matter since we've announced the transaction. It is about what we call the General Purpose Hardware Security Module, where -- I mean, the -- in particular, European Commission consider that there is a significant overlap and asking for, I would say, a clear-cut remedy from Thales. This business represents from Thales today a level of sales, which is slightly below EUR 100 million. And what we proposed to the regulatory authorities is to consider divesting this business. So I mean, this is the remedy that we proposed to the -- to those authorities. And of course, as you can imagine, it implies, I mean, being able to carve out this business and to -- and of course, to put it for sale and to find, I mean, a potential buyer and to complete a transaction. So it will take a bit of time, and this is the reason why we announced that we would delay our expected closing date from Q4 2018 to Q1 2019. Your second question was about Space and the commercial dynamics there or what is -- what -- my view is the following: There have been probably a bit of over-interpretations of what happened in the Space market with, in particular, some, I mean, investors or analysts considering that we would face a very severe downturn in this business from a commercial standpoint. And on that, we said from day one, from last year, we said that, no, this is not what we're expecting. It's true that we faced a drop in the specific civil telco business, but we believe that this will be manageable for Thales. What we see in 2018, we believe in this business is -- which is a significant increase in term of order intake as compared to the low level that we got in 2017. So I don't want to be more precise on it. It's a bit too early, but we expect the book-to-bill in our Space business for 2018 -- for the full year 2018 to be significantly above what it was in 2017. Now it's true that 2017 was quite low, but we see that the trend is overall positive. Having said that, we keep seeing market, which is still, I would say, overall soft on this specific civil telco business. How will things develop in 2019? I believe, probably a bit too early. Yes, I mean, at this point in time, it's a bit too early. We see a number of requests for proposal. So it's about moving from weakest proposal to striking deals, and this can take a bit of time. Overall, my view is that what I'm telling you today, very much in line with what we shared with you, I mean, in June when our Head of Space business, Jean-Loïc Galle, shared his views on how he sees, I mean, this business developing in the next 2 years with quite a modest cost, but overall, stable or slightly positive topline costs -- business for next years to come. Panasonic, Inmarsat, I would say, Romain, that you made the question and the answer and I agree with your comment about the fact that -- yes, I mean, this validates our view, which is quite simple, which is that we do believe that the future of connectivity for commercial Aeronautics will go through the development of the Ka-band technology as opposed to other technology, in particular, as opposed to the Ku technology. And yes, as you know, we have also an agreement with Inmarsat, and as you have in mind also, we signed 2 years ago an agreement with SES in order for us to take advantage of supply of Ka-band technologies to serve, in particular, the American continent. So yes, I mean, my view is that -- I mean, this move between Inmarsat and Panasonic validates our strategy to deliver high-speed connectivity based on Ka-band technology.

[Operator]

Next question from Harry Breach from Raymond James.

[Harry William Freeman Breach, Aerospace Analyst]

Pascal, can you hear me?

[Pascal Bouchiat, CFO and Senior Executive Vice]

Absolutely.

[Harry William Freeman Breach, Aerospace Analyst]

Perfect. Just 2 questions. Firstly, just -- I wonder if you can give us a feel -- I'm -- we all understand that the pace of order intake can be lumpy. And I heard your comments just earlier about book-to-bill in Space, but when I look at the book-to-bill for the group over the last 4 quarters on a trailing 12-month basis, it's just been a little bit below 1. And I'm just wondering, Pascal, when you look at the pipeline of bids and proposals that your sales teams are making, do you see, sort of, order intake looking out 1, 2 years, sort of, continuing to accelerate, maybe leveling off a little bit? And then a different question. Just looking over at Gemalto, can you tell me, are you happy with their execution of their business plan this year and their prospects looking next year? Just had a look at consensus expectations, for Gemalto's EBIT this year, and they seem to have fallen in a mid-single-digit level for 2018. And maybe those are nonoperational factors, but can you just give us -- tell us how happy you are with their execution and their business outlook, especially for the Siemen EMV businesses?

[Pascal Bouchiat, CFO and Senior Executive Vice]

Okay. Okay, Harry. I mean, 2 very different questions. On order intake, yes, I mean, we know that order intake can be a bit lumpy quarter-on-quarter. Now, I mean, we guided you for 2018 full year order intake, the EUR 15.5 billion. We also guided you on the overall level of sales, and I guess that if you will see that overall, it should be close to a book-to-bill raised to 1 for the full year 2018. Now in going forward, we see many, many opportunities in -- while walking on many commercial opportunities. Then it's moving from opportunity to signing a contract. My view today is that what we see from a commercial standpoint is very much in-line with what we shared with you [beginning of] June in term of our growth expectation at Thales. So yes, we updated you that we are from a commercial standpoint. In my view, this validates our midterm profile in terms of organic sales growth, it's 3% to 5%, that we mentioned in the midterms. This is what we shared with you at the end of June. On Gemalto, I mean, I don't want to make very specific comments. I mean, as you probably have in mind, I mean, Gemalto will be releasing their Q3 figures. I guess it's in a week time, Friday, next week. I mean, I don't expect any surprise on this -- I mean, from this release. I mean, very much in-line with the guidance that they presented to the market at the end of 2018. I mean, I don't have to be happy on it to be happy about that. This is, in my view, in line with what they said, and I guess, I mean, the consensus [ reflecting ] quite well. I mean, you have Gemalto's view on the commercial performance. So nothing very special for me to report on Gemalto. I don't expect any surprise upon the press release that Gemalto will be commenting in a week time.

[Harry William Freeman Breach, Aerospace Analyst]

And Pascal, can I just ask, in terms of the order booking, sort of, this year, is it right for us to assume there's been no -- sorry, no material change in your win rate of the bids and proposals you make?

[Pascal Bouchiat, CFO and Senior Executive Vice]

No. No, no, Harry. I mean, no, our win rate -- and this is something that, as you can imagine, we track at Thales. I mean, we have not seen any specific change. What we see is probably a bit more is in some countries and particularly in emerging countries, our -- I mean, a clear delay in the decision-making process at some of our potential -- or our customers. This is probably what we see on -- apart from that, I mean, nothing quite special to report. But you have understood that overall, I mean, we do confirm our order intake guidance for the full year, which is probably also a good demonstration that what we anticipated at the end of 2018 is materializing as I expected. So no surprise, no good surprise, no bad surprise in terms of how we see the department of our commercial performance.

[Operator]

Next question from Celine Fornaro from UBS.

[Celine Fornaro, Head of EMEA Industrials Research]

Yes. Celine. So just 2 questions, if I may. The first one would be related to the growth that we're seeing through the acceleration on mature markets against emerging markets. So if we were to put that in a context of the cash flow, should we expect maybe a change in terms of how you secured the cash payments on even your day-to-day business, not just jumbo contracts? Because you have more growth in DM compared to EM, my -- being my first question. And my second one is if you could comment a bit on the trends of the market on the IFE on what -- when you're expecting some pickup there or is that the profile of some slowdown in growth also to come in 2019?

[Pascal Bouchiat, CFO and Senior Executive Vice]

Okay. So first, on this balance between emerging markets and mature markets and the potential impact on cash flow. What can I say on this point? I mean, what -- and I was quite explicit on this aspect. One important factor is -- in term of cash flow profile is down payment associated with large-sized defense export contract. And we discussed quite extensively in the past about down payment coming from like large-sized defense export contract and in particular, I mean, the Rafale contract. Yes, I mean, this has a clear impact and hence, our discussion and how we guided you on the -- on Thales' expected cash flow when we adjust for those down payments. This is for me, I mean, a clear element coming from disbalance between emerging markets and domestic (sic) [ mature ] markets. For the rest, I would say it's pretty much neutral. I mean -- or no recurring kind of contracts. And in the balance -- I mean, the cash flow profile between mature countries and emerging countries, I would say it's pretty much the same. I don't see, I mean, any specific, I would say, difference in terms of cash flow profile between domestic -- mature markets and emerging markets. On IFE, it's true that I mean -- it's true that the -- in particular, in 2017, the comps are quite high for the Space and Defence. What I shared with all the investment community on IFE in the next years to come, and I guess, it was also part of, I assume, Michielin presentation, the Capital Markets Day or both, I mean, quite the difference in term of expected growth. On one side, the traditional IFE and on the other side, the connectivity growth is prudent. Significant part of the growth in this business would come from the connectivity where we expect double-digit planned growth. On the other side, on the traditional IFE, what we expect, more of a low mid-single-digit growth on this traditional IFE. So this is how I see, I mean, growth in this business next years to come.

[Operator]

Next question from Christophe Menard from Kepler Cheuvreux.

[Christophe Menard, Head of Aerospace and Defense Sector]

I have 3 questions. Actually, all of them on order intake. The first one is on transportation. Then -- you mentioned Q4 sales, quite obviously, will be down, but what about order intake? Because order intake has been quite strong. And so first question is on the trend of order intake in Q4. And if it remains positive, is it a result of the general environment? Or is it because your competitive positioning has improved? So that was for Transport. The other question is about the geographies and the U.K. I mean, of course it's very lumpy, but in H1, the U.K. order intake was minus 38%. It's up 5% now. In the context of Brexit, what are the trends you're seeing in terms of order intake going into next year? And what is that growth related to in the first 9 months of the year? Is it linked to signaling, precisely? Or is it also Defense that is growing? And the last question is on the small order intake. You mentioned 12% growth in Q3, which is a very good number. What is the breakdown between mature market and emerging markets in terms of those small orders which constitute the backbone of your order intake actually?

[Pascal Bouchiat, CFO and Senior Executive Vice]

I'm not sure that I will be able to answer all your questions in [fully], particularly the last one, but I will do my best. So I mean, on -- I mean, it is true that -- and your question as I understood was more on order intake profile in Q4 as compared to what we have seen so far. So first, it's true that end of September, order intake in Transport was quite strong with overall[Audio Gap}I don't expect for the full year in this[Audio Gap]but in Q4, I mean, might be a bit more modest as compared to Q4 2017, even though for the full year of 2018, the -- it should get to be growing. And on U.K., I mean, we are a bit vigilant, let's be clear. It's true that end of September, I mean, with a positive [report] as compared to the first 9 months of 2017. I mean, the Transport was also a key contributor. I mentioned, in particular, I mean, these contracts of the London Underground, a connected program for the London subway, we are a bit vigilant in this sense. Basically, today, there's a lack of, I would say, visibility in this market as opposed to markets like, as I mentioned France, Australia, Germany, where we see quite a strong momentum. We are today a bit more vigilant with regard to Defence. So at this point in time, a bit difficult to be more explicit, but we are a bit vigilant on how Defence will pick up in U.K. Your last question was about small orders, and I mean, the -- overall, do we see the breakdown of the Q3's full-sized order intake by geographies? I have to say that I don't know. And I'm turning back to my colleague [Bertrand Delcaire] Investor Relations that don't have this analytics. So I mean, probably Delcaire will be able to or [Paul] will be able to get back to you on this one though. So overall, my main message on small-sized contracts, here, again, it can be a bit lumpy. And I suppose that we had a number of questions on small-sized orders when we released our Q1 figures. And at the time I said, okay, it's done, I guess, Q1 2017, but our view is [the same]. It doesn't change, it will not change, which remains overall positive, and we think that progressively, it will become positive, and this is all what happened. So overall, I don't see overall a change in pattern in term of a split of our order intake across the various type of contract. All of them should be contributing to the growth of Thales. On a full year basis, of course, I mean small-sized contract, they should be much less volatile than large-size projects, by definition. And today, I mean, what you have seen in Q3 [for me] a confirmation that overall, the trends in terms of commercial performance remains positive for Thales as a whole.

[Operator]

We don't have any more questions for the moment. [Operator Instructions] We don't have any more questions. Back to you for the conclusion, sir.

[Pascal Bouchiat, CFO and Senior Executive Vice]

Okay. Okay, thank you to all of you. So I mean as a summary let me advise that our Q3 figures is a confirmation of our overall trend, which remains positive at Thales, giving us a lot of confidence on our ability to work, to deliver on the full year figures and as you have understood, probably on the upper range of our sales growth and our EBIT performance. So all of this is positive. So thank you very much. I guess, next time we'll be sharing with you, I mean, figures will be end of February when we release our 2018 -- full year 2018 figures. Thank you very much. Have a good day, and see you in the next month.

[Operator]

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