Earnings Call: Q4 2016

Feb 28, 2017

Ladies and gentlemen, welcome to the Thales Order Intake and Sales at 30 September 2016 conference call. I now hand over to Mr. Bertrand Delcaire, Head of Investor Relations. Sir, please go ahead. Yes. Good morning. Welcome, and thank you for joining us for the presentation of Thales 2016 full year results. I am Bertrand Delcaire, the Head of Investor Relations at Thales. With me today are Patrice Caine, Chairman and CEO, and Pascal Bouchiat, CFO of Thales. As usual, this presentation will be in English and followed by a Q&A session. It is webcast live on our website at thalesgroup.com, where the slides, press release, and consolidated financial statements are also available for download. A replay of the call will be available as from tomorrow morning. With that, I would like to turn over the call to Patrice Caine. Good morning. Let us start on slide 2. First, let me start with a few words on the trading environment in our key markets. Let us start with aerospace. The momentum in cockpit avionics remains good. In our case, driven by the increases in production rates at Airbus, both narrow body and wide body, on which we have an increasing exposure. IFE also remains very dynamic, with strong interest from airlines, not only in new generation IFE systems, but I would say also more and more for internet connectivity solutions. If we turn to space activities, I think it is important to make a distinction between the institutional and military segments on one side, and the civil segment on the other side. The institutional and military segments, which represents around 60% of our sales, remained solid, while civil telecom is more volatile. In all segments, we see strong interest from customers for more innovative solutions, such as HTS, high-throughput satellites, or constellations on which we have, as you know, a leadership position. The dynamics in transport is unchanged, driven by further growing urbanization in emerging markets, and second, by the upgrading of existing systems in mature markets. We continue to see a robust demand from both regions. Finally, defense and security. The context has not changed in the past few months. We are all aware of the higher level of geopolitical tensions, driving higher defense budgets in many countries. It is, of course, too early to have a clear view on the impact of the Trump administration on global defense budgets and the recent announcements. However, what priorities of a new government will have in France also, but we do see an inflection point with a broad political consensus in most NATO countries in favor of increasing defense budgets. One word, perhaps, on the security market also. The topic of cybersecurity, if not cyber war, has gained further interest in the past few months. Taking a step back, what I find quite striking, beside the inflection in defense budgets I have mentioned, is how in all our market segments, customers are showing a strong interest for digital solutions. Digital technologies, which are now so obvious in consumer markets, are clearly now arriving in the B2G and B2B markets that we serve. I will come back on this topic later in my update on our strategies. Moving to slide 3 now. In this context, our 2016 results are very much in line with our strategic roadmap. First, the order intake is quite robust and slightly above our expectations. 2016 is the third year that our book-to-bill is significantly above 1, which pushes our order book up to a record of EUR 33.5 billion at 31st December 2016, improving our visibility on sales for the coming years. Second, looking at sales. While sales growth is not only particularly strong, +7% organic, but also broad-based with all segments contributing. It confirms the inflection of the group's sales trajectory that we started to experience in 2015, a key strategic priority. This top-line growth was not achieved at the expense of profitability, which is improving well in line with our midterm objective. More broadly, last year, we have made good progresses on the deployment of Ambition 10 in all its dimensions, be it growth, competitiveness, or talent. I will, of course, come back on these topics later. Altogether, the key message for me is that these results are a good demonstration of our ambition, continuing to deliver profitable and sustainable growth. Now moving to slide number 4. This slide summarizes in a few charts our key figures and indicators. At EUR 16.5 billion, our order intake remained very high. Book-to-bill was above 1.1. On an organic basis, it was down 11% compared to the record level we had in 2015. Sales increased by 6.8% in line with our upgraded guidance of slightly above mid-single digits. This performance was broad-based, with all segments recording organic growth of at least 5%. EBIT. EBIT reached EUR 1,354 million, up 11% on a reported basis and up 15% organically compared to 2015. The EBIT margin was up 50 basis points compared to 2015, with all segments contributing here again. This progression puts us on a good path to achieve our midterm EBIT margin target. Adjusted net income. At EUR 897 million, adjusted net income was up by 11%, and our free operating cash flow was particularly strong, EUR 954 million, benefiting on top of the strong EBIT performance I just mentioned, of the prepayments received on contracts, including the Rafale in India. Pascal will come back on this later on. Finally, this strong financial performance has led our board to decide to propose to the next AGM an increase of 18% in our dividend at EUR 1.60 per share. After this brief overview, I now hand over to Pascal, who will comment our financial results in greater detail. Pascal? Thank you, Patrice, and good morning to everyone. I am now on slide five, focusing on our commercial dynamics in 2016. As Patrice mentioned, we achieved a solid order intake last year of EUR 16.5 billion. This was the third year in a row that we achieved a book-to-bill significantly above one, the fourth that it was above one. It was at 1.02 in 2013, demonstrating that the focus that we have put on growth in the past three years is delivering. As expected, it is lower than in 2015, which was, as you remember, a bit exceptional in terms of order intake, with a record of volumes of large contracts with a unit value over EUR 100 million, for a total of EUR 7.9 billion. This is the gray area in the middle of this chart. Large orders remained quite dynamic in 2016, with 14 contracts for a total value of EUR 4.7 billion. We find in the appendix a list of these 14 contracts. Among them, of course, we had a real jumbo, the Rafale in India. As indicated on our previous call, let me remind you that the value of this contract is in the range of EUR 1.5 billion to EUR 2 billion. Compared to 2014, orders were actually up 15%, including a very solid growth in small orders below EUR 10 million. One more comment on orders, which gives a good sense of the inflection we have experienced since we launched the current strategic plan. At the end of 2016, our order book reached a record EUR 33.5 billion. This is not only EUR 1.2 billion above the level at the end of 2015, but also EUR 9.1 billion above the level at the end of 2013. Moving on to slide six and looking at sales now. As usual, we focus on organic sales growth, i.e., excluding scope and currency effects. As a reminder, the scope effect was quite small in 2016, EUR 76 million, mostly due to the integration of Vormetric, which was, as you remember, effective from March 2016. The currency effect was larger, negative EUR 192 million. It was dominated by the weakening of the pound against the euro. As Patrice already stressed, one of the key messages of this year's results is the strength of our organic growth, +6.8% after 4.5% in 2015. How did we achieve this? We will look at each segment in a minute, but at this point, I wanted to stress the geographic split of this growth. As shown on the chart, emerging markets, a key focus in our strategy, have continued to deliver strong sales growth, +14% after 12% in 2014 and 16% in 2015. The novelty is a return, of course, in mature markets. In 2015, we had managed to record a small growth there, +1%. It has now accelerated to a healthy +4%. A brief word on Q4, as some of you may be surprised to see a slight negative growth in this quarter, -0.7% organic, even though we made it clear when we published our Q3 sales. You might wonder if it shows some sort of slowdown in our activity. The answer is clearly no. This is purely driven by cut-off effects, which translate into a very strong Q3 and a strong base of comparisons in Q4 in two of our three segments. Moving on to slide seven, which summarizes our adjusted P&L. As mentioned already, EBIT was up 11% year-on-year and 15% organically. The EBIT margin was up 50 basis points from 8.6% in 2015 to 9.1% in 2016. Looking at the P&L, there were two drivers to this 50 basis point improvement and one headwind. First, gross margin increased by 30 basis points from 14% to 14.3%. Second, we managed to reduce indirect costs by the equivalent of 30 basis points, keeping R&D expenses stable as a percentage of sales. Third, the headwind refers to equity accounted affiliates, which were down by EUR 21 million, excluding DCNS. This reduction was due to a scope effect, namely the disposal we recorded last year on our stakes in two JVs. One we had set up with Hanwha, and another one that we had with Hanwha, serving the Korean defense markets. On an organic basis, you see how the share of net results from equity accounted affiliates was slightly positive, and the contribution of DCNS was strongly up from a low base. Slide eight illustrates even more clearly these dynamics. Starting from the 2015 EBIT shown on the left. The mechanical effects of scope, currency, and pensions together weighed on our performance in 2016 to the tune of EUR 25 billion. The biggest of the swing parts was currency, again, primarily referring to the weakness of the pound against the euro. Scope, mostly the JVs that I mentioned on the previous slide, was also negative by EUR 30 million. Pension was a small tailwind, which will not be the case in 2017. At this point, we expect a pension headwind of around EUR 50 million in 2017. Which bring me to the middle of the chart. Our organic operational performance was particularly strong in 2016 at EUR 207 billion, driven by all our actions, combined with the recovery of our transport business. We continued to invest part of this operational improvements into R&D and sales and marketing, organically up respectively EUR 27 million and EUR 21 million. Moving on to slide nine. I will go through the performance of each of our segments in a minute. Just let me highlight three points. Aerospace and Defense and Security both continued to deliver a strong performance and are posting margin levels of about 10%. Both segments have already reached the 9.5%-10% level, which is our 2017, 2018 target at group level. Transport recovered back into a small profit in line with our expectations. DCNS continued to recover from its large 2014 losses. Its contribution to our EBIT was above our expectations, but you must keep in mind that like in 2015, its 2016 results included some positive one-off items. Therefore, we don't expect a significant improvement in its contributions to our results in 2017. Slide 10, a focus on our space segment. Starting with orders at EUR 5.9 billion, the order intake was down by 7%. Our in-flight entertainment business was particularly dynamic, recording a large order from Emirates. Our space activity kept a good commercial momentum, logically down on the strong 2015 figure. At EUR 5.8 billion, sales were up 7.9% on a reported basis and 8.5% organically. This strong growth was driven by three sub-segments. Aircraft avionics, with healthy growth from both civil and military platforms. Only civil helicopter avionics was down. Second was in-flight entertainment, and third was space on the back of its large backlog, with several large projects reaching important milestones in 2016, such as ExoMars, the spaceship that we built for ESA, and Iridium NEXT, whose first batch of satellites was put in orbit a few weeks ago. EBIT reached EUR 571 million, or 9.8% of sales, benefited from a good performance in avionics and space. This margin growth was, however, slowed down by two effects. First, an increase in restructuring expenses, primarily in our microwave and imaging system business. Second, a change in the way we allocate shared commercial costs to the different segments, which had a negative 0.2 impact on aerospace and a non-material improvement in the other segments. Moving on to slide 11 now. A few words on the situation in our transport business. First, the slowdown in order intake, which almost halved in 2015. This was expected considering that the exceptional order intake we recorded in 2015 with three large urban signaling contracts in Doha, Hong Kong, and London. Our 2016 order intake included another quite large order in the Middle East to supply innovative solution for the expansion of the Dubai Metro. Sales were up 8.3% on an organic basis. The strong recovery was driven by both the initial revenue recognition on the large urban rail contract we won in 2015 and the recovery of the executions on the contract that had faced challenges in the past. The return to a small profit, EUR 11 million, is in line with the expectation that transport would be at breakeven in 2016. It also shows that the operational recovery of this business is progressing well, but that the EBIT margin will take some time to recover, considering that loss-making contracts will continue to weigh on profitability until their conclusion. Moving on to slide 12. Last segment, defense and security. So, order intake in this segment remained high at EUR 1.1 billion. The 7% year-on-year decline simply reflected how exceptional the 2015 order intake was. The strong commercial dynamics has been feeding into sales, which amounted to EUR 7.4 billion, up 5% organically. Almost all business units had strong sales growth, with higher revenues, in particular from air defense, civil and military radars, equipment for fighter aircraft, and surface ship systems. Only infrastructure systems experienced a slowdown in sales with the end in 2015 of several large military network projects, including the Balard French MOD headquarters. On a reported basis, EBIT margin was stable at 10.7%. On an organic basis, notably correcting for the disposal of the stakes in two JVs I mentioned before, EBIT margin was actually up 30 basis points or so. So good margin dynamics in this segment as well, partly hidden by a decision to divest our stake in those two JVs. Turning to slide 13 now, a few comments on the items below the EBIT. Net financial interest and other financial results remain close to zero, as was the case in 2015. The finance cost and pensions was broadly stable, benefiting from the weakness of the pound. At 27.2%, our effective tax rate was slightly up. The increase was due to the recording of a one-off tax charge of EUR 18 million. This tax charge was triggered by a change in French corporate income tax rates as from 2020, which led us to remeasure our net deferred tax position. Excluding this item, our effective tax rate would have dropped further. Going forward, we expect our effective tax rate to be around 26% in 2017 and beyond. Minority interests were slightly up compared to last year, reflecting particularly the higher profitability of our space activities in JV with Leonardo. All in all, adjusted net income was up 11% and adjusted EPS by 9%. Moving on now to slide 14. Let's have a more detailed look at the conversion of EBIT into free operating cash flow. What were the key moving parts? The standard recurring items represented a little less than EUR 170 million. They included the financial interest paid, which amounted to EUR 8 million in 2016, driven, of course, by the high level of cash. Income tax paid was EUR 99 million, in line with 2015. Equity affiliates, which correspond to the gap between our share in their net income and the actual dividends we received from them, represented a negative EUR 58 million. As expected, our CapEx remain above our D&A. You see the numbers, EUR 472 million of CapEx, EUR 385 million of D&A. We are in a phase of higher investments, primarily to upgrade our information system and to further streamline our facilities. The change in working capital was a small negative, EUR 63 million. It benefited from the prepayments we've used on several export contracts. Other cash items, not including the EBIT, a negative EUR 85 million, were a mixed bag, the main items being related to Forex, restructuring, and pensions. Adding all these effects of free operating cash flow reached EUR 954 million, and the conversion of net income to free cash flow was above 100%. If we take a step back on this important topic of cash conversions, slide 15 shows our historical trends on this KPI. I believe it speaks for itself. On average, over the last six years, our cash conversion has been 102%. Of course, prepayment on export contracts and their reversal create some volatility in cash conversions. But our cash generation profile appears quite robust. These reversals will weigh on cash conversions in the coming years, but we expect to remain above or at 90% on an underlying basis. Moving on to slide 16 on the evolution of our cash position over the last 12 months and the use of our cash flow. Our net cash position on the balance sheet increased further in 2016. Besides the free operating cash flow that I just described, deficit payment on U.K. pension was down to EUR 88 million versus EUR 101 million in 2015, as a result of the weakening of the pound sterling against the euro. The acquisition of Vormetric was offset by the disposals of the two JVs I mentioned previously, and which have been done with quite a good price. Dividend payments amounted to EUR 297 million, in line with the increased dividends. At the end of 2015, our net cash position thus reached almost EUR 2.4 billion. To finish, a word on the dividend, slide 17. As you know, our payout ratio has been set at 35% of adjusted net income since 2013, when it was upgraded from 30%. This year, considering the positive momentum in our businesses and our confidence on free cash flow generation, our board has decided to increase the dividend to EUR 1.60 per share, which is faster than adjusted net income. This corresponds to a payout ratio of 37.6%. Put together, this makes for simple numbers. Adjusted EPS has been up 10% per year over the past five years, and in parallel, dividend has grown faster, 15%, and has, in other words, more than doubled since 2011. Now, I will turn over the call to Patrice to talk about our current strategy and guidance. Thank you, Pascal. Thank you. I am now on slide 19 with an update on our strategy and outlook. You have already seen many times this slide in one form or another. It shows you the ambition we gave ourselves at the beginning of Ambition 10 in 2013, early 2014, and the three pillars on which we have built our strategy. This framework, which has shown its strength in the results we just presented with Pascal, remains perfectly valid after three years of implementation. This is my first message. Our strategic focus is unchanged, equally balanced between growth and competitiveness initiatives, and of course, with significant ambitions on the people side as well. Let me first address our priorities in order to sustain growth in the long term. As you know, the first level of sales growth is the dynamics of our end markets. I am now on slide 21, which illustrates this point. As you remember, our portfolio is balanced equally 50/50% defense and 50% civil. First, starting with our civil markets. On the left side of this chart, we have shown the largest civil markets that we serve. Most forecasts expect them to grow annually by 2% to 4% over the next five to 10 years. Of course, some niches are expected to grow even faster, like in-flight entertainment or cybersecurity, above 8% or 10%. And some have been more volatile in the past two years, like the market for geostationary communication satellites or civil helicopter avionics. But broadly speaking, we have the chance, I would say, of having a portfolio of civil markets that are all well-oriented in the long term. Now if we turn to defense markets. As I briefly mentioned at the beginning of the call, the past few months have confirmed the trend we started to notice, I think it was in 2014. After several years of significant reductions in budgets, global defense procurement is now returning to growth. This shows in the forecast on the right side of this slide. Thales expects global defense procurement outside China to grow around 2% per year over the next three years, compared to a reduction of 1% per year over the previous four-year period. In terms of geographic exposure to this inflection, as you know, we are already very international in our sales exposure. When we look at our defense and security segment, 50% of our sales are in Europe, of which only 13% France and 40% are in Asia-Pacific and the Middle East, the regions with the highest forecasted growth in the coming years. In short, our business portfolio is already well-positioned to capture growth across a broad range of vertical markets, including defense. The second lever, slide 22, is the expansion into emerging markets. This is probably the most impressive achievement of our growth initiatives so far. Building on a sum of actions in terms of organization, of product policy, of competitiveness, of coordination with our partners, and so on and so forth. The two charts on the left speak for themselves. On average, emerging market order intake has been growing by 20% per year since 2012. Emerging market sales have been growing by 14% per year over the same period of time. The order intake momentum we show on the left, more than EUR 6 billion in both 2015 and 2016, will definitely feed sales growth in 2017, 2018, and beyond. The other KPI I wanted to share with you on this topic is the distribution of our sales in these markets. As you can see, they are very diversified with, for example, 15 emerging countries recording more than EUR 100 million of sales in 2016, including five in the Middle East and nine in Asia. In other words, we are not overexposed to a single country or to a single geography, and this definitely increases our resilience. Moving now to slide 23. The third lever I would like to stress this morning is the reinforcement of R&D investment. R&D innovation is at the heart of Thales, and it remains a key differentiator in our markets. Once again, a few months ago, we were recognized as one of the Top 100 Global Innovators with only three other aerospace and defense companies. Considering the opportunities to sustain long-term sales growth thanks to increased R&D, we have decided to grow our self-funded R&D effort as quickly, if not slightly faster than sales. This is what we show on the chart. For 2017, this will approximately correspond to a 25% increase in our self-funded R&D budget compared to 2013. As a reminder, our total R&D expenses are significantly higher, probably above EUR 2 billion, when you include customer-funded R&D. At the same time, we are aiming to further focus on these R&D investments on what we call internally dream products, with global leadership potential like very high throughput satellites, software-defined radio, new generation avionics. Second, on breakthrough innovations, and third on disruptive digital initiatives, and I come back on this topic in a minute. Now I'm on slide 24. The fourth growth lever I wanted to come back on is the digital transformation. As I mentioned in my introduction, we are seeing a strong interest from our customers across all of our market segments for this theme. We believe that we are particularly well-positioned to address and serve their needs in this area. But why? Well, first, because we are what I would call digital by nature. The nature of our products, typically based on advanced sensors, real-time processing, secured information systems, and telecommunications, means that 80% of our engineers are already working on digital topics. This explains why we have already built a broad expertise in the application to our markets on the four core digital technologies. Let's look at them one by one. First, I see connectivity. Connectivity, which is the base for mobility and the Internet of Things. Second, I see big data and data analytics. Third comes artificial intelligence. And fourth, of course, cybersecurity, which clearly is a must-have once things become connected and digitized. How does it translate into practice? I suggest that we go now onto slide 25. In terms of application, I will make a distinction between incremental and disruptive innovations, between the situations where digital technologies help us enhance products and when they allow us, with our customers, of course, to create new usages. The challenge of autonomous train is a good example of this. Most of you have probably already taken a driverless metro. Thales was, by the way, a pioneer in offering the signaling solution for this, and is the global leader in this field, having designed a solution for more than 30% of driverless metros in the world. But today, there are not yet any autonomous trains. But we are already working on the next generation signaling standard, which will allow us to implement this new challenge. Unfortunately, we do not have time to go through all the other examples on this slide, but we are working on many other breakthrough innovations, such as our stratospheric balloon project, Stratobus, or the deployment of autonomous ISR, intelligent surveillance reconnaissance underwater systems, and many others. The last point I wanted to make on this slide is that as the digital transformation impacts our markets in different ways, we can build on the expertise in one vertical market to accelerate our digital innovations in another vertical market, driving increased synergies among our businesses. This week, we will hold what we call the InnovDays in Paris, and we will showcase to our customers, partners, stakeholders, the breadth and the scale of our innovations. You imagine that our group-wide digital expertise will be central to many of the demonstrations. This gives me a good transition to the last growth lever I wanted to address, M&A. I am now on slide 26. The primary focus of our acquisition strategy is unchanged. It is to accelerate growth in our core businesses. Quite often, considering the context I just described, this can be done through carefully selected digital acquisitions, strengthening our competencies precisely in these four areas I have just mentioned. This is what we illustrate on this slide. Let us look at it. In 2014, typically, we reinforced our connectivity capabilities applied to the in-flight entertainment with the acquisition of LiveTV. Without this transaction, we would not have been able to, first, build a partnership with SES in in-flight connectivity that we announced last year. Second, establish ourselves as a key player in this area going forward. Last year also, we did two small acquisitions to further strengthen our capabilities in connectivity and mobility. We acquired RUAG’s opto-electronics business line in order to complement our portfolio of connectivity technologies used in space applications. Its technology is particularly useful for satellite constellations, an area where a lot of growth is expected. The second small acquisition is AvioVision, which is a mobility solution for pilots and complements very well our digital cockpit solutions. In cybersecurity, we made also two acquisitions in the past two years, as reported on this slide. First, Alcatel-Lucent cybersecurity business, which definitely strengthened our business of cybersecurity operations center. Last year, we finalized the acquisition of Vormetric, which strongly complements our existing cybersecurity product portfolio in data protection and encryption. In the coming years, we will continue to look for attractive targets that can strengthen our presence in these areas, as well as in core digital technologies, big data and artificial intelligence, as well as connectivity and cybersecurity. Moving now to the second pillar of Ambition 10, which is competitiveness. I am now on slide 28. Back in 2014, we had decided to focus our competitiveness initiatives on four high-stakes topics, which are outlined here. So excellence in product delivery, which remains, of course, the first priority in a project business like ours. Second, engineering competitiveness. Third, efficiency of structure. Fourth, competitiveness in sourcing. Optimization across the group of each of the associated processes can bring hundreds of millions of EUR of efficiencies. A year ago, I described our engineering competitiveness initiative, which continues to progress well with, for example, 70% of our software engineers now using the Agile method, and almost 60% of our engineers using the group engineering IT platform, Orchestra. Let me update you on the two other topics, which will gain further momentum in the coming years. First, our procurement initiative, and I am now on slide 29. This is obviously not the first time that we look at procurement, of course. But the opportunity remains significant since we purchase around 50% of our sales, EUR 7 billion. On the right, you see a breakdown based on the nature of what we buy. This breakdown is useful to understand that the drivers of long-term competitiveness will be different for each category. For example, for systems and equipment or IT solutions, the key driver will be what is called design to buy or design to value, involving the procurement teams earlier in the design phase, so that we can define simpler specifications in partnership with our suppliers. For industrial purchasing, which refers to simpler components, the focus will often be more on centralization and global sourcing. With the help of outside consultants, we have now planned 230 targeted initiatives over the next two years, 2017 and 2018, and across all units. At this point, it's too early to give you a sense of the size of the potential savings, but they are quite significant, even if they may take time to materialize. Turning to the topic of efficiency of structure and support functions on slide 30 now. Over the past few years, we've made significant progress in terms of our industrial footprint. Just a few months ago, we have inaugurated a new site in Bordeaux, where we have brought together teams coming from three different locations. This project follows on what we have done in Vélizy, near Paris, in the Netherlands, in Stuttgart, Germany, and also in the U.K. In parallel, we have increased our IT investments, for example, to streamline the number of ERPs we are using, in particular in France, reduce run costs, and facilitate collaborative work. Now we are increasingly focusing on the transformation of our support functions. Where do we stand on this topic? On the right, you can see our past performance looking at P&L G&A expenses, which is only half or so of our support costs. The message is quite simple. On an organic basis, we have managed to keep G&A expenses flat, while sales have been increasing, especially in the past two years. In the past few months, we have further expanded our actions in this area. Every support function from HR to legal or finance, has been working on a transformation plan using internal and external benchmarks. The levels for this are fairly well known. Standardization, simplification, automation, and mutualization. Just like procurement, this sort of initiative does take some time to deliver its results, especially when it includes new IT systems that need to be deployed. But as you can see, we really remain focused on the constant need to improve our competitiveness. Last topic I wanted to give you an update on is the recovery of our transport business. I am now on slide 31. After 18 months or so of work, we can consider that our operational recovery plan is properly deployed. By and large, the challenging projects have been executed in line with the new baselines, allowing profitability to return to a small positive last year, as explained by Pascal. The very last contract we booked in 2015 to upgrade the signaling of 40% of the London Underground is well on track. As planned, final design has been approved by the customer, and live installation has started on both the Circle and District lines. The management team is now devoting its time to the transformation plan necessary to achieve higher margins in the midterm, and this plan includes some rationalization of the product portfolio, for example, for interlocking solutions, where we still have multiple country-specific systems. It also includes cost reduction, for example, through product redesign and supply chain optimization that I just described under the procurement initiative before. In parallel, and linking with my previous comments on digital technologies, we are now accelerating R&D and innovation investments in two main areas, railway digitalization and autonomous trains. Let me finish up with a view of where we stand with respect to our medium-term financial objectives. I am on slide 32. You remember that 12 months ago, we upgraded our sales growth target to a mid-single-digit organic sales growth on average over the 2016-2018 period. At this point, with 6.8% in 2016, we are a bit ahead of this target. With respect to profitability, the target that we set in 2014 was to improve by 1.5 to 2 points our EBIT margin using the 8% we achieved in 2013 as a base. With our EBIT margin of 9.1% in 2016, we have now achieved almost two-thirds of this journey. As I have tried to illustrate, there is still a lot of work ahead of us in order to achieve these targets, but we are so far perfectly in line with our midterm ambitions. Turning to 2017, what is our formal guidance? Let us look at slide 33. For 2017, we expect to benefit from the good dynamics in most of our markets. We foresee that our order intake will remain quite high, EUR 14 billion, but it will not reach the record level we had in 2015, 2016, which benefited, as you remember, from jumbo orders. The record-high backlog should result in a mid-single-digit organic sales growth like in 2015 and 2016. This positive trend, combined with our efforts to improve competitiveness, should result in an increase of around 9%-11% in EBIT compared to 2016, of course, based on current exchange rates, to reach EUR 1,480 million-EUR 1,500 million. Let me conclude by saying that in 2016, Thales delivered, again, a strong performance. On all three pillars of our strategy, we are leveraging a rich set of initiatives addressing both the short-term and the long-term. This is how we are building a trajectory of profitable and sustainable growth, and how we are delivering further value to our shareholders. This concludes our presentation with Pascal. Many thanks for your attention, and together with Pascal, I will now be pleased to take your questions. Ladies and gentlemen, if you wish to ask a question, please press 01 on your telephone keypad. We have a first question from Mr. Olivier Brochet from Credit Suisse. Sir, please go ahead. Yes. Good morning, Patrice and Pascal. I would have two questions, if I may, please. The first one would be on M&A. You are targeting areas where technologies and market cycles are clearly faster than what I would call traditional Thales. Thinking of that, can you maybe discuss a bit how Vormetric has been doing in terms of growth results compared to your expectations, and how the integration is progressing? That would be the first one. On the second one, when we look at defense growth in Europe, a large part of that may be coming from Germany, given their plans. How are you positioned to capture some of that growth in the defense and security areas, please? Shall I start on M&A? Okay. Well, on M&A, in fact, this question, there are two sub-questions. The first on Vormetric and more generally speaking on digital technologies that are moving quite fast, and you are right. On Vormetric, the integration plan has been, I would say, performed as expected. So I'm quite satisfied with the integration of Vormetric. In terms of acquisition business plan, we are perfectly on track, and Vormetric is really performing very well in this respect. So far, so good or so very good, if I may say. In terms of acquisition in this field of digital technologies, you're right that this field is moving very fast. But the good news, if not the very good news, is that, as I tried to explain, we, Thales, we know very well these technologies. We have already a good set of competencies in these four main areas I've tried to summarize. Connectivity, big data, artificial intelligence, and cybersecurity. So the good news is that we know what we know, we know where we want to go, and we know how to make sure that when we look at the target, the assessments of the competency is clearly a very clean and clear assessment on our side. Does it make sense? Yes. Is the technology robust? Yes. Is the cutting-edge leading-edge technology? Yes. So in this field, you can have confidence that we know where we are going to. On defense, Pascal? Yes. On defense, Olivier, good morning. I guess your question was in particularly directed to the potential of growing our business in Germany following the announcement that Germany would increase its overall defense spendings. That's right. Yes, as you know, we have a solid industrial base in Germany to serve defense. Where do we see opportunity? We see opportunity, in particular, in the naval domain. Germany is considering the development of a new class of frigate, and this to be quite attractive in term of business potential. Then, anything connected with secured communications, intelligence, surveillance, which, as you know, is part of our key assets. Last but not least, we think that there might be also an opportunity in the overall radar domain. This also, in particular because Thales, on top of our industrial presence in Germany, can offer to Germany systems solutions coming from other countries. A good example of that is combat management system on the naval business coming from our Dutch business which, by the way, works hand in hand with our German colleagues to offer the best of Thales technology. Opportunities, now it has to, because so far, we have seen announcements. It's so that now we need to see the practical implementation of those overall statements being materialized in a true increase in the German budget. If it happens this way, we think that we can take advantage of that. Thank you. The next question is from Mr. Antoine Boivin-Champeaux from Natixis. Sir, please go ahead. Yes. Good morning, Patrice, Pascal, and team. I have actually two questions. The first one is related to your 2017, 2018 EBIT margin guidance, which is unchanged. I really don't understand why you decided to keep it unchanged, because you delivered more than expected in 2016, 6% above if we take into account the pound and the M&A effect. Second, your operational leverage deducted from your EBIT bridge is probably 2.4 times, was in 2016, 2.4 times. If we just simply apply this one into your 2017 and 2018 numbers, we end up with an above 10% EBIT margin for 2018. Just some kind of clarification on that. My second question is on DCNS. You mentioned a one-off. Could you be a bit more specific on this one for 2016? Thank you. Okay. Good morning, Antoine. On our 2017, 2018 guidance, we have decided not to change it, as it's between 9.5%-10%. You need first to have in mind that in putting 2017, but it will extend to 2018, we also need to take into account some headwinds we need to be aware of. One is the drops in the British sterling, which already had an effect on 2016, but we had, I would say, just a half year's impact on this headwind. Second point is the full year impact of the divestitures of our two JVs, and in particular, our Korean JV, which by the way, have been quite an accretive disposal for Thales. Overall, we managed to divest our share in this Korean JV at an EBIT multiple of 20 post tax. Which means that, portfolio management and being able to crystallize value when it makes sense, those are things that we have been able to do in 2016. But we have seen an impact in 2016, and this will continue in 2017. Last but not least, the fact that, as we said, we anticipate a rise in the pension cost in 2017, and this will continue probably in 2018. With all of that together, take into account also the expected growth of the top line, and you have seen that we confirm the mid-single digits growth rate on average over the 2016, 2018 period of time. With all of that together, we think that keeping our guidance as it was a good decisions. And reminding a very simple thing, it is between 9.5% and 10%. DCNS, yes, a slight one-off effect, which is not an operational one, which is the post EBIT for DCNS, which relates to one half positive interest profits. And as we include in our EBIT the share in the net income of DCNS, we benefited in 2016 of this one-off effect, which is not that materially represent for Thales overall. So, contribution for Thales overall of this one-off event was between EUR 3 million and EUR 4 million, which is in our 2016 EBIT. So not that material effect, but still. Thank you. The next question is from Mr. Tristan Sanson from Exane. Sir, please go ahead. Yes. Good morning, everyone. Tristan from Exane. I have a couple of ones. The first one is on your acquisition strategy again. I remember you said in the past that you could afford one large acquisition per year, and when you said large, you were saying the kind of size you had for LiveTV, so about EUR 500 million per year. Now, in 2016, you had the acquisition of Vormetric, but also the divestment of your JV, so it only costed you about EUR 100 million of cash. Does it mean that you are ready to do larger acquisition going forward in 2017? Do you rule out at this stage anything larger than EUR 1 billion if opportunities happen or not? That's the first one. The second one, I wanted to have your view on the stakes of the French elections later this year, whether it's regarding defense spending or corporate tax evolution. What will you look at as an important indicator for the future of Thales? The third one, I wanted to have a glance on where are your progress on the evaluation of the impact of IFRS 15, and how do you want to communicate on that in the next 12 or 18 months? Thank you. If I come back on Good morning, Tristan. If I come back on the acquisition question. No, we keep on with the well-known now, I would say, strategy, with bolt-on acquisition. As of today, I see no need to look for, I would say, large M&A deals. What will happen in 2017, I don't know. For sure we are working to reinforce as I said, Thales, in some niche technologies. But we keep the same stance as you know and as we took a while ago. French election, honestly, if you know what will happen, we'll be very interested to have your views. On my side, I don't know, so it's too soon to say. We'll see. It's also another kind, I would say, of uncertainty that explained that with Pascal, we didn't want to move our guidance. We have a certain number of uncertainties that we have to manage or to deal with or to live with. In particular, the evolution of the French defense budget. You mentioned also the tax rate. It's another question. In fact, there are many others. In Europe, you have the French election coming soon. You have also some very important election in Germany also. It's still unclear what will happen in the U.S., and so on and so forth. So we'll see. Now it's our job, I would say, to make sure that at the end of the day, we deliver what we committed to in terms of guidance for 2017. On IFRS- 15 15. Yes, Tristan, IFRS 15. What we might do is to refer to page 43 of the presentation in the appendix, where we provide you with some high-level elements on IFRS 15. Two points that we need to have in mind in term of impact of IFRS. First, today, in most of our contracts, we're presenting a bit more than 50% of our business. The current IFRS allow us to recognize revenue over time as opposed to at a point in time, which is at the end of the executions of our contract. This is the first, I would say, challenge. To which extent will we be able to continue recognizing over time most of our contracts. Today, we believe that it will be the case. The second matter, once the first has been fixed, which means that yes, we will be able to continue recognizing revenue over time, then it is about the methodology to recognize revenue and profitability. It's true that today, we recognize revenue on the basis of technical milestone, which will no longer be permitted under IFRS 15, and we need to move from technical milestone to cost recognitions. Because of that, it might change the profile of revenue recognitions over time. One thing which is also a bit not easy to understand is that, for instance, the impact on our 2017 P&L will not be representative of the following year impacts. We need to get used to that. In term now of communication on the impact of this new referentials, we will be communicating with you once we release our H1 2017 figures. Probably in the fall of 2017, we'll be able to come back to you presenting our H1 2017 figures based on the IFRS implementations. Then, of course, when we release our 2017 figures at the beginning of 2018, in a year time, together with our 2017 figures, we'll provide you with treatments under IFRS 15, so that you can have a full picture of the 2017 figures under the new IFRS 15 methodology. That's a very clear plan. Thank you, Pascal. Thank you, Tristan. We have no further questions. Ladies and gentlemen, let me remind you that if you wish to ask a question, please press 01 on your telephone keypad. The next question is from Mr. David Perry from J.P. Morgan. Sir, please go ahead. Yes. Good morning, Pascal and Patrice. Two questions, please. One, I know that the term mid-single digits doesn't have to mean 5%, but if we assume it does mean 5%, I just wanted to check, because you're giving us a three-year average, and 2016 was 7%, and let's assume 2017 is 5%. Are you implying there'll be a slowdown in organic growth in 2018? Should we assume 3%, or do you think it can be 5%-ish again? Second, I just wondered whether you could give us any color on the U.K. defense market. You're a big player there, and obviously the government has a lot on its mind at the moment. I just wondered whether you'd noticed any delays in any contract decisions there. Thank you. Good morning, David. On your first questions about our top-line goals. We confirm our 2016, 2018 guidance. Mid-single digit top line growth on average over this three-year period of time. A mid-single digit, I would say is probably close to 5%, can be a bit more, a bit less, of course. It's true that, in 2016, we are a bit ahead of the expected run rate. This gives us quite a good level of confidence to achieve this overall target. We guided you quite precisely with regard 2017. 2018 is still a bit early to be more precise. Let's keep what we said. Overall, mid-single digit top line growth on average, over this three-years period of time. Yeah. If I can just follow up. Clearly, you are saying, and it is nice that for you, mid-single digit does mean 5%. We have some companies where it can mean 2%, but I think you are quite honest. No, I know you are quite honest with that. The implication of what you are saying is that your base case today is a slowdown in growth in 2018. At that time, a lot of the Rafale exports are ramping up. The global defense environment feels better. The civil market is probably better, to be honest, given some of the delays we are seeing in 2017. So I am just trying to understand, because you are going to is saying 3% for 2018, and I would have thought you could do 5% and maybe better. No, David, I do not want to be more specific, except to say to you that, for us, 2% or 3% is not what we call mid-single digit. So let us be more clear. For us, mid-single digit is probably between 4% and 6%. This is what we have in mind. Please also do consider that 2018 is not tomorrow. So, we are a bit cautious. There is no, I would say, hidden message behind what we say, except that we keep confirming what we said. Then, we will see what happen. It is a bit too early, once again, to be more precise for 2018. Defense in U.K., Patrice? Well, defense in U.K., I am not sure I got perfectly your question. I do not see any major evolution in the near future in the U.K. As far as Thales is concerned, we enjoy a good position in some key areas for the UK MoD. We also have a strong support from the UK MoD in terms of export from the U.K. And we have, I would say, many interesting products or systems that we are pushing on export markets from the U.K. So for me, the perspective, I would say, are positive. But it is not new. So did I get correctly your question, David? No, I was just wondering, because obviously the government has got a lot to think about with Brexit. And I just wondered whether you had seen any delays in the awards of defense contracts or decision-making. No, not at all. Typically, the bilateral programs between France and U.K., if I just take this small example, are continuing. The MMCM project between U.K. and France, related to mine countermeasure systems for the future, still, I would say, is highly supported by the U.K. and by France. In the U.K. per se, I've not seen any slowdown or change in terms of contract award. Overall, David, today, positive message from Thales about the potential consequences of Brexit. As Patrice Caine has pointed out, we don't see anything today. Second point that we also need to have in mind is that our business in U.K. is essentially a local business. We have quite a strong industrial base in U.K., 12 sites, more than 6,000 people there. It's predominantly a defense business. Our key customers is UK MoD, and quite a few interactions and flows between U.K. and the rest of the other businesses at Thales, which means that in case of potential implement installations of tariff or these type of things, we don't see for us any significant impact on that. So not significant flows between U.K. and the other Thales businesses, and quite a local business. Today, no any negative sign we get from our customers there. Very clear. Thank you. The next question is from Mr. Zafar Khan from Société Générale. Sir, please go ahead. Thank you very much. Good morning, gentlemen. Just needed clarification, please, Pascal, just on the tax rate for 2017-2018, if you can give us some best guess on that. Then I have a couple of other minor ones to follow. Yes, Jassa. Good morning first. Yes, it gives me the opportunity to come back to what happened in 2016. It's true that in 2016, our view was to have a tax rate between 26% and 27%. It ended up slightly above 27%, but for one-off item, which is a decision in France to drop in corporate tax as from 2020, which is quite a positive news, but which has an accounting effect in 2016, which is for us to remeasure the value of our deferred tax assets. So going forwards, I do think that 26% is quite a good proxy of the tax rate that we could expect in this company, which by the way, is down as compared to what it was even three years ago. We were more in the range of 28%. Today, we can confirm that 26% is a good proxy of tax rate that we expect today. Of course all of that based on the current tax situation in each country. As you know, things might change here and there, but today, this is what we have in mind. Okay. That's good. It looks like the Thales Alenia business did very well. In the minorities that you have there, the charge, is that mostly Thales Alenia? Is there anything else in that one? It's a significant part of our minority interest. We have in 2016 some other JVs. The bulk of it is our space business. I would say that minority interest are made up of something like 65%-70% of our space business. It's true that our space business has done quite well in 2016. Better volume, good project delivery, and a level of sales that went up in 2016. Yes, overall, happy with the space performance in 2016, both from a top-line standpoint and from an EBIT margin standpoint as well. That's very good news. Just as far as the top line is concerned, are you able to help us with the Thales Alenia sales? What was the sales number there? Uh- Do you have that data with you? No, but overall, if we take our overall aerospace business, the organic growth was in excess of 8% in 2016 versus 20% in 2015. I don't have in mind the specific figures on space, but you should consider that it is around double digits top-line growth. In space? Space. Yeah, that's- That's actually good. Yeah, it's excellent outcome. This on the back of quite a large backlog. You probably have in mind that 2016, in term of order intake for space was quite good. Yeah. Also, a book-to-bill above one in space in 2016, so all of that driving a good progression in the top line 2016. That is excellent, and hopefully that sort of double digit carries on, because you do have a very good backlog, I think, in that it has been order intake over the last two or three years been very good indeed. Yes. When we said that our backlog has increased a lot since 2013, it is true that space is a contributor of this increase in the backlog. So yes, today we see quite a strong level of activity in our space business, and this is positive. Okay. Just one for Patrice. I think it's in slide 2 or 3. You mentioned, Patrice, the inflection of defense budgets in Europe is confirmed, and I know you show the 2% increase. Do we have any hard evidence just by looking at the larger countries in Europe where we do have confirmation of defense budgets turning? Because there's a lot of talk, and I guess in the U.S. last night, we actually had some hard evidence with Mr. Trump asking for a EUR 54 billion increase. But in Europe, again, there's a lot of talk, and I know there's pressure from the U.S. for NATO members to up their spending to the kind of agreed levels. Do we have any hard evidence yet of this inflection? Yes, Zafar. If you just look at official budget or budget spendings in NATO countries, in Europe, you can see this inflection. So take France, you take Germany, even in the U.K., you take Poland, you take many countries. In fact, I think 23 out of the 24 NATO country in Europe have resume spending more or investing more in defense. So this is a real figure. It was, I would say, official test statements, but it has been translated into real figures. Now, when you look at the amount at stake, of course, it's very different from Germany to Poland in terms of absolute value. But for me, it's a reality. It's not anymore, I would say, just words or nice messages to please, I don't know, the environment or military people or people looking at this particular topic. Yeah. We saw that NATO estimating that in 2016, its members, including the U.S., would have increased the expenditure by about 3%. Yeah. But I couldn't really get the granularity on that, so maybe we'll just have to dig deeper. Thank you very much indeed. Thank you. You are welcome. The next question is from Mr. Tristan Sanson from Exane. Sir, please go ahead. Yes, good morning again. I have a few follow-up. I hope I am not preventing anyone from asking questions, so this will be short. First one, I wanted to have a view on the size of zero margin contracts you now have in your 2016 sales. So how many hundred million EUR are continuing provisions here? Second one is the book-to-bill at 0.9 guided for 2017 is probably the only part of your release that is a bit below the expectation of consensus. So how should we see that the fact that you are growing mid-single digit your revenues, but with a book-to-bill at 0.9, is it because you are going to have a continuing flow of alternance between book-to-bill at 1.1.2, and 0.9, so it is just lumpy? Or does it mean that you have a slowdown actually in the momentum of orders, and at some point, the top line will have to slow down as well? The last one is on the A400M, so heavily debated in that recent season. Can you remind us what development is left to be done on your side? How does the execution happen? I am not aware of any problem on your side, but I would be keen to get this reconfirmed. I would be interested in knowing if you have entered any talks with Airbus to renegotiate price or the burden of overruns as part of the ongoing negotiation. Thank you. Okay, Tristan. Good morning again. Your first question about zero gross margin contract, was it specifically on transport? I mean At group level. At group level. If you refer to the zero gross margin contract, on which we communicated five years ago, I would say that most of them are close to being completed. For me, it is not, in particular in 2017, no longer an issue in terms of gross margins. As opposed to overall, our transport business, where last year we mentioned that approximately 20% of our business was on the basis of zero gross margin, which by the way translate in something like -15% EBIT margin for this business. What we said is that it is still true. Of course, this will progressively drop until probably in 2020, 2019. So there will be, I would say, the progressive ramp down on those 20% of more sales in transport that we will see in the next two to three years to come. All of that, consistent with what we said, which is getting back to historical level of profitability in this business probably in 2018, 2019. That was your first questions. Maybe I could answer the A400M before leaving the floor to Patrice Caine on the other business, and in particular, the book-to-bill for 2017. A400M, no impact for us. We all know that Airbus announced additional charges in 2016. For us, we deliver our A400M program in line with the new baseline that we built back in 2011. Very much on track. Most of the development is behind us today, so I don't anticipate any, I would say, impact, and in particular, any negative impact coming from the executions of the A400M contract. You mentioned, are we negotiating with Airbus on this program? Of course, should we negotiate, I wouldn't inform all the investor community on that. This is business as usual. Once again, for you, please do consider that A400M for Thales is delivering on the new baseline that we built back in 2011. Book-to-bill- Thank you. 17. Yes. If I take your question on the book-to-bill, Tristan Sanson. First, let's keep in mind that we have had four years in a row, a book-to-bill greater than one. You have the sequence, I think on slide 5. You just missed the 2013, which was 1.01 in terms of book-to-bill, then 1.11 in 2014, 1.34 in 2015, and 1.11 again last year. As a consequence, we have, I would say, a huge amount of contracts. That's why this year, we showed, or we discussed, or we mentioned the order book, because the order book now is very significant at EUR 33.5 billion. It gives us a lot of visibility, and I think the guidance we gave in terms of sales growth as a consequence, is credible and should give you, I would say, a good level of confidence. Then coming back to the single question of the level of order intake for 2017. You know that in our businesses, honestly, it's not a given to really predict when jumbo contracts or large contracts comes and when we can book them. So this figure of we said around EUR 14 billion, as usual, exclude jumbo orders or jumbo contracts. As we did last year, and last year when we guided you on the order intake side, we gave an implicit guidance of EUR 13.6 billion. So you see it's the same, it's a bit better than last year, but it's quite consistent with what we said last year. Of course, if a jumbo contract comes, fine, but as of today, it would not be wise to say something else than what we said in terms of level of order intake. It is still a strong level of order intake for this year. And here again, looking at the order book, I would say for the years ahead of us, we have everything enhanced to deliver sales growth, as we said, Pascal and I. If I may, the new program for frigates for France to be launched formally in 2017, is baked in that guidance or you consider it as a jumbo contract? First, it's part of the figures. Okay. However, I'm not sure it's really a jumbo contract, because as usual, the French MOD will first, I would say, award a tranche ferme, and then you will have several, I would say, additional tranches which will come into force later on. So normally the first contract or the base contract will not be a jumbo one. Very clear. Thank you very much. We have no further questions. Okay. No further questions. Okay. Thank you very much. Maybe as a wrap up, I guess that you understood that we are quite happy with our set of results for 2016. We exceeded our guidance on all indicators slightly, but exceeding this guidance, whether it's order intake, top-line growth, EBIT, free cash flow generations. So of course, giving us quite a good level of comfort for 2017 and beyond. Of course, we'll have many opportunities to discuss in more detail all those figures in our roadshow. Thank you very much for having attended this call, and see you next time. Thank you very much. Bye-bye. Thank you. Goodbye. Ladies and gentlemen, this concludes the conference call. Thank you all for your participation. You may now disconnect.