Thales S.A. (HO) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to today's Thales H1 2021 Half Year Results Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today. I'd now like 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' H1 2021 results. I'm Bertrand Delcaire, the Head of Investor Relations at Thales. With me today are Patrice Caine, our Chairman and CEO; and Pascal Bouchiat, our CFO. As usual, the presentation will be in English and followed by a Q&A session. It is webcast live on our website at thalesgroup.com, where the slides, press release and the consolidated financial statements 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. So let's begin with Slide 2. As usual, let me start with the highlights of our H1 2021 results. First, the commercial dynamics were undoubtedly strong. Our order intake was not just significantly above last year, which was, of course, deeply affected by the COVID-19 crisis. It was also clearly above H1 2019, making it a record first half in terms of order intake. Second, as expected, both sales and EBIT rebounded materially from the heavy COVID-19 disruptions last year. Once again, the teams have delivered an excellent performance in terms of free operating cash flow significantly ahead of plan, and Pascal will explain it in more detail. Considering our sales performance year-to-date, we have decided to upgrade our full year guidance. Finally, and I will come back on this in the second part of the presentation, as we start to talk about the world after the COVID-19 crisis, it is becoming clear that for Thales, the broad range of digital and innovation opportunities are gaining momentum. But first, let me comment on a few key figures, and I'm now on Slide 3. At EUR 8.2 billion, order intake was up 35% with strong performance from Defence & Security and Space. The rebound in sales, plus 9.8% on an organic basis, was driven by the recovery in Q2 almost 18%. EBIT and adjusted net income recovered massively as well, plus 121% and plus 155%. Let me point out that this EBIT level, EUR 768 million, is actually only 7% below H1 of 2019. The solid improvement of profitability in Transport and at DIS offset the majority of the decline recorded in civil aero. Since the beginning of this unprecedented crisis, we have asked our teams to be very focused on cash management, and this led to another excellent performance in terms of free operating cash flow, EUR 420 million. This free operating cash flow level drove our net debt position down to EUR 2.5 billion. The chart at the bottom right of the slide shows the deleveraging sequence since we completed the acquisition of Gemalto, a reduction in net debt of no less than EUR 1.9 billion over the past 2 years. So after this rapid introduction, I now will hand over to Pascal, who will comment our financial results in greater detail.

Okay. Thank you, Patrice, and good morning, everyone. I'm now on Slide 4, looking into details at our order intake. So Q2 was again a strong quarter for us in terms of commercial activity with a reported growth at plus 41%, which follows an already dynamic first quarter, resulting in H1 order intake 35% above H1 2020 and also strongly up versus H1 2019. Looking at the chart by unit value, it's quite encouraging to note that all categories, smaller, medium and large orders, progressed over the period. The strong growth was driven by both large orders above EUR 100 million, increasing from 4 last year to 7 in H1 2021; and medium orders between EUR 10 million and EUR 100 million, which increased by 55% during the period. You can find the list of the large orders in the press release. They were spread across many geographies in Defence & Security and also in Space. Last point, small orders were also up by 5%, and this despite the ongoing impact on civil aero and biometrics. Turning now to Slide 5, looking at sales growth. As Patrice mentioned before, we recorded an impressive 9.8% organic growth in H1 2021. But let's not forget that Q2 2020 was heavily impacted by the beginning of the health crisis, hence providing easy comps over the period. However, Q2 2021 has proven to be strong in terms of rebounds with an organic growth of 17.8% despite our civil aero and biometrics business still are heavily impacted by COVID-19. The biggest drivers behind the positive organic growth were twofold. First, the ongoing recovery of sales in Space on the back of the commercial successes we recorded since Q3 last year; second, a continuous robust scenario in Defence & Security with double-digit organic growth versus the same period of last year. Turning to the geographical perspective, let me just point out that the rebound was stronger in mature markets, which didn't come as a surprise considering the strong impact of the health crisis in emerging countries as well as the continuous phasing down of some major projects, notably in Transport. Moving on now to Slide 6, now looking to greater details at the drivers of the change in our EBIT between H1 2020 and H1 2021. Starting with H1 2020, our EBIT amounted to EUR 348 million. The mechanical impact, scope, currency and pensions were not significant over the period, minus EUR 1 million. Our gross margin recovered strongly from 23.8% last year to 26.3% this year, which drove a EUR 393 million improvement. There were multiple drivers behind it, but the majority comes from the recovering sales, our global adaptations plan implemented last year soon after the beginning of the health crisis on top of all ongoing ambition plan initiatives, competitiveness, procurement, value-based marketing, product policy and so on, which, as you can see, continue to deliver. On the other side, we managed to keep indirect costs stable. The small increases in R&D and G&A were offset by savings in marketing and sales. The phasing of restructuring costs represents a small headwind over the period, EUR 12 million versus last year. Let me point out that we expect our restructuring costs to end up around EUR 150 million over the full year, i.e., to remain slightly above the normalized level. Finally, the contribution of equity affiliates recovered strongly. This is especially true for Naval Group, which contribution is now back to the 2019 level after year 2020 also strongly affected by the health crisis. Now looking briefly at each segment one by one. I'm now on Slide 7 for Aerospace. Orders were massively up, as you can see, plus 80% organically, thanks to a strong momentum for the Space business and the additional 2 large contracts booked during Q2, the second tranche of EUR 650 million on the Galileo order and also SICRAL 3. We also noted a progressive recovery of civil aero demand during the second quarter. Sales were up by 10.2% organically, driven by the strong rebound in Space with Q2 more than 50% above Q2 2020. Similarly to my comment on order intake, we saw a slight recovery in sales coming from the flight Avionics business, up by approximately 20% during the second quarter versus Q2 2020, this especially amidst aftermarket activities. EBIT is back at a positive EUR 69 million after H1 2020 deeply affected by the health crisis. This recovery is, of course, driven by the improvement in sales and by the effects of both the global adaptations plan and the civil aero structural cost adaptations program. Let me point out that it also includes a negative one-off of EUR 10 million related to the higher income tax rate in the U.K., which affects one of our JVs based there, AirTanker. Turning now to Slide 8 with Transport. Order intake was up by 32% from EUR 442 million to EUR 579 million, thanks to a strong demand momentum in our mainline business coming from both mature and emerging countries. Sales were up by 6% organically, thanks to growth in our mainline business with projects like the Stuttgart digital node contracting in Q4 2020. This improvement was achieved despite the continuous phasing down of large contracts still impacting our urban rail business. EBIT margin continued to progress in line with our transformation plan, reaching 5.2% at the end of June 2021, fully in line with our midterm target of a margin between 8% and 8.5%. Now moving to Slide 9, Defence & Security. Order intake amounted to EUR 3.4 billion, up by 39% organically after H1 2020 affected by a weak second quarter due to the beginning of the health crisis. The segment recorded 4 orders above EUR 100 million versus 3 in H1 2020, including a new one in Q2 for modernization and support contracts of tactical radars in Canada. The strong rebound in orders confirmed again the solid momentum of the group solutions. At the end of June 2021, the segment had a backlog of close to EUR 23 billion, representing almost 3 years of sales. Sales amounted to EUR 4.2 billion, only up by 14.9% organically versus a weak H1 2020 but also 7% above the already robust H1 2019. Many business units contributed to this solid recovery, including electronic warfare systems, networks and infrastructures and also sonars. As expected, EBIT margin recovered versus H1 2020, up from 10% to 12%. As you remember, our operation in April and May 2020 were affected by COVID-19-related disruptions. Last segment, on Slide 10, with DIS, Digital Identity and Security. As usual, I don't comment on orders as they are structurally aligned with sales. Sales amounted to EUR 1.4 billion, down 2.2% organically. The decline resulted from different moving parts: the ongoing impact of the crisis and biometrics, which has been impacted by travel restrictions since Q2 last year; a high basis of comparison in EMV payment card, which are particularly strong H1 2020. These 2 factors offsetting the double-digit growth of both cybersecurity and IoT. At EUR 152 million, EBIT was up by 6.6% organically, with an EBIT margin progressing further from 9.5% to 11.1% despite the ongoing disruptions I just mentioned in biometrics. The segment benefited from the additional cost synergies in line with our plan together with a tight control on costs and also the leverage of the cyber sales growth. Turning now onto Slide 11. Just one comment on items below the EBIT regarding taxes. Our tax flow changes in the U.K. but also in Italy triggered some noncash one-off items. I already mentioned the negative one-off recorded in Aerospace EBIT. This item show here at 2 levels. First, our income tax expense includes a EUR 51 million income, which explains this low effective tax rate 14.7%. Correcting for this one-off item, our effective tax rate would have been slightly above 22%. Second, these tax one-off items also increase the share of minority interests by around EUR 10 million. All in all, this drives an adjusted net income group share of EUR 591 million and an adjusted EPS of EUR 2.78, which are both actually higher than in H1 2019. Finishing up with 2 slides on cash flow. I'm now on Slide 12. As you know, our working capital is usually negative in the first half of the year mostly due to a strong seasonality. However, during the first 6 months of 2021, our operational free cash flow has reached a solid EUR 420 million coming, of course, as you can see on the first line of the table, from a higher EBIT but also clearly from a much stronger working capital performance. These positive outcomes result from our strong level of order intake and associated down payments as well as our permanent efforts that the group places on cash management and, in particular, on the reduction of overdue balances; the tight control of our supply chains; and also proactive negotiations with both customers and suppliers in order to obtain more favorable payment terms whenever possible. H1 free operating cash flow also benefited from 2 factors you can see at the bottom of the table. First, income tax represented an income over the period EUR 29 million, this due to a positive cutoff effect at the end of last year. And the second, CapEx was still lower than D&A in the periods. However, we expect CapEx to grow in the next few semesters and to come back progressively to a level in line with our D&A. Looking at the full year net, I expect the headwind versus our 95% target conversion ratio to be closer to EUR 50 million compared to around EUR 200 million at the start of the year, also keeping in mind that the adjusted net income will benefit from around EUR 40 million of net noncash one-off items. As usual, this guidance doesn't include the potential benefits from down payments and potential large export defense orders. Moving on to Slide 13 with a quick look at the evolution of our net debt positions. Nothing special to comment on the individual drivers. The more important to measure, the intensity of deleveraging we've achieved in the past 2 years from EUR 3.9 billion at the end of 2020 to EUR 2.5 billion at the end of June 2021, i.e., reductions of more than EUR 1.4 billion over 12 months. This being driven by our cash flow generations, which amounted to close to EUR 2 billion in the last 12 months. And this, I'm handing over to Patrice for our strategy and outlook.

Thank you, Pascal. I'm now on Slide 14, turning to our strategy and outlook. Back in March, I listed 3 strategic priorities for 2021. First, the implementation of the structural cost adaptation plan in civil aero; second, our continued focus on growth initiatives; and third, our decision to sustain a high level of R&D. So this morning, I thought it would be useful to give you an update on this initiative and also start to discuss the trends and opportunities that will gain momentum in the coming year. Starting with aeronautics, and I'm now on Slide 15. The adaptation of our aeronautics business to the new context remains a key short-term priority. And as Pascal showed earlier, we have already made solid progress on this topic. More than 3/4 of the necessary staffing adjustments have already been implemented, around 1,600 people worldwide. Thanks to internal mobility and transfers of work passengers, we have been able to maximize the retention of competencies. In parallel, the global service business line I announced in March is now fully operational. As a reminder, it will allow us to consolidate some sites, improve customer service and expand in these higher-margin activities. In terms of near-term market dynamics, let me point out that, as shown on the chart on the right, IATA expects that the recovery of air traffic will remain modest in 2021. So it is important to remain a bit cautious regarding the second half of the year. On the other hand, the medium-term outlook is very supportive. The updated A320 production plan announced at the end of May by Airbus with the firm rate of 64 by Q2 2023 is, of course, very positive and will provide a strong tailwind for our Avionics business in the coming years. On top of this recovery dynamics, we see a multiplication of growth opportunities, especially around digital and green solutions. I'm thinking of our solutions around flight trajectory optimization, virtual training and simulation as well, Internet connectivity on board aircraft or UAV. To complete the picture on the Aerospace segment, let me provide a quick update on our Space business, Thales Alenia Space. Pascal mentioned how our commercial dynamics remained very strong in H1, with the signature of Phase 2 for Galileo and SICRAL 3. These dynamics extend to the commercial exploration market. At the beginning of the month, we have booked the contract for the construction of the first commercial space station, Axiom. Turning to the commercial telecom side, no need for me to come back on our constellation leadership, which was demonstrated by our term selection by Telesat for its projects. On top of this, we continue to invest in the development of our new generation of flexible satellite named Space Inspire. I'm now on Slide 16. So turning to the second priority, growth initiatives. We first remain focused on the capture of revenue synergies with Gemalto, which are progressing in line with the plan. You remember how the combination of Thales and Gemalto cybersecurity assets is a major synergy opportunity. While in September last year, we launched cyber -- CipherTrust Data Security Platform, which integrates the best data security technology from both side. Many large companies have deployed this platform in H1 and, for example, 4 of the top 10 U.S. banks. The success of this product or service drove solid double-digit sales growth for this business over H1. In addition, we announced an extended partnership with Google for further integration in Microsoft products. Of course, we continue to leverage our global sales network to sell DIS solutions on a global basis. And over H1, we booked projects both with defense customers and with civil ones, such as banks or mobile operator. The third area is insertion of Gemalto technology into Thales solutions will naturally occur over a longer time frame. One emerging opportunity is private 5G networks. Security forces, public services or companies that manage critical infrastructures are more and more interested in setting up their own private 5G networks, which offers more robust security features than previous generations. And our solutions for this market now includes the full range of Gemalto security capabilities from SIM and eSIMs to subscription management and, of course, HSM. So all in all, we won 49 revenue synergy projects in H1 2021. Moving now to Slide 17. So taking a slightly longer-term perspective, I wanted to share the world picture of the solutions that will drive growth in the coming years. Thinking about our digital growth strategy, you remember the framework that we presented back at the CMD in 2018. Our first priority has been to insert digital technologies inside our core products, our green products as we call them internally. This is the column on the left. Behind these concepts are many of the successes over the past few years. In parallel, and it is the column on the right, these investments and the acquisition of Gemalto provided a strong boost to this strategy. These investments have allowed us to target new emerging markets. Many of these emerging markets will gain prominence in the coming months. And now on Slide 18. So let me take 2 examples. As the volumes of data explode even on the theaters of operation and onboard platforms, defense forces want to have access to the benefits of cloud technologies, notably to foster agility and enable collaboration on the balance sheet. Depending on the infrastructure, the changes are quite different. First, at HQ level for the core infrastructure, the key priority is the management of security levels. On cases of operations, whether it is the size, what we call the size for soldiers, vehicles, aircraft, platforms in general or simply the edge, what we call the edge for the command post, it is essential to address some of the unique requirements of different customers. The ability to run off-line, [indiscernible], form factor, simplicity of deployment, interoperability including [ equation ]. In addition, it is important to provide continuity among all these layers. And thanks to the breadth of our expertise in both defense and civil technologies, we are very well positioned to address this emerging high-growth market. Earlier this year, NATO awarded us the first contract for a theater-level deployable cloud. This solution reduces the time it takes to set up the infrastructure for a rapid response force from a few weeks to a few days. The corresponding product, Nexium, recently received an award on Microsoft. So we are starting to incorporate combat cloud features in ground vehicles, and it will represent an important project within FCAS, the future combat aerial system -- the Future Combat, sorry, Air System. So now turning to Slide 20 -- 19, sorry. The second example I wanted to give is the transition from removable to embedded SIM. Market research companies now forecast an even faster adoption of eSIM than they assumed 2 years ago before the COVID-19 crisis. They now expect that by 2025, 1 billion eSIM-equipped smartphones will be shipped. On top of that, they expect a dramatic increase in the percentage of eSIM actually activated as the main subscription identification. This will generate 2 revenue streams for us. On top of the purchase of eSIMs by smartphone manufacturers, we will receive fees from mobile operators for the remote management of network subscriptions. These subscription services, for which we are the global leader, run on an attractive software and service business model. Altogether, the eSIM market represents for us a EUR 150 million revenue opportunity by 2023 with a further doubling by 2025. Turning now to Slide 20. Third key priority, which extends beyond 2021, sustaining high R&D investments. More than ever, technology leadership remains our biggest driver of differentiation and, hence, pricing power. Over the coming years, while we will remain very selective, we intend to continue to increase R&D faster than sales. On top of the focus areas I've mentioned in the past, cybersecurity, big data analytics, AI, IoT, we will step up our investments in new areas to ensure that we remain at the leading edge of technology in our markets. I'm thinking of edge and far edge computing, for example; the application of quantum physics to sensors and communications; or post-quantum cryptography, just to mention a few, which brings me to our financial objective for 2021. And I'm now on Slide 21. As you understood, considering the strength of sales year-to-date, we have decided to upgrade our sales guidance. Based on the July 2021 scope and foreign exchange rates, we expect sales to amount to between EUR 17.5 billion and EUR 18 billion. This concludes our presentation. Many thanks for your attention. And together with Pascal, we are now pleased to take your questions.

[Operator Instructions] And your first question comes from the line of George Zhao from Bernstein.

Your guide implies about EUR 9.3 billion of sales in H2 at the midpoint. That would be down almost 9% versus 2019, and that compared to Q2 essentially flat 2 years ago. So I guess, could you talk about what's driving that given your more positive commentary regarding the growth rebound? And my second question is more on the long term. On DIS, clearly, the environment now is very different from back when you provided the 4% to 6% revenue growth guide. So what will it take to get back to that growth trajectory? If travel takes longer to recover, what will this segment be like? And when can we expect to see the growth acceleration for the segment as a whole?

Yes. George, So on your first questions about, I mean, H2, I mean, first, I guess, it's important to recall everybody that even though today we have, of course, a better view on the full year 2021 as compared to our initial view beginning of March when we set our initial target of sales, you have seen probably that we have reduced the range of our guidance with regard our level of revenue for 2021. Initially, we provided you with EUR 17.1 billion to EUR 17.9 billion. We've decided to have a much narrow range, EUR 17.5 billion to EUR 18 billion, reflecting, of course, a better view but still recognizing that there's still a number of uncertainties ahead of us. So I mean, the primary reason behind that is our Aerospace business and, in particular, of course, our aeronautics, civil aeronautics business, where today, there's clearly, I mean, uncertainties and, of course, I mean, driven by, I mean, what we keep hearing and in particular about travel restrictions. So at this point, we're a bit cautious on how we could see H2 level of revenue for this business. So this is the first point. The second point is also, I mean, to consider that with regard our DIS business, H2 was also a pretty solid base. You probably have in mind that in H2 2019 but also in H1 2020, we took advantage of this renewal of payment cards in the U.S., and hence, the fact that in H1 2021, we report a negative growth on this business. And we believe that H2 for DIS could be probably slightly negative or 0 on H2. And here again, I mean, travel restrictions, it's clear, I mean, a point of concern for us, in particular, in our secure document business line but also our biometric business line. Third item is Defence & Security. You probably have in mind that H2 last year was especially strong in terms of top line as compared to, of course, I mean, to H1 2020 but also quite strong against H2 2019. So overall, even though, I mean, the dynamics is there on Defence & Security business, I mean, today, after quite a strong growth in H1. But once again, against quite a modest comparison base, today in H2, of course, we will need to compare us against a much stronger base. Last point is transport, where, as we all know, we will still -- yes. I think I've been a bit -- yes. I mean, my phone, I mean, I got...

Sorry, we have a little problem with the phone connection. But I will not...

Okay. So last point was on Transport, wherein, I mean, we believe that H2 in terms of top line growth will be positive against H2 of 2020. But also recognizing that here again, we take advantage of a strong momentum on mainline but also the fact that we also are in more phasing-down situations and some large size urban project in our Transport business. So this is, I mean, George, what is behind this guidance for H2. Once again, probably the most important point to have in mind is the level of uncertainties are relating to, I mean, the impact of the sanitary crisis. Second point on DIS, Patrice?

But I can start, and I will let Pascal completely [ say on ] the other points to be added. Yes, we gave out a midterm growth perspective when we discuss DIS a while ago, it was in 2018, yes, in 2018. Well, in fact, it's a mix of different business segments, as you know. Clearly, it's composed of fast-growing markets or fast-growing segments like cyber. And cyber, it's data protection, data management. And all the recent, I would say, scandals show and illustrate how, I would say, strong is the need for more and more data protection in our digital world. It's also the case for what we call identity and access management, which is a very important segment and which will drive growth for the CPL business line and the cybersecurity business line of DIS. And I could also add the eSIM activation or subscription I've just talked about. Or last but not least, the need -- the growing need for digital identity. I don't know if you have noticed that the EU was -- the commission, sorry, has proposed to modify EU directive to enable what they call EU digital wallets across all European countries. And clearly, this will drive -- this will boost the implementation of digital ID across Europe, across EU. On the other hand, we have a market that will be flattish, like probably a smart card for banking sectors. And our SIM will be even decreasing, of course. So this mix led us to foresee this range that you have recalled, 4% to 6% in average. Clearly, I see no change or no, I will say, no facts that would make us change our mind in terms of growth rate for DIS in the years to come. So clearly, it confirms, in fact, what we said a while ago now.

And your next question comes from the line of Celine Fornaro from UBS.

My first one would be if you could give us a little bit more color on the performance within the Aerospace division, saw a very strong uptake of recovery in the Space business and how sustainable this is. I mean, we know Space is always very cyclical, so if you could just give us a little bit of a view over the next 6 to 12 months on this top line and EBIT performance there. And also, the recovery on the civilian avionics, IFE and connectivity businesses in terms of maybe comparing to 2019 levels of sales but also on the profitability and how you see the recovery path there. And then my second question would be on the point that you raised, Patrice, regarding R&D, which should grow above the sales level and some of the areas that you mentioned. If you could maybe help us a little bit to understand what is already core and strong in Thales and where you could actually gain by going and acquiring this externally as maybe you have done with some of your previous smaller acquisition before Gemalto.

Okay. Celine, maybe I will start maybe with the first 2 questions and leave the floor to Patrice for the third one. So Aerospace, I mean, first, I mean, I guess, it was quite obvious from our presentation that we are taking advantage of quite a strong momentum in our Space business. You probably have in mind it was already the case in H2 2020. We made it clear that we were extremely happy to win a number of projects on the observations, explorations, navigation activities. And I mean, an additional example that we commented a few weeks ago and on this call in H1 2021 is the fact that we managed to book this huge Galileo project in total EUR 750 million. This coming on top of what also a good last year both on the observation business with, I mean, this famous Copernicus program and also various exploration mission. And by the way, we announced a few days ago, I mean, a new success in terms of explorations missions with Thales Alenia Space, our JV with Leonardo, being the development of the ISS, I mean, projects. This comes on top of a clear strong momentum on the more commercial telco business with, in particular, we see today a number of projects emerging with regard constellations. Now I mean, as we all know, constellations are pretty large and, in some cases, with jumbo projects. And of course, none -- excuse me, not all of those projects will go through. But just to recall you that we've been selected by Telesat a few months ago, and this is a clear jumbo opportunity with a potential $3 billion of level of business for Thales Alenia Space. At this point, as you know, I mean, Telesat keep working and putting together its overall financing, and they are making progress on this point. It's also true that in addition to this large-sized project, there are additional other ongoing projects. So clearly, I mean, all of that resulting in a number of opportunities. And it's also true that we are seeing in H1 2021 quite a strong increase in our Space business as compared to H1 2020, which has been, as we all know, also affected by production disruptions because of the health crisis. If we take, I mean, the H1 and comparing, on one side, our Avionics business and, on the other side, the Space business. Our Space business in H1 2021 is up something like almost 40% in terms of level of revenue as compared to H1 2020. On the other side, our Avionics business is still down, I mean, between mid-single and more high single-digit drop against H1 2020 but, of course, with a profile which is quite different between Q1 and Q2. Q1 2020 was not -- almost not affected by the crisis. So it's true that Q1 2021 for Avionic business was significantly down. And Q2 on the other side is showing a bit of a recovery. Now going back to your questions against what would be a normative level of activity from Avionics business. If I take one figure, Celine, I'm confident that a pre-COVID level of activity for Avionics business would be 100%. We have seen in the bottom of the crisis a drop in this business between 40% and 45%. So moving from 100% to something between 55% and 60%. And then from that, it's true that in Q2, we have seen a recovery, I would say, between 15% and 20% but, of course, on the basis of a reduced level of business. So overall, Q2 2021 in rough figures is probably down between 30% and 35% against what it was in 2019 before the crisis. So a recovery in Q2 but a recovery which is still, I would say, quite modest, but showing a bit of recovery, in particular, in the aftermarket. What was your second question?

IFE and connectivity.

I have no specific comments on IFE and connectivity. But as I mentioned, it's more aftermarket, so I think it is also in Q2, I mean, helped in terms of level of business by this aftermarket slight recovery. Having said that, it's probably more in the cockpit avionics than IFE that we have seen in Q2 most of the recoveries that I've just mentioned. Patrice?

So Celine, on the R&D side, I've got a few things to be said. One, we do think it is so important for us to continue to sustain a high level of R&D and to reach this type of percentage when we say between 6% to 6.5%. In fact, we already do a lot of R&D at Thales, of course. But we see additional growth opportunities coming from the mastering of technologies that could allow us to tackle new market. And that's what I've tried to explain shortly because with this presentation, it's always too short, but by mentioning some of them like quantum. Quantum clearly is the next revolution in the domain of sensors or communication, sensors that will, I would say, embed quantum, I will say, quantum characteristics. We'll see their performance being multiplied by a factor of 100 or 1,000, which is a revolution. Quantum in communication and what is called QKD, so Quantum Key Distribution, will make communication, I would say, impossible to be intercepted, to be breached. So this will be a key revolution for everybody, by the way. And mastering this technology will allow Thales to be in a leading position in this domain. I've also mentioned the far edge and edge computing because one key question of typically [indiscernible] is, how can we leverage the power of the cloud? When we are far from the cloud? And you take a command post. The command post, there is a connection to, I would say, back office or headquarter, but it's far from insufficient. So how do we deploy the cloud technologies in a command post or even in more -- in an even more demanding, I would say, environment like a platform, like a tank, like a vehicle, like an aircraft. 5G is another area where we see a lot of opportunities for Thales. Definitely, Thales, we are not competing against Nokia or Ericsson. We are not a 5G equipment provider. What we do in 5G, we provide brand new services, again, to highly demanding customers. One of the revolution of 5G is the ability to slice the network, to create virtual network within the physical network. And typically, there are already, I would say, large tenders in some European countries from typically police forces or security forces. They need to have their own virtual network with a high quality of service. And for that, 5G is a big solution. It's impossible to do so with 4G or 3G standards. And the last example to show that we need to expand our R&D exposure in post-quantum cryptography, so this is nothing to do with quantum physics. This is how do we design a new crypto algorithm, so this is math and computer science, and it's not quantum. How do we design new crypto algorithm to, I would say, resist against the future arrival of quantum computing? And we are 1 of the 2, I would say, [ concession ] that is competing at the NIST, which is an international body that will certify this algorithm against IBM. So showing that Thales is again a leader in this domain. And once it will be, I would say, standardized, we will be able to inject these new crypto algorithms in, for instance, our HSM, hardware security module, in our chips for banking cards, for example, that will, I would say, offer a level of security in terms of crypto, which will be unbreakable even by quantum computers. So I take with these different examples to show why we need to increase our R&D because, clearly, we see a lot of new opportunities ahead of us -- business opportunities ahead of us by mastering these technologies. Now we do need probably to activate the 2 levers. One is organic. So we need to develop competencies, hire new talent in these domains. Mastering quantum physics is not an easy task, so we need to increase our old internal resources. And of course, we are open to activate M&A levers to buy small companies, medium companies, almost, I would say, large, if I may say, to complement what we do on an internal, I would say, standpoint. So I hope it gives color to this key question of R&D growth at Thales.

And your next question comes from the line of Tristan Sanson from Exane BNP Paribas.

It's Tristan here. I have a few quick questions or clarification, if I may. First would probably be for Pascal, just to get a clearer view on the trajectory for full year free cash flow this year, to be sure I would understand your message. So, so far, you had a guidance which was about EUR 1 billion, there's EUR 1 billion of free cash flow for 2021. You say that you're going to get a cut-off effect or headwind from normalization of the FX that would be maybe EUR 150 million better than initially expected. There's a comment also on the noncash tax one-off that you're going to have on net income, but I'm not sure exactly how we should impact it. So if I understand correctly, it would point to EUR 1.15 billion, EUR 1.2 billion of underlying free cash flow, plus the benefit of down payments from extra export contracts. So if we take the Rafale orders already announced, including Egypt, even though this has not been formalized, I understand that you should get towards something like EUR 1.3 billion. Is that the right way to see it just according to your official message? That's the first question. The second one is on cost management. We have complex movements in the cost base year-on-year because we have inefficiencies that disappear. We have temporary savings that are disappearing as well. We have some restructuring benefits. And all in all, we have -- if I look at the sum of R&D, G&A and marketing expenses, we have a cost base that is fairly flat year-on-year. Can you give a bit more granularity on how these elements are offsetting each other? Do we really have significant restructuring benefits already on the year to come? And if we look at inefficiencies disappearing, is it a material number, to get a better feel? And maybe the third question is on the Aerospace momentum to follow up on the previous one. So since the beginning of the year, you had a number of positive developments. We talked about the strong book-to-bill and the continuing strong order intake in Space. We had the positive momentum for Rafale on the military part. We have the uptick in the A320 production rate, which is an important program for your Avionics business. And you mentioned good aftermarket momentum. What does it mean for the first field that -- of the trajectory of the Aerospace division over the next few years? You talked about Space, but Aerospace overall, is it becoming like a mid- to high single-digit or high single-digit growth business? That would be a very helpful view.

Okay, okay. So a number of questions with a lot of details that you're asking us, Tristan. So first, free cash, your analysis is almost right but with a slight caveat. I mean, the first one is, I mean, we can really guide you on, I mean, elements that -- in which we are almost certain to get. And it's true that you mentioned Rafale orders, on Rafale orders the we have already booked and which are, because of that in terms of down payments, already taken into account in our updated guidance. And there are future Rafale orders which at this point are not booked; and in particular, Egypt, which are not part of our guidance with regard 2021. So which means that as opposed to what you mentioned, Tristan, I mean, the positive down payments coming from Greece is a factor in our guidance. So now in terms of guidance, overall, I mean, the math that you mentioned are pretty much right. I mean, initially, I mean, beginning of 2021, we guided you to a 95% pre-one-off conversions ratio. And we said that we would face something around EUR 200 million headwind coming from the reversal of down payments. And with all of that, probably a level of free cash that the market considered being around EUR 1 billion, slightly below EUR 1 billion. Now from that, what do we say? We say first that, I mean, net this EUR 200 million of headwinds would be much lower. It's going to be much more EUR 50 million than EUR 200 million. So overall, I mean EUR 150 million of additional free cash in terms of guidance for the full year 2021. On top of that, it's also true that we mentioned a one-off noncash item on our net adjusted income, which is those EUR 40 million one-off noncash tax item. And despite -- I mean, this is a noncash item which would normally drive a reduction of our conversions ratio. What I keep telling you is that this 95% will still apply to our guidance for 2021. So it's 95% on a basis of a higher level of net income because of this one-off noncash item and also a much more reduced level of headwinds in terms of one-off cash items. And of course, as I mentioned, this guidance doesn't take into account additional potential large-sized export contracts that we could book in H2, and of course, we all think about Rafale in Egypt. Second point about cost management. So overall, I think probably a smart -- I don't know, smart but a simple way, I mean, to look at our, I mean, cost management is really, I mean, to see how we see our gross margin moving from H1 2020 to H1 2021 and also are considering our level of indirect costs which are below the gross margin. So first, I mean, the good thing is that, I guess, that you have seen this quite significant progress of our gross margin from 23.8% H1 2020 to 26.3% in H1 2021. And this also, I mean, reflecting both, I mean, a more normalized level of productions but, of course, also, I mean, the first impact for global adaptations plan and, in particular, in Aerospace, in particular, in our Avionic business. So overall, I guess that you have understood that, overall, we managed to kept our headcount base for organic business by something like [ 1,500 ] headcounts, which is quite significant. On top of that, of course, I mean, we keep working on all our competitiveness program that we have already commented in the past. And lastly, on more indirect costs, I guess, it's quite obvious from our P&L that we are quite cautious in terms of managing our sales, marketing and G&A expenses. You have seen that, overall, despite this almost 10% organic growth on our revenue, overall, I mean, if I add up marketing, sales and G&A, I mean, we were slightly less expenses as compared to H1 2020. Where we have decided to go a bit is more R&D, and this would continue in the next semesters. So this is what I can tell you in a few words. In terms of overall aerospace trajectory in the next year, so I mean, basically, I mean, what we share with you today is consistent with our previous messages, which is that on Space, this business which in 2020 dropped below the EUR 1.9 billion mark should be around EUR 2.5 billion in 2024. This level of revenues do not take into account the potential impact of our Telesat project. So you see here, I mean, quite a strong growth. Now on the Avionic business, at this point, and sorry for that, but it's a bit too early. I mean, we did welcome, I guess, like everybody, the Airbus announcements, which overall are getting back to, I would say, a pre-COVID level of production output as soon as 2023 and then in 2024, 2025 with production output which would be significantly above pre-COVID level, so which is quite a good news. Now of course, I mean, as everybody else, I mean, we'll look very carefully at how the recovery, I mean, the normalization of the situation with regard travel materialize. And from that, I mean, of course, we will come back to pre-COVID, I mean, based on this overall evolution of the situation in terms of travel. At this point, it's probably too early, Tristan, to be more vocal as there are still uncertainties in this matter.

And your next question comes from the line of Christophe Menard from Deutsche Bank.

Yes. I have 3 questions on my side. The first one was on the order intake guidance, which you left book-to-bill above 1. My question is considering the better sales, should we -- the nominal number of orders considering the very strong performance in H1, are you looking at higher orders than you were initially looking at in -- at the start of the year? I mean, still book-to-bill above 1, but is that above 1 higher than what you initially thought? The second is on the M&A priorities and the R&D, what you mentioned earlier. I mean, we're seeing a number of transactions in defense at the moment and the latest being Ultra this morning, I mean, kind of some announcements. I wanted to understand the priorities on your side. Is it more bolt-on on your side? Or would you be considering mix of large acquisition and bolt-ons? Or it's really about acquiring technologies that is the top priority if you do M&A, of course? And the last one is on the free cash flow performance in H1, which was, I mean, in my knowledge, one of the best performance you've ever done or at least in the last -- in several years. How repeatable is it? How -- I understand there are prepayments, but is it the new norm? Do we have a more balanced H1, H2 to come? Or is it something exceptional?

Christophe, thank you for your questions. I will take the first and the last one, and Patrice will take the second one. I mean, order intake, I guess that from our tone, I mean, we are quite positive in terms of commercial dynamism for Thales overall. And I would say that our view today is more positive than it was a few months ago when we released our 2021 guidance. And it's true that, I mean, H1 gives us strong confidence to achieve this book-to-bill over 1. At this point, I mean, we don't want to be more specific, but it's true that both what we managed to book in H1 and also our view in terms of potential additional order intake in H2 give us quite a good level of confidence. The question in...

Christophe, on the M&A side, what we intend to do, and you will not be surprised, is of course, to look -- to continue to look at bolt-on acquisitions as we did in the past, mainly to complement our technological portfolio and to accelerate what I call our ambition strategy in terms of growth and competitivity. So these technologies are there to serve growth and competitiveness. Now it's true that we do not exclude to look to larger ones. By saying so, I have nothing specific in mind. And so don't draw any, I would say, quick conclusion on this point. But clearly, this is a possibility. We do not exclude at all because we generate a good level of cash flow, because we have drastically reduced the net debt position of the group in the past years and so on and so forth. By the way, and as usual, but if we do so, we will always keep very, I would say, strong financial discipline. I think the track record speaks for us. And typically, we never, I would say, go for something or look for a target for which the value would be, I would say, at least to our mind, not the right one. That's why, by the way, on the latest transactions you may have in mind, you have mentioned Thales, clearly, our approval of the value was clearly not the one that has been, at the end of the day, acquired by some competitors. So financial discipline, value creation synergies, cost synergy, revenue synergies, that will drive, of course, either our bolt-on acquisition or, as it may happen, larger ones.

Okay. Christophe, on free cash, on your last questions, and thank you for your questions. It also gives me the opportunity to come back on, I mean, the drivers behind our H1 very strong level of performance, but also coming back on your question about a more balanced cash flow between H1 and H2. So first, I mean, coming back on the key drivers behind this level of performance, which is very strong, I mean, for H1 at Thales. In the past, I remember 1 year, I guess, 2, 3 or 4 years ago, where we had a positive H1 free cash, but it's something which is quite unusual at Thales. And it's true that we see our working capital going up quite substantially in H1 and then dropping in H2. This is the overall usual pattern at Thales. Now coming back on our H1 performance, there are various components behind that. First is we have a very solid level of order intake. And of course, I mean, we mentioned a record level of order intake, which means that some of those order intake also came in with down payments -- with significant down payments. This is quite simple. Second component is really, I mean, the impact of our cash optimization program. You probably remember that back in October 2019 at Capital Market Day, I mentioned our desire, our willingness to put in place a strong, I mean, cash optimization program. I mean, at that time, remember a bit of skepticism from some analyst on this cash program. But when I look back at what we have done, I'm quite proud on what we have done. And it's true that H1, I mean, would, I mean, running full speed on this matter in terms of chasing overdues, in terms of, I mean, putting a bit more pressure on supply chain and negotiating payment terms, both at customers but also on some suppliers. So now I mean -- but we also need to have in mind is that once you have put in place those drivers and you get the benefits, now it's -- from a cash flow perspective, it's from this new base is to keep at this level that will not generate additional cash flow but maintaining the level of [ clearance ] that we managed to get. And third point that we also need to have in mind in H1 is some more of the specific items. I mentioned in particular, I mean, this tax situations, where I will give you a very simple example. In H1 2020, we pay our interim tax contribution on the basis of the 2019 fiscal, I mean, exercise. In 2021, we paid, I mean, this interim tax contributions on the basis for 2020 level of debt, which was, of course, much lower than a year ago. Also in this matter, we took advantage of what we call, I mean, true-up, and being -- and in the fact that we get reimbursed of a bit of excess of tax cash contributions that we paid in H2 2020. I mentioned about also, I mean, this positive gap between D&A and CapEx that will progressively narrow in the next semesters. And last item that also I would like to comment is that in H1, in particular in June, we also took advantage of advanced payments from some customers, which is more H1 versus H2 kind of cutoff. That is true that probably some of our customers were also achieving a good level of free cash and decided to pay us in advance, which is also quite positive. So you see a number of drivers behind that, some of them driven by [ really ], I mean, the action plans that we have put in place; some of them more linked to the overall commercial dynamism; and the last more on -- probably more one-off temporary effects. Now adding all of that in mind, it's true that we wish to have a more balance of cash flow between H1 and H2. Now it also comes to, I mean, our order intake pattern and our ability to convince some of our customers, I mean, to grant awards and/or to award contracts, not at the very end of the year, but more on a regular basis throughout the years. Now it is our wish. It is our wishes. We also need to convince our customers. And I guess that it will allow us to have this more balanced view from a cash flow standpoint between H1 and H2. But you understand from my comment that, of course, we are not -- and we want to decide when we discuss about timing for contract awards with our clients.

And your next question comes from the line of Andrew Humphrey from Morgan Stanley.

I've got a couple about DIS, Gemalto, if I may. One is on the banking wins that you highlighted, 4 out of 10 of the top U.S. banks. Is that happening in the old SafeNet business? And I guess, in that -- I think that was a business that had been maybe slightly neglected. Are you finding it easier to, I guess, exploring new opportunities there with potential customers? And secondly, the eSIM revenue opportunity you put up, I think, EUR 150 million in a couple of years' time and then doubling beyond that, is that incremental? And how should we view that in the context of overall SIM revenues that continue to remain under pressure?

Okay. I'll take the first part on this one. So yes, I've mentioned that 4 out of the 10 U.S. banks have adopted our new software platform to, I would say, manage their data, encrypt and decrypt their data and so on and so forth. It is -- it's a clear synergy coming from the acquisition of Gemalto by Thales. It's what I call -- and if you remember, I used this expression, the merger within the merger. It's clearly coming from the merger between Vormetric, which was Thales asset -- we acquired before the acquisition of Gemalto which was Thales asset; and the merger with SafeNet that was a Gemalto asset. So this merger within the merger between Vormetric and SafeNet led to a very, I would say, important rationalization in terms of product policy, R&D, go-to market, leading to a brand-new successes as the one I have mentioned. It is, I would say, a very positive looking ahead. On the second part of your question, when I presented the transition between rSIM to eSIM, and it's not only the eSIM, it's also the fact that we are in the business of activation of eSIM. So when you subscribe, when you get a subscription, in fact, beyond the telco operator, you find that Thales which activates your eSIM. Yes, the figures are impressive. The figures are material. It's clearly something which is sizable. There is a slight, however, with the fact that partially, it will cannibalize the rSIM business, of course, partially. So all in all, you should, I would say, combine the positive effects that are described during the presentation in the center, with the fact that the rSIM business is, and we know that's not as [ good bit of ] a surprise, is a declining business. But it's a very smart way, I would say, to compensate the decline by being, I would say, also a player in the eSIM, and not only in eSIM but as well in the, what I call, the subscription business. And by the way, Thales is in a leading position compared to our competitors on this particular part of the business.

And your next question comes from the line of Harry Breach from Stifel.

Just 3 hopefully very quick ones, all quite different. Space, clearly, the selection by Telesat was a major event. But I wonder if you can help us to think about the level of bid and proposal activity that Thales Alenia has underway for its more traditional telecom satellites. So I'm thinking about more the fixed satellite services, satellites that were previously the larger part of its telecom and satellite business rather than constellations. Secondly, a completely different area, just looking over at the Middle East, I think in the slide presentation, in the appendix, you mentioned that orders from the Middle East in the first half, I think, were down 40%, 4-0 percent, organically against the first half of 2020. Is there any -- are there any particular elements going on there? I know in the past, Patrice, you said that the customers there are still keen, still motivated to buy products. Is there any sort of hesitation and any drivers you can help us to understand and whether you see that perhaps rebounding later this year or next? And then maybe just finally, guys, if I can. Naval Group seems to have made a good rebound, strong rebound in its first half of 2021. Can you give us some sort of feeling about where Naval Group margins or EBIT might get to for the full year? Should we take the first half results for Naval Group, that EUR 34 million, I think, and double it? Or could it be better?

Okay. Thank you. Harry, so I will answer your first question, and Pascal on the 2 remaining ones. So Space, it's important really to understand or to keep in mind that we need to stay on 2 legs, on both legs: geostationary satellites and constellations. We are very happy to having been selected by Telesat for this mega constellation. At the same time, we cannot, I would say, bet all our future on constellations. We need to stay a leading player, by the way, in geostationary telecommunications, sorry, satellite, and hence, the need for investment in our brand-new software design satellites named Space Inspire. The main difference between the 2, of course, is the size of the opportunities. When we bid for a constellation, it, I would say, draws or consume, I would say, more, I would say, bid resources than for a geostationary satellite. But the reward is higher, of course, as well, looking at the magnitude of -- typically of Telesat, I would say, future order intake compared to [indiscernible] geostationary order intake amount. So I hope it answers your question on this front.

Yes. Harry, on the Middle East, and you mentioned that you're absolutely right, I mean, 40% drop in order intake in H1 '21 versus H1 2020. But I mean, we need -- we really need to bear in mind that, of course, I mean, order intake can be a bit volatile. In particular, the more you dig and you look at small parameters, the more it can create, I mean, volatility. And it's true that in Q1 2020, you probably have in mind that we booked a large size in excess and much above EUR 100 million, a large-sized contract in Iraq, which was not the case in H1 2021. Now I mean, to take a bit of a high level -- higher level of -- high level of perspective, I mean, we keep seeing in the Middle East, I mean, a number of opportunities. We managed to sign, I mean, a very large-sized project in Q4 2020 in one key country in the Middle East. We keep working on various opportunities in these geographies. Now having said that, I mean, what would happen in Q3? What would happen in Q4? I mean, it can be volatile, but please do consider that, I mean, the level of activity from a commercial standpoint in the Middle East is today pretty high in our businesses and starting with, of course, Defence & Security. Third question about Naval Group. I mean, yes, I mentioned that Naval Group in H1 '21 came back to, I would say, a normative level of profitability, which is more in the 7% plus EBIT margin overall and which results in the level of contributions from a net income perspective that you have seen in our contributions from JVs. And I can say that Naval Group is active and on many opportunities with a number of ongoing projects today. Naval Group has been affected by the pandemic, in particular, in Q2 with, I mean, some quite significant production disruptions in Q2 last year. This is over, and they came back to a normalized level of production.

Patrice, sorry, I think you cut out for a little moment earlier on. Just on the geostationary satellite side, do you see -- is there a good level of bid and proposal activity on that front? Or does it remain still quite slow?

Okay. So sorry if I've been cut. Sorry for that. Definitely, the level of activities is strong in terms of geostationary satellite. So we are currently bidding on a number of prospects or RFPs across the small world of satellite operators. So definitely, this is an active market currently. Now we need to win, of course, in this competition. But it is clearly an active one at the moment.

And your next question comes from the line of Sean Stewart from JPMorgan.

I have 2 questions actually on the DIS business. In 2019, when you first consolidated DIS, you flagged to us that H1 is usually weak for that business. However, in H1 this year, the margin was very strong. So I just wondered if there were any one-offs there in H1, or do you think that the DIS business can do a sort of double-digit margin in H1 going forward? And then the second question, you've spoken a lot about the cyber business in your presentation today. Would you say the strategy going forward is -- are you looking to do more large deals in that area going forward?

So first, so I mean, the DIS, first, I mean, we think that we can really operate this business with a more balanced level of profitability between H1 and H2 that this business has done in the past, the first point. I'm not telling you that the level of margins that we have reported in H1 which is above our expectations, ahead of our plan. But I do think that overall, I mean, this large disconnect that we mentioned as we consolidate this business for the first time, what we think we can probably have a more balanced level of profitability between H1 and H2 going forward. Now there might be, of course, a bit of gap but not in the magnitude that we have seen in H1 2019, where, at that time, the level of profitability was below 5%. Now overall also, which is probably the most important part of the answer, is when you compare, I mean, our 2019 level of profitability for DIS for the full year than 2020 -- than our guidance for 2021, it's a gradual but quite significant improvement in terms of level of margin. And this is, in my view, what is the most important part. Second question?

Cyber, sorry. Cyber, we're not -- it's clearly a core business for Thales, doing very well. So if we can reinforce this cyber activity through acquisition, we'll look at them very simply. So we need to stop, sorry -- all your questions this morning, which showed the interest you're paying in Thales. So just a few words in terms of conclusion. As you understood, we are ahead of plan on the first 6 months of 2021, leading us to upgrade our guidance on sales. We continue to execute on our strategy, especially around digital technologies, as underlined during the question. We see plenty of value creation opportunities in the post-COVID-19 world, which opened up many growth areas for us. So together with Pascal, I look forward to seeing you at the upcoming roadshows and conferences. And finally, as noted on Slide 22, please mark your calendars for the 5th of October for our ESG Investor Day. Have a good day. Thank you all, and bye-bye.

Bye-bye, everyone.

Thank you. Bye-bye all.

Thank you, ladies and gentlemen. If you didn't have a chance to ask a question on today's call, please do not hesitate to send your question to Thales Group Investor Relations at [email protected], and we'll get back to you as soon as possible. Thank you for all participation. You may now disconnect.