Earnings Call: Q4 2019

Feb 26, 2020

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Thales 2019 annual results conference call. There will be a presentation followed by a question and answer session, at which time, if you wish to ask a question, you will need to press star one on your telephone and wait for your name to be announced. I must advise you this conference is being recorded today. I would like now to hand the conference over to Mr. Bertrand Delcaire, VP, Head of Investor Relations. Please go ahead, sir. Yes. Hello. Good morning. Welcome, and thank you for joining us for the presentation of Thales 2019 full year results. I am Bertrand Delcaire, the Head of Investor Relations here at Thales. With me today are Patrice Caine, Chairman and CEO, and Pascal Bouchiat, CFO of Thales. The presentation will be in English and followed by a Q&A session. It is webcast live on our website at thalesgroup.com, where the slides, press release, and consolidated financial statement are also available for download. A replay of the call will be available in a few hours. With that, I would like to turn over the call to Patrice Caine. Good morning, everyone. Let's start with slide number 2 on the highlights of 2019. Starting first with the commercial perspective, where last year we achieved a strong performance in terms of order intake, more than EUR 1 billion above our guidance, thanks to a record Q4, which included great successes in commercial satellites and in the naval domain. Secondly, organic sales growth is in line with the revised target of around 1%. As previously stressed, this sales level reflects the impact of the slowdown of space and a high basis of comparison in transport after several years of exceptional growth. Even with the lower than expected sales growth, EBIT is slightly above our initial target, demonstrating the resilience of our business model. Final point of satisfaction from a financial point of view, the group delivered a strong cash flow performance. Last but not least, we have been consolidating Gemalto since the 1st of April, and the integration has been completed fully in line with the plan. Let's move now to slide number 3. As usual, our key figures in a few charts. At EUR 19.1 billion, order intake is up 4% on an organic basis and up 19% after the consolidation of Gemalto. This is significantly above our target for the year, which we had set at EUR 19 billion. Book-to-bill is clearly above one, 1.04 to be exact. Sales benefited as well from the integration of Gemalto. They grew by more than 16%, reaching EUR 18.4 billion. EBIT is slightly above the EUR 2 billion mark, EUR 2.008 billion to be exact. At 10.9%, EBIT margin is once again progressing, in part because we are consolidating Gemalto on its nine most profitable months. At EUR 1,405 million, adjusted net income is strongly up as well by 19%. Free operating cash flow amounts to EUR 1,372 million. This strong performance includes the negative one-offs that we had previously flagged, but also some positive one-offs, and Pascal will, of course, explain them in more detail in a few minutes. Last chart on the slide, the dividend. This new year of strong financial performance has led our board to decide to increase the payout ratio to 40%, leading us to propose a 27% increase in the dividend to the next AGM at EUR 2.65 per share. After this rapid introduction, I now hand over to Pascal, who will comment our financial results in greater details. Thank you, Patrice, and good morning to everyone. I am now on slide 4. Starting with our order intake dynamics, as Patrice mentioned, we achieved a very solid order intake in 2019. EUR 19.1 billion, 19% above 2018 and 4% up organically. The +19% is obviously resulting from the consolidation of Gemalto, with an addition of EUR 2.4 billion of orders recorded in 2019. With 21 orders and EUR 4.5 billion, we maintain a strong performance in term of orders of over EUR 100 million. As you remember, our 2018 order intake included the jumbo order OneSky in Australia for EUR 855 million. Q4 was a really strong quarter with 12 large orders, including three commercial telco satellites, Eutelsat 10B, NileSat-301, and Amazonas Nexus. Two large orders in transport in Sydney and in London. Six large orders in defense and security, including several major programs such as the mission system and the U.K. Type 31 frigates or the strategic airborne intelligence program of the French Armed Forces, a project called Archange. Orders with a unit value of less than EUR 100 million were up 28% compared to 2018, +8% at constant scope, in particular, with a sharp increase in orders with a unit value of between EUR 10 million and EUR 100 million, +18% at constant scope. The dynamics were strong in both emerging and mature markets, with an organic increase of 19% from emerging markets and 9% from Europe. This drove a book-to-bill of 1.04, and even 1.05 if we exclude DIS businesses, whose book-to-bill is structurally equal to one. Overall, a very strong performance in 2019 in regard to order intake. Moving on to slide 5, now looking at sales. Here as well, the reported growth of 16% is of course driven by the consolidation of Gemalto. The currency effect remained slightly positive for a little under 1% of sales over the period, EUR 118 million positive impact, mostly due to the stronger US dollar. Excluding scope and currency, organic growth was just below 1% for 2019 and quite contrasted from a geographic perspective. Mature markets confirmed their growth profile with an organic growth of 4.7%, while emerging markets were down by 7.7% versus 2018. As you can see on the chart on the right, this negative growth in emerging markets comes after a long and uninterrupted period of outperformance. Moving on now to slide 6, looking at the adjusted P&L from sales to EBIT. Here we have the usual presentation of our adjusted P&L, which is a bit difficult to analyze considering the significant scope effects. As mentioned already, EBIT is up 19% year-on-year and 4% organically, and the EBIT margin continues its progressions, increasing by another 30 basis points from 10.6% in 2018 to 10.9% in 2019. Let me point out that this level benefits from the consolidation of Gemalto over its three best quarters of the year. If we had consolidated Gemalto since January 1st, 2018, EBIT margin would have been 10.6% in 2019 compared to 10% in 2018. Looking at the key item of the P&L, let me point out that, first, gross margin increased by 170 basis points from 25.8% to 27.5%. Organically, it was up 70 basis points, demonstrating that our efforts to improve this crucial KPI keep delivering. Indirect costs were up by 1.5%, growing only slightly faster than sales. As planned, we continued to ramp up R&D expenses, up 3.2%, while controlling marketing and sales. We also kept working hard to reduce G&A, down by 2.7%, while absorbing salary inflation. Third, restructuring costs were a bit lower than expected, EUR 106 million, despite the significant adjustments implemented within space and transport and the addition of Gemalto. So overall, good control of the restructuring costs. Finally, Naval Group delivered a slightly better contribution to our EBIT, EUR 65 million, in 2019. Slide seven, now looking at the usual in greater details of the drivers of the change in our EBIT between 2018 and 2019. Starting with 2018, our EBIT amounted to EUR 1,685 million. The mechanical impact scope, currency and pensions were of course very material this year following the consolidation of Gemalto. The small positive currency impact was offset by a negative pension impact, which will, by the way, continue to weigh in 2020. At EUR 156 million, our organic operational performance remains strong, demonstrating that our Ambition 10 initiatives, growth, value-based pricing, procurements, product policy, set of functions competitiveness, project executions, all of that continuing to deliver. In parallel, we invested part of these operational improvements into R&D, organically up EUR 29 million, as you can see on the right side of the chart. Slide eight, now looking at our Aerospace segments in more details. Starting with orders. At EUR 4.8 billion, the order intake was down by 11% organically compared to 2018. This change reflects the drop in order intake in space and in-flight entertainment. As I already mentioned, space had a strong Q4 performance, winning three out of the four tenders we mentioned in October. At EUR 5.6 billion, sales were up 4.2% organically. This trend is due to the 13% decline in space sales, in line with our revised guidance, while our avionics business kept growing. EBIT amounted to EUR 521 million or 9.3% of sales. The 0.7 point margin decline reflects the decline in space sales, the increase in restructuring charges, combined with the step-up in R&D investments. Now, moving on to slide nine with Transport. Market dynamics in this segment remain solid. The small decline in order intake simply reflects the phasing of large contract awards. Sales were organically down by 5.8%, but it is important to remember that this segment is facing exceptional comps. Over the 2015, 2018 period, it grew organically by more than 45%, including +18% in 2018, when it reached peak workload on four major urban rail signaling contracts. Excluding these four contracts, 2019 sales were actually organically up by 5%. Profitability was down with EBIT at EUR 56 million. As explained previously, the underlying margin improvement is masked by the recognition in the first half of 2019 of two one-off charges totaling around EUR 60 million. The restructuring charge related to our engineering transformation plan in Germany and cost overruns in the executions on the very specific urban rail signaling project. Corrected for these one-offs, margin was around 6%, continuing to increase in line with the mid-term targets. Now moving on to slide 10, Defense and Security. Order intake amounted to EUR 9.9 billion, up 17%, benefiting again from robust orders in many areas. The book-to-bill was strong at 1.2, and the order book for this segment reached a new record of EUR 21.8 billion. Interestingly, many of these orders were multi-year and will underpin long-term growth. Sales amounted to EUR 8.3 billion, up 6.4% organically, slightly above our mid-term targets. Many business units contributed to this momentum. Air traffic control, optronics, systems for fighter aircraft, system and services for ships, military radio communications, cybersecurity, and many other examples. As expected, EBIT margin reached a record 14%. This exceptional level was driven by several positive factors. Stronger euros, our competitiveness initiatives, good project executions, very low restructuring costs, but also the one-off provision release of around EUR 40 million booked in H1 2019. Last segment on slide 11 with DIS, Digital Identity and Security. Let me first stress that overall, the integration is progressing fully in line with our expectations. At EUR 2.6 billion, order intake is in line with sales as the majority of business units in this segment operate on short cycles. Sales were in line with the full-year targets which we had set in June, an organic growth between 0% and 2%. This low growth reflects different moving parts. Quite a strong performance is in EMV payment cards, driven by the reissue cycle in the U.S. The impact of the reorganizations of the HSM businesses and the continuing declining sales of traditional SIM cards, very much in line with expectations. At EUR 264 million, EBIT was slightly above the upper range of the target set in June 2019, EUR 214 million to EUR 216 million, which reflects lower than anticipated integration costs, partially offset with negative impacts of the reorg of the HSM business. Turning now to slide 12. A few comments on the items below the EBIT. The cost of net financial debts and the other financial returns was up by EUR 40 million. This is mostly due to the impact of the new IFRS 16 standard, which represented EUR 27 million, and also because in 2018, we benefited from EUR 9 million positive one-off. It means that the additional interest costs linked to the funding of the Gemalto acquisitions is overall not material. Finance cost on pensions was stable, and so was our effective tax rate, just slightly down at 26.3%. Minority interest were down compared to last year on the back of the lower profitability in Space, leading to an adjusted net income group share of EUR 1.4 billion and an adjusted EPS of EUR 6.61, both up by 19%. Moving on now to slide number 13. Let's have a look at the conversions of EBIT into free operating cash flow. The usual recurring items were up versus 2018. Financial interest increasing from EUR 2 to EUR 37 million in 2019, mostly because of IFRS 16. Income tax paid EUR 154 million in 2019 versus EUR 91 million in 2018. Equity affiliates, which corresponds to the gap between our share in the net income and the actual dividends we receive from them, represented a negative EUR 60 million. We remain very selective with CapEx projects, resulting in a global balance between CapEx and D&As. Once again, the swing factor was a change in working capital requirements, which represented a EUR 341 million headwind in 2019. It included positive and negative one-offs that I am going to describe in a minute. Other cash items not included in the EBITs, such as tax items related to Gemalto acquisition and IFRS 16 depreciations, amounted to a negative EUR 39 million. Now on slide 14, we still charge to help you qualify this strong free cash flow performance. On the left side, you see our reported cash conversions at 107%, on average, over the 2014-2018 period, which benefited from a favorable down payment sequence. You also see the 98% cash conversions in 2019 that I have just showed you. The right side, you see the same comparison based on amounts before one-offs, exactly as I presented them back in October during our last Capital Markets Day. The 2019 underlying cash conversions is at 105%, significantly above the guidance of 95% on average over 2019-2023. The cash action plan we put in place in 2019 has clearly allowed us to over-deliver on cash flow performance. Adjusting for the IFRS 16 impact on both adjusting net income and free cash flow, this underlying cash conversions comes to 91%, which is above the 2014-2018 average as well. To help you track these one-off effects, we have added a slide in appendix on the subject. In short, these one-off effects are smaller than expected, thanks to a positive EUR 200 million related to cut-off effects advance payments, which will obviously revert going forward. Let me finish on this topic by stressing that the unwinding of exceptional down payments will continue in 2020. There are roughly EUR 400 million left of exceptional down payments on the balance sheets at the end of 2019, and a significant portion of them should unwind this year. In a nutshell, a solid 2019 cash conversions ahead of our 2019, 2023 guidance, and some material reversal of down payments should be expected, in 2020. Moving on to slide 15, with a quick look at the evolution of our cash position. As expected, two major items take our net cash position from EUR 3.2 billion at the end of 2018, down to a net debt of EUR 3.3 billion at the end of 2019. The acquisition of Gemalto and also the application of the IFRS 16 standard. Excluding the impact of IFRS 16, our net debt at the end of 2019 would be EUR 1.6 billion to be compared to a EUR 2.5 billion of EBITDA. Interestingly, IFRS 16 adds some volatility to the net debt position, depending on the volume of leases that are renewed or extended. And in 2019, as we renewed and extended some important leases, the new lease debt amounted to EUR 299 million, clearly above the corresponding depreciation and impact on free cash flow. To finish, a word on the dividends on slide 16. This year, the board has decided to increase the payout ratio from 38% to 40%, which combined with the significant EPS increase, also driven by the Gemalto acquisitions, pushes the dividend up by 27%. This adds one major step up to the attractive growth trends you see on the chart. Adjusted EPS has been up 14% per year since 2015, and in parallel, dividend has grown faster, 18% per year. That is the end of this financial review. I am now turning over the call to Patrice, who will address our current strategy and guidance. Thank you, Pascal. Now I am on slide 18, turning to our strategy and outlook. This slide, which I have shown before, is just here to remind you that our roadmap for the coming years remains structured around the five key strategic priorities that we defined and explained back at the CMD in June 2018. Each of them represents a key contributor to the delivery of sustained and profitable growth. This morning, I thought it would be interesting, important, to focus on this year's strategic priorities, and I am on slide 19. As you see, I have listed three key focus areas. First, growth, second, operational performance, and third, space. Let us start with growth and moving to slide 20. I have already mentioned how 2019, and in particular Q4, was quite strong from a commercial point of view. This was, in the end, clear for commercial space, where we won three of the four tenders we had mentioned back in October, Eutelsat 10B, NileSat-301, and Amazonas Nexus. Our performance on the defense side was also very robust, with major wins in both Europe and emerging markets. This was in particular the case in the naval domain, with major projects won in the U.K., such as Type 31, in Spain, with the sonar suite on the F110 frigates. Emerging market orders were up 19% after a slow 2018, with strong growth in every region. Last but not least, France had another year of very good performance with a book-to-bill of 1.2, benefiting from the multi-year growth in the French defense budget. On top of these solid dynamics, we started to see the first revenue synergies with DIS, with already more than 20 CNG projects won. Turning to 2020, we will be able to capitalize on three drivers. First, while we always need to stay cautious on the timing of orders, of course, we see a robust pipeline of opportunities, including, in particular, the German MKS 180 frigates, for which we have been selected together with Damen and Blohm+Voss, and now await German parliamentary approval. Second, we are accelerating our sales transformation project. In practice, we have decided to combine our European and international development organizations, which on top of savings in terms of cost structure, will allow the teams to better focus on growth areas. In terms of sales organization, we are progressively moving to a strategic account management, SAM model, which supports a closer and more focused management of key strategic accounts. Also in line with our ambition in services, the teams will put an extra focus on targeting servicing opportunities on our installed base, which is sometimes very large. Third, we will benefit from the further ramp-up of revenue synergies with DIS, which strongly enriches our digital positioning. Altogether, the solid order intake dynamics we have seen in 2019 and its expected continuation in 2020 pave the way to sales growth acceleration from 2021, in line with our medium-term guidance. Now on slide 21 with our second priority, operational performance. The development of a performance culture is at the heart of our strategic plan, Ambition 10. The chart on the left is a good illustration of what we have achieved on this topic in the past two years. It shows the improvement since 2015 in terms of both gross margin and G&A expenses as a percentage of sales. Since Gemalto comes with a higher gross margin than the rest of the group, the 2019 figures do not include it. Evidently, gross margin aggregates many drivers on top of operational performance, such as value pricing and increased project selectiveness. Still, these improvements, which total 2.9 points over four years, clearly show the material impact these operational performance initiatives have had on profitability. Going forward, the teams continuously add new actions to the portfolio of initiatives. For example, looking at procurement performance, 2019 was the first full year of implementation of our new global procurement organization, which was launched in April 2018. This organization delivered clearly a step change in terms of procurement massification, with over 30% of the spend now concentrated on strategic suppliers, compared to 5% or 10% before. Over 2018 and 2019, it carried more than 60 so-called product conventions, in which cross-functional teams rigorously optimized the value of a given product. Turning to engineering competitiveness, we are ramping up our engineering competency centers in Romania and India, targeting almost 2,000 engineers in these two centers by 2021, compared to less than 500 in 2018. To accelerate the deployment of digital engineering best practices across the group, we have decided to put in place a single leadership for both the group engineering function and our so-called digital factories. Support function efficiency continues to benefit from additional platforming and the extension of shared support services, such as in accounting. Finally, as mentioned by Pascal at the CMD in October last year, we have launched a group wide cash initiative as we felt that this key value creation driver was not getting sufficient attention from the operational teams. Moving now to the final 2020 key priority, space. Let me start with the commercial telecom side. In previous presentations, we have stressed how in 2017 and 2018, this market has faced a deep down cycle in terms of quarters, with a progressive recovery in 2019. This appears on the upper-right chart and has been a key driver behind the decline in space sales we experienced in 2019. Considering the solid long-term growth prospects in this market, we decided to accelerate R&D investments while implementing the necessary adjustments to our cost base with, for example, headcount, including contractors, down around 11% over two years. These R&D investments have led us to win significant market share in 2019. We had a 30% market share in terms of units and probably closer to 40% in value. As previously announced, we will further grow our R&D investments in 2020 to reinforce our product range with a new generation of fully flexible satellites called Space Inspire, which will strengthen our positioning in order to capture future market growth. Moving to the institutional and military markets, which generate more than two-thirds of our space sales, they continue to offer many domestic and export opportunities. In particular, last November, the European Space Agency Ministerial Council committed to its biggest-ever budget. 2019-2021 total subscriptions by member states are equivalent to a 6% per year growth in the European Space Agency budget, which will drive many opportunities for us. Now, moving on the outlook for 2020, I am on slide 23. You can find on this slide some perspectives on each of our segments. In particular, we expect that both space and transport sales will continue to face negative growth in 2020 on the back of the progressive recovery in commercial space and the ramping down of the four large urban rail contracts. Let me stress here that while my view on the group's business environment remains clearly positive in the medium term, considering the unchanged solid underlying trend in our markets, the global environment at the start of the year displayed several uncertainties. For example, the direct impact of the coronavirus outbreak on our market is currently low, but it is starting to cause difficulties to parts of our supply chain, especially for the DIS business. All this brings me to our financial objectives for 2020, considering the business environment that I just described very shortly. I am now on slide 24. With respect to order intake, we expect another year of strong commercial performance, driving a book-to-bill ratio above one. Based on February 2020 scope and foreign exchange rates, we expect sales to amount to between EUR 19 billion and EUR 19.5 billion. Thanks to the initiatives I presented earlier, we expect a further improvement in EBIT margin, reaching between 10.8% and 11%. At constant scope, this corresponds to a 20 to 40 basis point margin expansion. This concludes our presentation. Many thanks for your attention, and together with Pascal, we are now pleased to take your questions. Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. As a reminder, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the hash key. Once again, it is star one to ask a question. The first question comes from the line of Olivier Brochet from Credit Suisse. Please ask your question. Yes. Good morning, gentlemen. Thank you for taking the question. I would have three quick ones, please. The first one is on the free cash flow for 2020-2021. If you could give us a bit of more flesh around the moving parts and where we should be landing, if there is anything you can share there. The second one on the R&D and restructuring levels that you have included in the 2020 guidance, if you could also share some color. And third, on the payout at 40%, is that the level that we should be using going forward, and that you would be advising the board to serve to investors in the future? Okay. Good morning, Olivier. First question about free cash. I mean, we have a bit of time to guide you and certainly let me come back in 2019. Our level of free cash was above target, above guidance. First, I am very happy to report to you that overall, our cash action plans delivered even better than expected. First one, seven points. It is also true that the strong order intake in Q4 also clear help in terms of free cash flow generations with also, as we mentioned, a EUR 300 million positive impact of, I would say, cut-off advance payment from some customers. And last point, also and as expected, that in 2019, as expected, a progressive reversal of down payment that we cashed in a few years ago when we We have a technical problem on the line. Can you hear us? Yes, you can be heard. More in 2019 in terms of free cash flow and transitioning to guidance for 2020. First point, starting from our, I would say, expected net income, which if I follow the consensus, should be between EUR 1,450 and EUR 1,500. If we apply our typical conversions ratio, which is 95% Are we back online here? This one. I can hear you now. I think so. I think it's back online. Sorry for the technical problems. I hope connected. I guess, Pascal, if you don't mind coming back and resuming your explanation on free cash flow, which is an important question. Okay. I think everybody It was not made on purpose. Starting the communication on one bit complex topic, which is cash flow, with this technical problem is probably not- The ideal time. Hopefully, my explanation of the 2019 free cash flow was clear. I was trying to move to the explanation on 2020 and starting from our net income, which if I follow the today consensus, expected net income for 2020 is slightly below EUR 1,500 million. If we apply 95% conversions ratio, it should be around EUR 1,400 of underlying free cash flow generation. What is important to consider is that we still have today on our balance sheet, EUR 400 million of down payments related to a large export project that we signed a few years ago, and that should, for most part of it, get unwinded in 2020. A significant part of those EUR 400 million should get unwinded in 2020. Last point, which creates a bit more uncertainty, is the reversal of what I mentioned, the EUR 200 million advance payments cut-off effect. This is where there's, of course, more uncertainty, because yes, there will be reversal, but we might also have a positive advance payments end of 2020. Here, a bit of uncertainty. A level of free cash flow, if I put aside the reversal of the EUR 300 million, should be around EUR 1 billion. It's probably a good guidance for all of you. R&D and restructuring. With regard to R&D, overall, our intent is as planned. In our midterm target, is to keep growing our R&D, as a proportion of our revenues. It was the case in 2019, and will continue to be in 2020, driving us progressively to a level of R&D as a proportion of sales in the midterm that should be around 6.3%. Restructuring, probably a good rule of thumb is to consider a level of restructuring that should be around EUR 100 million plus for 2020. Payout ratio, Patrice? Well, one word on the payout ratio. Clearly, when we tackle this topic at the board level, looking at first all the, I would say, past operational performance improvement and looking ahead, the discussion was extremely smooth and easy to come to this conclusion to augment the payout ratio. It's also a clear sign of confidence from our board about the future profit and cash generation of the group, of course. 40% now. For me, but I don't want to pre-empt future decision of the board, of course, as you all know, but for me, it should constitute a new floor in terms of payout ratio looking forward. Next question. Oh, my God. Can you hear us? Operator? Can we move to the next question? Yes, I can. Okay. Yes, sure. Next question. The next question comes from the line of Tristan Sanson. Please ask your question. Yeah, okay. Good morning, everyone. Thanks for taking the time for my question, and thanks for your patience in giving these answers. First question is a quick point of detail on the DIS, the net integration cost. You said that you had lower cost than initially expected, that you had higher cost on the divestment of HSM. You are talking about EUR 30 million of impact. I am not sure what this EUR 30 million is, so if you could detail that would be helpful. Second, a follow-up on Olivier's question on R&D. I am not sure to have understood exactly when you want to reach the 6.3% of sales on the R&D to sales ratio. But if you could refine the type of EBITDA win we should get for 2020, that would be useful. Maybe a third one would be on Naval Group. Maybe if you can give a bit of color on the debate around the Australian submarines execution. We know about the few weeks of delays on the first milestone. We heard comments about the political debate and the dispute around this contract. How do you monitor yourself this execution risk in your portfolio? Thank you very much. Okay. Good morning, Tristan. If I understood well, your first question was about some detail on this EUR 30 million of integration cost associated with the Gemalto acquisitions, right? Mm-hmm. Yeah, exactly. I mean, behind that, it's both a few integration costs, like for instance, IT costs, this type of things. But also, and primarily, restructuring costs in order for us to deliver on our synergies. Those are essentially labor cost-related restructuring costs. Overall, this level of restructuring cost is below our initial view, and the reason behind that is quite simple. We managed to reclass Gemalto managers within Thales whose job was suppressed because of the integrations and our synergies delivery. What was positive was the fact that as Thales is recruiting a large amount of employees on a yearly basis, we took advantage of open positions within Thales to reclass a number of good quality Gemalto managers. Second question was about If I may, just on the first one, to be clear, I just wanted to know whether this figure also included the reorganization of the HSM business following the Gemalto acquisition. Yes. Of course, I mean, the cost associated with the merger of the ex-Gemalto and ex-Thales, in particular, cybersecurity, HSM, data encryption business. Those costs were part of the EUR 30 million. That's just. Now, with regards a level of R&D as a proportion of revenue. So first, if you take our 2019 R&D to revenue ratio, it was 6%. Now, this was based on just nine months of Gemalto. If we are taking into account a 2019 pro forma, including 12 months of Gemalto, our level of R&D in 2019 would have been 6.1%. And you know what I mentioned, what I recall was that overall, our view in the midterms is to reach a level of R&D representing around slightly above 6.3%. This is the midterms. Now it means that for 2020, we believe that overall, our R&D expenses should represent between 6.1% and 6.2% of our sales. Naval Group. I can take this one. Naval Group is in charge, not Thales. First, so several facts to have in mind regarding this contract. First, this contract is a complex, long-term, and multi-goal one. That's a fact. It's not new, by the way. Nothing new. Complex because there is a relationship between Naval Group and Lockheed Martin on one hand. Long-term, it will last several decades. When I say multi-goal, it's because first you have to fulfill, I would say, operational capabilities, but also to fulfill what is called AIC, Australian Industrial Content, and so on and so forth. This is a starting point, and this is not new. This is known from the very beginning. Secondly, and this is a fact as well, the contract has not come in one single big contract. In fact, so far, Naval Group has booked, I would say, several small contracts, very small contracts, to start the early phase of development. The contractual mechanism is quite protective for Naval Group, because it's quite similar to a cost-plus contract. Third point, the management of Naval Group reports, let's say, regularly or several times per year to the audit committee of Naval Group board, the progress on this contract. Recently, they have told us that what you have heard from Australia had nothing to do with, I would say, technical difficulties or delays, because a few weeks of delays over a contract of several decades is clearly not material or negligible. But more, I would say, a political dispute in Australia. That's what we have been reported by Naval Group management. Okay. Thank you for your answers. Okay. Thank you. The next question comes from the line of Andrew Humphrey from Morgan Stanley. Please ask your question. Hi. Thanks for taking my questions. Just a couple, if I may. Firstly, can I get you to distinguish a bit between the EUR 400 million that you talk about being prepayments that you are expecting to unwind in 2020, or most of which you are expecting to unwind in 2020, and the additional EUR 300 million of cut-off items where there seems to be a little bit less clarity and a little bit less certainty. Can you talk about why that is the case and maybe talk in a bit more detail about what those cut-off items are? My second question is on space. You talk about developing a new generation of flexible product in satellites. Can you talk about when that might be available, what it is that has led you to undertake that development, were there concerns on market share or just a view on how the market is going? How that will sit compared to your current product range? Okay. On your first questions, on one side, we have the reversal of down payments relating to large size defense export project that was awarded back, in particular, in 2015. We already communicated quite extensively on this matter, explaining that those large size defense export projects were very well-funded, with large down payments, which, of course, reverse as we execute those projects. So here, of course, we have quite a clear visibility in terms of the sequence of reversal of those down payments. End of 2019, we have here a remaining balance of EUR 400 million. This, we have quite a clear visibility. On top of that, we have more in cutoff of advanced payment from some clients, which by the way, is quite a good news, with our clients, in some cases, deciding to pay us a bit ahead of the expected due time. All of that is positive. This is also our responsibility. When I was explaining our overall cash program in order to optimize cash flow generation at Thales, we ask also our sales force, our sales teams, to discuss with clients and to convince them to pay us as soon as possible. All of that is probably a bit more difficult to anticipate in terms of the sequence of reversal of those advanced payments. This is where I need to be a bit cautious because, as opposed to what I mentioned on the large size export program, down payments where we have a clear visibility in terms of reversal. On those, I said advanced payment cutoff, it is always a bit more difficult. This is, by the way, why we also communicate on our free operating cash flow before one-off, which is reported on page 31 of the presentation pack. You will see that year after year, we see a steady growth of our generations of free operating cash flow. Yet, I need to analyze that because of the nature of our business, with also down payments, but also some cutoff and advanced payments. We have some kind of volatility in reported cash flow generations. On a long period of time, I guess that you will agree with me on overall, a level of conversions ratio, which is overall pretty strong. In 2019, once we put aside those, I would say, the non-recurring items creating this volatility, the underlying conversions ratio of 2019 has been overall pretty good, 105%. If we adjust for the positive impact of IFRS 16, that will report, by the way, as opposed to many other companies. We provide you full transparency of the impact of IFRS 16. Our 2019 underlying cash flow generation, excluding IFRS 16, was slightly above 90%. Overall, pretty good level of performance. Patrice, Space Inspire. Yes, on Space Inspire. If you remember well, we announced the launch of this new generation of satellite back in September last year. It is not a scoop. It was disclosed during, I think, Euroconsult Forum in September 2019. This constitutes a real breakthrough. This is really a new breed of satellite, because this new generation will be fully flexible. What does it mean by fully flexible? It means that satellite operators will be able to reconfigure the mission of the satellite in orbit, which is so far absolutely impossible. Switching a given Space Inspire satellite from a broadcast mission to a pure telecom mission, for instance. This satellite, to be fully designed and developed, will take a few years, as usual in this domain. Of course, the sales and marketing campaigns have started already. We have had many positive feedbacks and signs of interest from many satellite operators. 2020 could be, I say could be, not will be, but could be, could see, sorry, a first order of this Space Inspire new breed of satellite. Okay, Andrew, does it answer your questions? Yeah, that's great. Thank you. Thank you very much. Thank you. The next questions come from the line of Harry Breach from MainFirst. Please ask your question. Yes. Thank you for taking my question. Morning, Patrice. Morning, Pascal. Shall I ask maybe three slightly different ones? Firstly, just thinking about defense and security. I think in the second half of last year, which was maybe a slightly more normal picture, the EBIT margins there are about 13.4%. Is that a sort of reasonable, sustainable margin rate you think for the business going forward? Secondly, just wondering in terms of tax rate in France, can you give us any sense of whether you expect overall for Thales Group, how you expect your tax rate to change this year and maybe going forward? Finally, just maybe on the transport side, just if you can give us your thoughts about scaling that business given the Alstom-Bombardier transport transaction. Thank you. Okay. Good morning, Harry. You can thank you again. You have run your math and ending up at 13.4% of EBIT margin in H2 2019. I have to concede that I have not made this calculation on my own, but I do trust your own calculation. Is this level of margin the type of long-term recurring margin that we expect from our defense and security business? I will come back to what we shared with you a few months ago at our Capital Markets Day, where, if my recollection is correct, I guess that we guided you more to a level that should be between 12% and 13%. Now, do we expect a level of 12% to 13% in 2020? The answer is no. We expect EBIT margin for defense and security in 2020 to be above this range. Will it be at the level that you mentioned? I guess this is maybe a bit optimistic. But once again, it is 2019. As I said many times, all planets were fully aligned in our defense and security business. Of course, when we provide guidance, we need to be a bit more cautious. My view, for 2020, is that we should be at the upper part of the 12% to 13% range. Will it be 13% plus, 13% minus? At this point, a bit too early, but there is nothing negative I can report to you on our overall defense and security business in 2020. However, and considering that 2019 was great in terms of executions, let us be a bit cautious when we guide you. Tax rate, it is quite simple in France. In 2020, for the first time, we will benefit from a first reduction in the overall tax rate in France that should move from 34.4% down to 32% in 2020, with a trend which has to be confirmed year after year by the French government. That should lead us to a level of tax rate in France that should be at 28% in a few years' time. When we put this drop in the tax rate in France and considering where we pay tax at Thales, overall, probably a good guidance for you in term of tax rate for Thales in 2020 is probably something between 25% and 26%. So slightly below what it was in 2019. Transport, Patrice? Well, on transport, a couple of thoughts on your question on Bombardier and Alstom, the potential merger, what they have announced. As you know, we are a pure signaling player at Thales, and Bombardier is not, at least in terms of size, a first-tier player. Their signaling business is roughly around EUR 700 million or dollars, I don't remember. Euros. EUR 7 million. EUR 700 million, sorry. EUR 700 million in terms of sales. So it's not a big business. As a consequence, the combination between this signaling business and the one of Alstom clearly does not constitute a game changer. Let's remember that Thales is now the second-largest player worldwide in this signaling business, with a level of sale of around EUR 2 billion. So clearly, we have no concern in terms of size in this business. Perhaps last element you should always keep in mind is the fact that this signaling business belongs to a group worth EUR 19 billion, which brings a lot of technologies coming from outside the pure signaling business of Thales. Let me give you two or three example. Cybersecurity. We leverage, clearly, cybersecurity expertise. It's a business of now EUR 1 billion at Thales. We leverage all this business, all this competence to the benefit of our signaling business. Second example, IoT, coming from DIS acquisition. Rail IoT is clearly a future revolution for rail operators or ground transport operators, and clearly our GTS business leverage IoT competencies coming from DIS. Third one, and I will now stop there. AI, artificial intelligence. We leverage AI R&D centers of competence coming from the wider Thales to position our signaling business clearly as a leading player in terms of autonomous train, autonomous controls. In a nutshell, clearly it's not a game changer, and we have no concern as a pure signaling player on this merger. Great. Thank you very much. Thank you. The next question comes from Malini Usurper from Redburn. Please ask your question. Morning, Patrice, Pascal. A couple of questions from me. Firstly, on the transport division, what gives you confidence in achieving the medium-term margin ambitions? Is there any more risk of cost overruns, or have you really de-risked the contract portfolio there? Two, on your growth expectations for the defense and security division in 2020. What's that looking like given the really strong order intake you had in 2019 here? Then space, just another quick question here on the order pipeline, what's that looking like for 2020? Okay. Good morning. Good morning, Malini. On your first question about transport. As we mentioned, our 2019 financials were impacted by first, what was more investments, which was our competitiveness plan to move a significant part of our engineering base from Germany to Romania. It is a one-off restructuring cost that I put aside. Second, as we mentioned, on a very specific project, a safety incident that resulted in this program being put on hold, and some over costs, over one associated with this very specific project. When we go through our various project in term of quality of executions. Overall, it's pretty positive, which means that we are progressively putting behind us the executions of difficult project. We also see a level of margin on new order intakes that are in line with our midterm targets, in term of EBIT margin. In a nutshell, progressive rundown as expected of previous contracts in which we had in the past some difficulties, and that we are still running with a negative net margin. Second, on those project, overall, a level of execution that is in line with this re-baselining. Second, overall, our order intake with a level of margin and project execution, which is in line with what we expect in term of margin for the midterms. Defense and security, I have to say that I've not fully understood your question. Was it about growth? Our growth? Yeah. What's your organic growth expectations roughly in 2020 because of the. You had very strong order intake performance for that division this year. Okay. Yes, a strong level of order intake, book-to-bill, which is significantly above one. Also, and it is important, we signed in 2019 a few large size projects with With executions will be on a long period of time, and in particular, we signed large size MRO or maintenance contracts that provide us quite a long-term visibility, but not resulting in very short-term goals. When we put all of that together, you probably have in mind our mid-term guidance for this business that we shared with you at our Capital Markets Day. We said that it should be between 4% and 6% on average until 2023. We are clear about this level in 2019, with the level of organic growth that is in excess of 6%. 2022 will be lower. It's matter of fact. Will it be, I mean, low to mid-single digits growth? I mean, probably a good reference. We see that overall, the momentum is there. A lot of demand from our customers, with probably the only caveat is in emerging countries, and time to strike deals to get contracts being awarded, and that's something that we shared with you in 2019. In emerging markets, we have seen a clear increase in order intake in 2019, and in particular in Q4. But still, we see some of our customers taking time to make final decisions in terms of awarding contracts. Space visibility in terms of order intake. Patrice, well, can you comment if you wish, but as I said during the course of my presentation, yes, definitely looking at the institutional market, there is a, let's say, a robust pipeline of opportunities. I should say, or I could say the same, looking at the commercial sector. Now, you have a way to stay a bit cautious because the pipe is one thing. The fact that, and typically in the civil business, satellite operators take the decision at the end of the day to invest, it's another thing. So that's why we say on the mid to long term, we are clearly positive on this business because the level of opportunities and the potential of this market is important, is significant. Now, the timing, will it be in 2020 or a bit later? It's always difficult to predict. So yes, on the pipe. Now, you should be cautious in terms of decision in 2020, because it's two different things. Excellent. Thank you. Thank you, Monique. Thank you. The next questions come from the line of Celine Fornaro from UBS. Please ask your question. Yes. Hi. Good morning, gentlemen. Thank you for taking my question. I have two, please. The first one would be on the transport division, where the execution seems to finally come through in H2. If I remember well, last year you said that you were slowing down a little bit, the growth voluntarily, if I can say that way, just to get on with the restructuring. How comfortable do you feel now? What are you thinking in terms of the order intake for 2020? Can you be slightly more, I would say, adventurous on that one? My second question would be regarding the Asian exposure of the group. If you could just maybe run us through, given the coronavirus situation, from aviation to Gemalto exposure, which in Asia is probably 20% of the old portfolio, and also on the transport divisions, and what are your thoughts there? Thank you. Okay. Good morning, Celine. On transport. We remain quite vigilant in term of order intake, which means that it is not because we have improved quite significantly the quality of project execution, that we are going to expose ourself in countries where we believe that the level of risk is not acceptable. We remain cautious. Now, of course, we analyze all the markets. We do our own analysis. We assess the level of risk, the level of competitions. It is project by project, country by countries, before making meaningful decisions. I'm not saying that we gave up hope in this business. What I'm meaning is that we are quite vigilant because we don't want to get trapped in the difficulties that we had in the past. Part of those difficulties, and we have been clear about that, was also some deficiencies that occurred in terms of execution. But part of the difficulties were also relating to lack of maturity of some customers, some countries, with also some difficulties to get protected from a contractual standpoint. So overall, keep focus on profitability, while of course trying to develop this business, but very much monitoring the overall level of risk project by project. Asia, so overall, Asia to a large extent represents, for Thales, overall 14% of Thales' share, but this is in the global Asia. Now, when we look China is a small country for Thales in term of countries by destinations. China represents only 2% of Thales revenue. So overall, it is not, I would say, the issue with regard the coronavirus. Where we are vigilant is more on, I say, the side effects, and probably there are two items that we are tracking. One is side effects on, in particular, the overall avionics business. In particular, in term of course, the impact of the drop in traffic on the aftermarket business. Because there will be impact. It is quite obvious on our avionics business. Also probably, we could consider that some airlines might decide to postpone investments, for instance, in term of IFC or connectivity business, considering what they need to go through in term of difficulties on their own business. And second side effect, and this is what Patrice started to mention at our DIS business, some difficulties in the supply chain. In particular, when it comes to providing some electronics modules or parts, where we see today some that, at this point in time, quite limited disruptions in our supply chain. So all of that to tell you that overall, probably Thales as a group is probably one of the least exposed company to the coronavirus difficulties, and in particular, because of our strong presence in defense. Having said that, what we are sharing with you today is, yes, our view of a limited impact of this crisis, but of course, all of that being based on the current situations. Thank you. Thank you, Pascal. And sorry if I may, but just on the follow-up on the first question, so the book to bill for the year or the order intake for the year on transport, you would still expect some decline there? I don't want to be that specific, Celine. We'll see. It's not what I'm trying to drive you to. I don't want to be more specific, but I'm not telling you that today we believe that the book to bill for transport will be below one, so we'll see. Thank you. Okay. Thank you very much. The next question comes from the line of Milene Kerner. Please ask your question. Yes. Good morning, Patrice, Pascal and Bertrand. Thank you for taking my question. I just have one, please. Could you tell us what is the impact of the lower wide body production for your avionics and the in-flight entertainment business medium term, please? The impact of the lower rate of the- Wide body? Of the wide body, Airbus wide body. Airbus and the 787, please. For the in-flight entertainment. It's not measurable. There is no connection. Overall, our IFC business is not directly connected to the production outputs of the narrow body or of the A350. No, I don't see a direct impact. Where we have seen in 2019 an impact, and on which we have been a bit vigilant is, as you know, some difficulties at Airbus to ramp up the production of the A321 extended long range or extended range. So this is where we might have a bit of an impact, but the impact of the overall IFC business is, for me, it's probably not measurable. One second, where we are probably more vigilant is to which extent the coronavirus crisis could affect decisions from airlines to invest in the new generation of IFE in 2020, which is where we need to be probably a bit more vigilant. Okay, thank you. So limited impact from A380, A330, and A350 production coming down on the commercial avionics in 2020 then? Bertrand, you want to- No, yes. Well, of course, mechanically, if the wide-body production is revised down by Airbus, if you take EUR 1 million per ship set, let's say an average value, if you cut your forecast for production by 20, EUR 20 million. That's not very material. Okay. Thank you. Okay. Thank you, Mylène. Maybe a last question? We have no further questions at this time. Please go ahead. Okay. If there are no further questions, let me conclude this call by stressing again that we remain focused, of course, on the implementation of our Ambition 10 strategic plan, which will continue to deliver profitable growth for the years to come. We all look forward, Pascal and myself, to seeing you in our upcoming roadshows in Paris, London, and in the U.S. Have a good day. Bye-bye. Thank you very much. See you. Bye-bye. Bye-bye. Thank you. Ladies and gentlemen, if you didn't have to ask a question on today's call, please do not hesitate to send your question to Thales Group investor relations at ir@thales.com, and we will get back to you as soon as possible. Thank you all for your participation. You may now disconnect.