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Thales45 rue de Villiers

92526 Neuilly-sur-SeineFrance

Tél. : + 33 (0)1 57 77 80 00www.thalesgroup.com

Ann

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Annual report2009Financial informationBusiness reviewShareholders information

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The English language version of this report is a free translation from the original, which was prepared and filed with the Autorité des Marchés Financiers in French language. All possible care has been taken to ensure that the translation is an accurate presentation of the original. However, in all matters of interpretation, views or opinion expressed in the original language version of the document in French take precedence over the translation.

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Annual report 2009>>

3. Shareholders information1. The Company and the share capital ............................................................................................................... 1622. Corporate governance ....................................................................................................................................................... 1863. Stock market information and financial communication .................................................... 221

1. Management report ...................................................................................................................................................................102. Consolidated financial statements .........................................................................................................................293. Parent company management report and financial statements .................................88

1. 2009 financial information

Person responsible ......................................................................................................................................................................... 3Overview ........................................................................................................................................................................................................ 4Timeline ........................................................................................................................................................................................................... 6Key figures ................................................................................................................................................................................................. 7

Table of contents .......................................................................................................................................................................227European cross-reference list .................................................................................................................................231Reconciliation table for annual financial report ..............................................................................235

2. Business review1. Overview ................................................................................................................................................................................................. 1322. Aerospace / Space ................................................................................................................................................................ 1443. Defence ................................................................................................................................................................................................... 1494. Security ................................................................................................................................................................................................... 158

annual report 2009 – Thales

Person responsible>>

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DECLARATION BY PERSON RESPONSIBLE FOR THE REFERENCE DOCUMENT

I certify, after having taken all reasonable measures to this effect, that, to the best of my knowledge, the information contained in this reference document is accurate and does not omit any material fact.

I certify, to the best of my knowledge, that the statutory and consolidated financial statements have been prepared in accordance with applicable accounting standards and give a fair view of the assets, liabilities, financial position and results of the company and of all the entities taken as a whole included in the consolidation, and that the management report included on page 10 of this document presents a fair view of the development and performance of the business and financial position of the company and of all the entities taken as a whole included in the consolidation, as well as a description of the main risks and uncertainties to which they are exposed.

I have received a letter from the statutory auditors confirming that they have completed the work they undertook to audit the information related to the financial situation and the financial statements included in this document, as well as a review of this document in its entirety.

The statutory auditors have issued reports, without qualification and with observations, on the 2009 consolidated financial state-ments (pages 86 and 87 of this document), the 2007 and 2008 financial statements included for reference purposes, and the 2009 financial statements of the parent company (pages 129 and 130 of this document).

Neuilly-sur-seine, 26 March 2010

French original signed byLuc Vigneron

Chairman and Chief executive Officer


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Overview>>

Thales provides integrated solutions and equipment to meet security requirements of government, in-stitutional and private customers in the aerospace, defence and security markets.

Globalisation is making the world more open, enabling peo-ple to move around more freely and easing flows of capital, goods, services and data. a more open world, however, is also more vulnerable. Contemporary societies are vulnerable in particular to the failure of large-scale critical infrastruc-ture such as transport networks, energy grids and informa-tion systems. They are also exposed to new threats such as trafficking, terrorism, cybercrime, failed states and localised but high-intensity conflict.

Thales draws on world-class expertise in information sys-tems and electronics to meet rising demand for security and to seize growth opportunities across all its markets. The company’s key strengths include proven skills in complex system design and integration and the ability to contribute to projects in any capacity – as prime contractor, lead systems integrator or provider of high-value equipment and services – depending on the requirements of each customer.

Thales establishes sustainable relationships with government and institutional customers, maintaining a local presence in each of its countries of operation and building the mutual trust required to conduct complex, long-term projects.

Thales solutions meet the three key security requirements of its customers:

• defend and protect nations and populations. Thales provides military forces and civil defence organisations with communication, command, force protection and threat detection capabilities. The company also designs and delivers combat systems for all types of air, land and naval platforms,

• maintain surveillance and control to prevent breaches of national security and threats to pub-lic safety. Thales provides public administrations with the systems and equipment they need to maintain surveil-lance, gather intelligence and control the flow of people, goods and data (earth observation from space, Internet surveillance, intelligence, airspace control and population flows control),

• enhance the dependability and security of critical civil infrastructure. Thales is a major player in trans-port safety and a global actor in both rail transport secu-rity and civil air traffic management. The company also provides security solutions for interbank transactions, enterprise and government information systems, energy networks and sensitive sites.

The dual civil/military nature of these technologies and ap-plications is central to the Thales strategy:

• with a balanced mix of businesses (57% defence, 43% civil), Thales is recognised for its expertise in all the technologies that are key to effective defence and security capabilities in the 21st century: large-scale software sys-tems, onboard electronics for all types of platforms, secure communications and transactions, sensors (radar, sonar, optical), supervision and control, and satellite technologies,

• this comprehensive coverage of the defence-securi-ty continuum has brought Thales a high-quality portfolio of customers, including operators of mission-critical infra-structure (air traffic control, rail signalling, etc.), govern-ments and administrations (identity systems, information systems security, satellite observation, etc.), civil defence and military forces (surveillance and intelligence, command information systems, communication systems, combat systems, etc.).

as a result, Thales maximises the synergies between military and civil applications and technologies, drawing on a compa-ny-wide R&D capability with the critical mass to develop and preserve the skills that are critical to national security. The company’s research and development programmes, imple-mented through a network of 22,500 engineers and techni-cal staff operating in all Thales subsidiaries around the world, constantly enhance this platform of technologies. Thales’s tradition of technological excellence gained further recogni-tion with the award of the 2007 Nobel Prize in Physics to al-bert Fert, scientific director of a joint research unit operated by Thales and France’s national research institute CNRs.

In 2009, Thales was organised into three segments:

• aerospace & space,• Defence,• security.


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around half of the company’s production and three-quarters of its revenues are generated outside France: staff from Thales commercial and industrial operations on five conti-

nents maintain close relations with domestic customers in each country. The United Kingdom is the company’s second-largest country of operation after France.

New Thales organisation for 2010

In early 2010, Thales put in place a new organisation to simplify its working methods, develop synergies across the Group, make commercial decisions more quickly and improve performance. Under the new organisation, the Group will

conduct its business through three large geographical areas and seven divisions.

each geographical area has responsibility for its profit and loss statement.

as from the 2010 financial year, first-level sector information will therefore be consolidated by geographical area.

The divisions have worldwide responsibility for research and development, product policy and industrial policy.

Geographical areas

Area A: United Kingdom, australia and New Zealand, United states, Canada, the Netherlands, Central and Northern europe, Central and Northern asia, NaTO and the United Nations.

Area B: Germany, spain, Italy, other european countries, south and southeast asia, Middle east, latin america and africa.

France is considered an area in its own right.

The seven divisions are as follows:

• Defence & security C4I systems

• air Operations

• Defence Mission systems

• land Defence

• avionics

• space

• Transportation systems

a new executive Committee (see details on page 211) was appointed when the new organisation was implemented.


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Timeline>>

1893 Compagnie Française Thomson-houston (CFTh) es-tablished to exploit the patents of the Us company

Thomson-houston electric Corp. in France, in the

field of electrical power generation and transport.

1918 Compagnie Générale de Télégraphie sans Fil (CsF), a pioneer in broadcasting, electro-acous-

tics and radar technology, set up in France.

1968 CsF and the professional electronics businesses of Thomson-Brandt merge to form Thomson-CsF.

1982 Thomson-CsF nationalised.

1983 Civil telecommunications businesses sold to Com-pagnie Générale d’Électricité (now alcatel-lucent).

1987 Medical imaging business (CGR) sold to General electric; semiconductor business merged with

those of the Italian company sGs (IRI group) to

form sGs-Thomson.

1989 Thomson-CsF acquires the defence electronics businesses of the Philips group.

1997 Interest in sGs-Thomson (now sTMicroelectronics)divested.

1998 Thomson-CsF privatised; alcatel and Groupe In-dustriel Marcel Dassault (GIMD) contribute as-

sets and become shareholders.

satellite businesses of alcatel, aerospatiale and

Thomson-CsF merge to form alcatel space, jointly

owned by Thomson-CsF (49%) and alcatel (51%).

1999 Thomson-CsF acquires 100% control of sextant avionique, the avionics joint venture between

Thomson-CsF and aerospatiale (now eaDs).

2000 Thomson-CsF completes takeover of Racal elec-tronics in the United Kingdom.

Thomson-CsF changes its name to Thales.

Thales and Raytheon form ThalesRaytheonsys-

tems in air defence.

2001 Thales sells interest in alcatel space, then mainly serving the market for civil telecommunication

satellites.

2007 Thales acquires the transport, security and space businesses of alcatel-lucent; sells French naval

surface business to DCNs and acquires a 25%

equity interest in DCNs from the French state.

2009 acquisition by Dassault aviation of Thales shares held by alcatel-lucent and GIMD. Dassault aviation be-

comes a Thales shareholder with an interest of 26%.


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FINANCIAL DATA

Key figures>>

(€ million) 2009 2008 2007

Order book at year-end 24,731 22,938 22,675

Order intake 13,927 14,298 12,856

Consolidated workforce at year-end 64,285 63,248 61,195

(€ million) 2009 (a) 2008 (a) 2007 (a)

Revenues (b) 12,881 12,665 12,296

France 3,019 3,165 3,108

United Kingdom 1,467 1,556 1,584

Other Europe 3,464 3,302 3,276

Rest of world 4,931 4,642 4,328

EBIT 151 877 858

Net income “Group share” (128) 650 1,008

Operating cash flows before working capital changes 485 1,135 1,101

Capital expenditures (including capitalised R&D) (413) (523) (506)

Net (acquisitions) disposals (152) (119) (697)

Company-funded R&D (including capitalised R&D) (664) (569) (584)

Net debt (net cash position) 91 456 291

Shareholders’ fund (excluding minority interests) 3,744 3,949 3,881

(a) Before “Purchase Price allocation” (PPa) (see box page 10).(b) Revenues by destination.


8 annual report 2009 – Thales

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2009 financial information>>

3. Parent company management report and financial statementsA. Management report on the parent company financial statements .........................88B. Parent company financial statements ..............................................................................................................95C. Statutory Auditors’ Report on the annual financial statements ............................. 129

A. Management discussion and analysis of 2009 financial statements ...................10B. Risk factors ............................................................................................................................................................................................17C. Events since year-end ..............................................................................................................................................................27

1. Management report

2. Consolidated financial statementsA. Consolidated profit and loss account .................................................................................................................29B. Consolidated statements of comprehensive income ....................................................................29C. Consolidated balance sheet ...........................................................................................................................................30D. Consolidated statement of cash flows .............................................................................................................31E. Consolidated statement of changes in shareholders’ equity

and minority interests ............................................................................................................................................................32F. Notes to the consolidated financial statements .................................................................................33G. List of main consolidated companies ..................................................................................................................85H. Statutory Auditors’ Report on the consolidated financial statements ................86



2009 Financial information>>

1. MANAGEMENT REPORT

A. MANAGEMENT DISCUSSION AND ANALYSIS OF 2009 FINANCIAL STATEMENTS

In a persistently depressed global economic environment, rev-enue growth and robust order intake are testimony to the solid foundations of the Group’s customer base, primarily govern-ments and infrastructure operators. however, results were

affected by significant difficulties on a number of contracts and by the crisis in the air transport sector. In response, Thales launched an ambitious performance improvement plan at the end of the year, with a new management team in place.

Key figures 2009 (€ million) 2009 2008 Total change Organic change

Order intake 13,927 14,298 -3% -2%

Order book at 31 Dec. 2009 24,731 22,938 +8% +5%

Revenues 12,881 12,665 +2% +2%

EBIT (a) 151 877 -83% -84%

As % of revenues 1.2% 6.9%

Net income, Group share (128) 650 -120%

Net debt at 31 Dec. 2009 91 456

(a) Before adjustment for PPa (cf. box below).

In order to monitor and compare the Group’s economic performance, the consolidated profit and loss account is restated from the adjustment entries related to the Purchase Price allocation (PPa) recognised through significant business combinations. These mainly relate to the acquisition of the space, transportation and security businesses of alcatel-lucent in 2007 and the 25% equity interest in DCNs.

All figures in this report are before adjustment for PPA. PPa reduced eBIT by €(99)m and reduced net income by €(74)m. In view of these adjustments, net income, Group share, stood at -€202m at end-2009, compared with €560m at end-2008.

CHANGES TO ACCOUNTING INFORMATION

PRESENTATION OF ACCOUNTS

From 1 January 2009, warranty costs, whether related to long-term contracts or not, are presented in the consoli-dated profit and loss account under cost of sales. They were previously included in marketing and selling expenses except when directly allocated to contracts.

NEw APPLICABLE STANDARDS AND INTERPRETATIONS

The consolidated financial statements of the Thales Group are prepared in accordance with IFRs (International Finan-

cial Reporting standards) as approved by the european Un-ion at 31 December 2009. The accounting policies applied by the Group are consistent with those followed in the prep-aration of the Group’s annual IFRs consolidated financial statements for the year ended 31 December 2008, except for the adoption of certain new standards and interpreta-tions: IFRs 8 (operating segments), amendment to Ias 23 (borrowing costs), amendment to Ias 1 (presentation of fi-nancial statements) and amendment to IFRs 7 (financial in-struments). These new standards and interpretations have no impact for the Group and have led, where applicable, to the disclosure of certain additional information.

annual report 2009 – Thales 11

Management report Consolidated financial statementsParent company management report and financial statements

>> �Management discussion and analysis of 2009 financial statements

1. BUSINESS ACTIvITY

Revenues increased by 2% on a like-for-like basis and with constant exchange rates, with sharp rises in Defence and security, which offset lower sales in aerospace.

Order intake at €13,927m remained very high in 2009 – just 2% below the record level achieved in 2008 (in organic terms, i.e. on a like-for-like basis and with constant exchange rates). several major contracts were booked in France and on export.

eBIT stood at €151m, affected by significant exceptional ex-penses on programmes and a difficult economic environment in aerospace and security.

Net income, Group share, was -€128m, after significant im-pairment of intangible assets.

The Group’s financial position remains solid, however, with a marked increase in free operating cash flow to €800m,

allowing a further reduction in net debt, limited to €91m (compared with €456m at end-2008).

1.1. Consolidated revenues

a. Consolidated revenues by segment

Consolidated revenues amounted to €12,881m at 31 December 2009, compared with €12,665m in 2008, an organic increase of +2%. Exchange rate fluctua-tions reduced revenues by €134m, almost entirely as a result of the conversion into euros of sales by subsidiaries based outside the euro zone. The main fluctuations involved the weakening of the pound sterling (–€168m) against the euro, which was partially offset by the stronger Us dollar (+€59m). Changes in the scope of consolidation 1 corre-spond to a net increase in revenues of +€161m.

Aerospace & Space

The aerospace & space businesses recorded revenues of €4,071m, a decrease of 5% from 2008.

Aerospace revenues decreased by 7% to €2,638m, both in the civil sector and in military markets (military avionics, helicopter systems). The downturn was particu-larly significant in regional aviation, reflecting the drop in aircraft production rates at Bombardier, and in IFe, reflect-

ing lower investments by airlines as well as delays on the Boeing B787 programme.

lower sales by the space businesses (€1,433m, down -2%), despite their substantial underlying strengths, re-flects the impact of the earthquake at l’aquila in Italy in early april, which damaged Thales alenia space’s facilities and affected billing cycles, as well as the temporary suspension of the Globalstar programme and a slowdown in services activities (Telespazio).

Revenues (€ million) 2009 2008 Total change Organic change

Aerospace & Space 4,071 4,140 -2% -5%

Defence 5,763 5,502 +5% +6%

Security 2,977 2,893 +3% +4%

Others and divested businesses 70 130 ns ns

Consolidated revenues 12,881 12,665 +2% +2%

1. Primarily the sale of IT services activities in Germany in January 2009 and the consolidation of nCipher, Diehl aircabin (both since 1 January 2009) and CMT Medical Technolo-gies (since 1 July 2009).



Defence

Defence revenues stood at €5,763m, up +6% on 2008, with growth recorded in all the main segments of this mar-ket. The sharp increase in naval revenues is mainly due to in-creased activity on the CVF aircraft carrier programme in the United Kingdom as well as contracts to equip patrol boats for Denmark and FREMM frigates for France, Italy and Morocco. air systems sales were also higher, particularly in air traf-fic management (Nigeria, Coopans programme for sweden, Denmark and Ireland). The increase in land & Joint systems revenues was driven by growth in optronics and networks.

b. Consolidated revenues by destination

Security

Security revenues were up +4% to €2,977m, compared with €2,893m in 2008. Rail signalling revenues continued to grow, driven in particular by the spanish high-speed rail and Dubai metro projects. however, the global economic crisis affected sales across the rest of the sector. In par-ticular, the sharp decrease in revenues in critical informa-tion systems and special components (for industrial and medical applications) and the more moderate decrease in security systems reflect lower demand in these short- cycle segments.

Revenues (€ million) 2009 2008 Organic change 2009 (%)

France 3,019 3,165 -6% 23%

United Kingdom 1,467 1,556 +3% 11%

Other European countries 3,464 3,301 +3% 28%

Total Europe 7,950 8,022 -1% 62%

North America 1,158 1,190 -7% 9%

Australia 525 571 -7% 4%

Asia 1,158 1,139 +2% 9%

Near & Middle East 1,319 1,135 +17% 10%

Rest of world 771 608 +26% 6%

Total outside Europe 4,931 4,643 +5% 38%

Consolidated revenues at 31 December 12,881 12,665 +2% 100%

europe accounted for close to two-thirds of revenues in 2009, with particularly strong growth in the United King-dom, as a result of significant orders in recent years. In the Near & Middle east, revenues were markedly higher, not only in Defence but also in civil markets (space, Transportation), particularly in saudi arabia and the United arab emirates.

1.2. order intake

New orders booked in the 2009 financial year amounted to €13,927m, a slight decrease of 2% on an organic ba-

sis compared with 2008, when order intake was particularly brisk. The book-to-bill ratio 1 stood at 1.08.

The order intake figure reflects several major orders worth a total of €3,513m, including Tranche 4 of the Rafale pro-gramme and FReMM frigates in France, the Sentinel pro-gramme for the european space agency, the North-South rail link in saudi arabia, the Mexico City urban security programme and air defence radars in Finland. however, the volume of orders with a unit value of less than €100m fell, particularly in aerospace / space and security.

1. Total value of orders booked divided by total revenues for the year.




Order intake (€ million) 2009 2008 Total change Organic change Book-to-bill

Aerospace & Space 4,332 4,184 +4% +1% 1.06

Defence 6,093 6,547 -7% -5% 1.06

Security 3,390 3,461 -2% -1% 1.14

Others and divested businesses 112 106 ns ns ns

Consolidated order intake 13,927 14,298 -3% -2% 1.08

Aerospace & Space

In the Aerospace & Space segment, order intake amount-ed to €4,332m, up by 1%, with a book-to-bill ratio of 1.06.

Aerospace orders fell by 7% to €2,736m, but the book-to-bill ratio remained higher than 1 (at 1.04). Order intake by the civil aerospace businesses fell by -34% compared with 2008 and continued to reflect the crisis in air trans-port, with significantly lower orders for avionics for regional and business aircraft (Dash, CRJ, Global Express), in-flight entertainment (IFe) systems and, to a lesser extent, sup-port services. Conversely, orders in military aerospace were higher, thanks in particular to the contract for Tranche 4 of the Rafale programme in France and sustained sales of support services (Rafale, ATL2 upgrade).

Order intake by the space businesses increased sharply (+17%) to €1,596m, with several major orders for obser-vation satellites (Sentinel 3 for the european space agency) and telecommunication satellites (Eutelsat W3B, Global-star) as well as pressurised modules for the International space station (Cygnus). The book-to-bill ratio was 1.11.

Defence

Defence orders decreased by 5% to €6,093m, compared with €6,547m in 2008. The book-to-bill ratio remained higher than 1 (at 1.06), even though the naval business benefited from a volume of major contracts in 2008 (CVF aircraft car-rier programme in the United Kingdom, corvettes for Morocco and FREMM frigates for Italy) that was not repeated this year, despite several significant successes, including the minehunt-er upgrade programme in singapore and equipment for the

three additional FREMM frigates in France. Order intake by the air systems business was also lower, with the replication orders of the ACCS LOC1 air command and control system contract for NaTO and the GM400 radar contract for Fin-land failing to offset the decrease in orders for civil air traffic control systems, weapon systems and missile electronics (the air traffic control business had booked the Lorads III contract in singapore in early 2008). By contrast, new orders booked by the land & Joint systems business increased significantly, with growth driven in particular by major contracts in domestic markets (Rafale optronics in France, FIST future soldier sys-tem contract in the United Kingdom) as well as tactical com-munication and vehicle system contracts in export markets.

Security

Security orders were virtually stable compared with 2008, at €3,390m (-1% on an organic basis). The book-to-bill ratio remained high, however, at 1.14. Order intake from institutional customers was strong. several key orders were booked in rail signalling and rail traffic management, both for urban transportation projects (Mecca, Dubai, Cairo, etc.) and main line projects (North-South rail link in saudi ara-bia, Barcelona-Figueras high-speed line in spain). In security systems, Thales won the major Ciudad Segura urban secu-rity contract in Mexico City. however, order intake showed a sharp downturn in areas directly affected by the economic environment, with a decrease of up to 25% in industry and services (critical information systems, special components) and exceeding 50% in simulation.

at 31 December 2009, the consolidated order book stood at €24,731m, or approximately 23 months of revenues (compared with 22 months at end-2008).



EBIT (€ million) 2009 2008 Total change Organic change

Aerospace & Space (310) 207 -250% -261%

Defence 544 540 +1% +3%

Security (11) 157 -107% -112%

Others and divested businesses (73) (27) ns ns

EBIT 151 877 -83% -84%

2. RESULTS

2.1. eBit

EBIT stood at €151m and represented 1.2% of revenues, compared with 6.9% in 2008, as the strong performance of the Defence segment failed to offset significant difficulties in the aerospace and security segments.

Restructuring costs amounted to €116m, the equivalent of 0.9% of revenues, compared with €33m (0.3% of revenues) in 2008.

a. EBIT by segment

Aerospace & Space

The aerospace & space segment recorded eBIT of -€310m, compared with a positive figure of €207m in 2008.

In addition to further deterioration in the civil aerospace mar-ket, with a reduction in airline business, further delays on the B787 programme and a marked increase in restructuring costs (€43m compared with €10m), several unfavourable factors eroded the eBIT of the aerospace businesses, which amounted to -€389m (compared with a positive fig-ure of €127m in 2008):

• cost overruns on several avionics software developments, which were charged as expenses,

• an increase in estimated costs at completion for a naval electronic warfare programme,

• uncertainties concerning the outcome of discussions with the customer on the Meltem programme (maritime patrol and surveillance aircraft for Turkey), with the risk of further delays to delivery schedules as well as additional expenses 1,

• higher estimated development costs for the a400M flight management system, leading to a further exceptional charge of €102m from the first half of 2009 to account for the greater technical complexity of the solution and contingencies related to delays and general uncertainties on the programme In addi-tion, uncertainties about the outcome of discussions between the various stakeholders and about the future stability of the programme’s functional and financial parameters could have a significant positive or negative impact on the overall profit or loss on completion of this programme over the coming years 1.

The space businesses recorded eBIT of €79m, an or-ganic increase of 7%, but the earthquake that damaged the l’aquila facility in Italy in april 2009 had a negative impact on several programmes.

1. For more details about the a400M and Meltem programmes, see note 16 to the consolidated financial statements.




Defence

The Defence businesses again performed very satisfacto-rily, with eBIT amounting to €544m, representing 9.4% of revenues, a level close to that achieved in 2008. Continued good performance by the three divisions in this segment is attributable to further growth in activity, smooth programme delivery and effective control of indirect costs.

Security

The Security businesses recorded eBIT of -€11m, com-pared with a positive figure of €157m in 2008. This de-crease is due to two similarly significant factors:

• the global economic crisis and the impact of lower rev-enues (with the exception of rail transport) on profitability,

• continued difficulties on a number of programmes, particu-larly for ticketing solutions, where, despite ongoing correc-tive measures, the Group booked further and significant exceptional charges to ensure smooth contract delivery and completion also, in simulation, the development of the new product range generated cost overruns.

b. Components of EBIT

Despite the very satisfactory performance in the Defence segment, negative variances on a number of programmes, particularly in aerospace, significantly reduced gross mar-gin, which contracted to 17.6% of revenues, compared with 21.4% in 2008.

Research and development (R&D) investment was maintained at close to 20% of revenues: total expenditure reached ap-proximately €2,500m in 2009, compared with €2,400m in 2008. self-funded R&D stood at €664m, or around one-quarter of total expenditure. This breaks down into €113m capitalised under Ias 38 and €551m charged as an expense. Capitalised R&D was lower than the previous year, particularly in aerospace. In addition, Thales decided at the end of 2009 to introduce stricter criteria for recognising research and de-velopment expenses as assets (higher internal rate of return required and more stringent evaluation of project feasibility).

2.2. other results

as part of its systematic review of the value of assets on the balance sheet, the Group recorded €240m of impairment charges on capitalised development costs, almost en-tirely for aerospace-related businesses. The fall in value has no impact on cash flows and is attributable to a combina-tion of unfavourable factors (crisis in the air transport sector leading to a sharp fall in expected business volumes, the persistently weak dollar, development cost overruns and new aircraft programme delays) affecting the business plans of the programmes concerned 1.

Net financial expense amounted to -€111m, which is a higher expense than in 2008, due in particular to the cost of hedging strategies in persistently volatile foreign exchange markets and expenses related to the bond issues conducted early in the year to secure the company’s liquidity. The other components of pension charges amounted to -€105m, compared with -€11m in 2008, as a result of a significant reduction in investment income forecasts and certain non-recurring costs, whereas this figure at 31 December 2008 still included part of the exceptional impact of the pension scheme renegotiations concluded in 2007 and 2008. In-come of equity affiliates amounted to €56m, compared with €66m in 2008.

2.3. net inCome

Net income, Group share, for 2009 stood at -€128m (compared with a positive figure of €650m in 2008), after an income tax expense of €142m compared with -€145m in 2008.

3. FINANCIAL SITUATION AT 31 DECEMBER 2009

In 2009, free operating cash flow 2 stood at €800m, a very significant improvement over 2008 (€377m). This improvement is the result of significant cash inflows from customers at the end of the year and unrelenting efforts to manage working capital requirements throughout the year.

1. For more details, see note 6 to the consolidated financial statements.2. Operating cash flow plus changes in working capital requirement (WCR) and reserves for contingencies less payment of pension benefits (excluding deficit payments on pensions

in the UK, considered as payments of a financial nature) less tax less net operating investments.



summarised statement of Cash flows

(€ million)2009 2008

Operating cash flow 485 1,135

Change in WCR and contingency reserves 925 (44)

Payment of pension benefits and scheme settlements (99) (111)

Income tax paid (98) (80)

Net operating cash flow 1,213 900

Net operating investments (413) (523)

of which capitalised R&D (113) (129)

Free operating cash flow 800 377

Net (acquisitions) / disposals (148) (84)

Deficit payments on pensions in the UK (58) (79)

Dividends (205) (195)

Net cash flow 389 19

Operating cash flow was substantially lower at €485m com-pared with €1,135m in 2008. however, a favourable trend in working capital requirements (after provisions) and lower investments enabled the Group to reach an excellent level of Free operating cash flow. after recognising an earn-out pay-ment of €130m to alcatel-lucent for the space businesses acquired in 2007, and a payment of €58m towards the un-funded status of pension obligations in the United Kingdom, net cash flow stood at €389m.

Given this level of net cash flow, net debt at 31 December 2009 was significantly lower than a year before, at €91m 1, compared with €456m at end-2008. Shareholders’ eq-uity (excluding minority interests) amounted to €3,744m, compared with €3,949m at end-2008. Thales has access to confirmed, undrawn bank credit lines for an amount of €1,500m, maturing at end-2011, with no prepayment provi-sions linked to ratings or financial covenants. standard & Poor’s and Moody’s also recently confirmed Thales’s long-term rating of a- /a1.

4. PROPOSED DIvIDEND

In view of the loss reported for the 2009 financial year and the business outlook in the Group’s main markets, which have led to the launch of an ambitious performance improvement plan, the Board of Directors will propose that the General Meeting of shareholders of 20 May 2010 approve a reduced divi-

dend of €0.50 per share. If approved, the dividend will be paid on 31 May 2010 (ex-dividend day: 26 May 2010).

5. vIEwS FOR 2010

For 2010, Thales expects revenues to remain stable, with the significant volume of new orders recorded over the last two years from institutional customers (government and in-frastructure operators) offsetting the unfavourable impact of the economic climate and the crisis in the air transport sector.

Growing pressure on budgets in Thales’s main domestic markets could lead to lower order intake in 2010 and a book-to-bill ratio substantially lower than 1.

While the 2009 financial year was marked by considerable difficulties on a number of complex programmes, Thales has taken substantive measures to incrementally improve eBIT margin, including the launch of the Probasis plan, which is expected to generate €1.3bn in full-year savings in 2014. against this backdrop, Thales expects to achieve an eBIT margin of between 3% and 4% in 2010, taking into account a persistently unfavourable situation in the air transport sec-tor and certain other civil businesses, restructuring costs as high as 1.5% of revenues, lower capitalisation of research and development expenses and the dilutive effect on eBIT of the provisions on contracts booked in 2009.

1. a detailed breakdown of gross financial debt is given in note 24 to the consolidated financial statements.

17

>> �Risk factors


Consolidated financial statementsParent company management report and financial statementsManagement report

B. RISK FACTORS

Thales is exposed to a number of risks and uncertainties that could have a significant effect on its business activity, finan-cial position or results. The risks described below are not the only ones that Thales faces. Other risks of which Thales is not aware, or which are not believed to be significant at this time, could also have an unfavourable impact on the com-pany’s revenues, profitability or financial position.

as a general rule, some of these risks are external in nature (relating for example to developments in financial markets or the political environment) whereas others are internal in nature (relating to programme management or compliance with legal or regulatory frameworks, etc.).

1. FINANCIAL RISKS

1.1. liquidity

Thales’s liquidity risk corresponds to its level of exposure to changes in the main market indicators that could lead to an increase in the cost of credit or even to a temporary limita-tion of access to external sources of financing.

Thales manages this risk by anticipating its liquidity require-ments and by maintaining committed, undrawn credit facili-ties granted by banks as backup for the commercial paper programme and representing, as such, a financing reserve.

This risk is hedged by Thales’s short- and long-term financial resources:

• shareholders’ equity, listed by heading in Note 20 to the consolidated financial statements,

• gross debt, listed by date of maturity in Note 24 to the consolidated financial statements,

• committed, undrawn credit facilities granted by banks as backup for the commercial paper programme and repre-senting, as such, a financing reserve (the characteristics of these facilities are presented in Note 24 to the consoli-dated financial statements).

This principle of consolidating and centralising the short-term surpluses and requirements of units (cash pooling) is

applied to units in the same currency zone – euro zone (with separate cash pooling for French units), sterling zone, dollar zone and australian dollar zone, etc. – and, in some cases, in the same country.

Through the consolidation and centralisation of cash require-ments and surpluses of its units, the Group is in a position to:

• simplify cash management and match the cash positions of units to produce a single consolidated position that is easier to manage,

• gain prime access to financial markets through the par-ent company’s financing programmes, rated by standard & Poor’s and Moody’s (see below).

at 31 December 2009, cash recorded under consolidated assets amounted to €1,960m (compared with €1,500m at end-2008), including:

• €1,401m held by the parent company and available for immediate use,

• €357m in the bank credit balances of subsidiaries, most of them outside France (this figure includes payments re-ceived in the last few days of the financial year and sub-sequently transferred to the corporate treasury account),

• €202m in cash invested directly by joint ventures (pro-rated by Thales’s interest in each joint venture), since cash pooling is not applicable to joint ventures.

Cash at bank and equivalents at year-end is solely invested in either bank deposits or in very short-term bank certificates of deposit with first-tier banks, and is therefore not sub-ject to mark-to-market valuation. at the date of publication, Thales’s credit risk ratings were as follows:

Moody’s Standard & Poor’s

Medium- & long-term loans A1 A-

Outlook Outlook stable Outlook stable

Commercial paper & short-term loans Prime-1 A2



Thales’s ratings remained unchanged in 2009.

a decrease of Thales’s credit risk ratings would have no im-pact on the terms and conditions of committed financings, since they are not linked to financial covenants included in fi-nancing contracts. Pursuant to the credit facility documents, clauses providing for accelerated repayment would only apply in the event that the state no longer held its golden share and, simultaneously, the ratio of consolidated net financial debt to eBITDa (earnings before interest, taxes, deprecia-tion and amortisation) were to exceed 3.

1.2. interest rates

Thales is exposed to interest rate volatility and in particular its impact on the conditions associated with variable-rate financing. To limit this risk, Thales operates an active policy of interest rate hedging.

1.3. foreign exChange rates

Due to the globalised nature of its business activities, Thales is exposed to the risk of exchange rate fluctuations.

1.3.1. Business-related currency risk

Business-related currency risk occurs when some business is billed in a currency other than that of the costs incurred.

a. as a general rule, Thales is structurally immune to ex-change rate fluctuations for a significant part of its business activity. almost half of Thales’s revenues are generated in the euro zone, which is also where the larg-est proportion of its industrial operations are located. In addition, Thales’s international development policy, both in europe and in other regions of the world (the United states, australia, south Korea, south africa, etc.), has

The Corporate Financing & Treasury department con-solidates data on Thales’s exposure to interest rate risk and uses the appropriate financial instruments to hedge those risks.

Thales policy is to control interest rate and counterparty risks and to optimise its funding and banking operations by consolidating and pooling the cash surpluses and require-ments of all its units.

The breakdown of Thales’s debt by type of interest rate is de-scribed in Note 24 to the consolidated financial statements. The table below summarises the company’s exposure to in-terest rate risk before and after hedging.

Based on the average debt for 2009, a 1% rise in interest rates would increase financial expense by €3 million.

the added advantage of allowing the company to manu-facture and bill in local currency, thereby eliminating ex-change rate risk.

b. The accounts of Thales subsidiaries located in countries with functional currencies other than the euro are trans-lated into euros in the company’s consolidated accounts. The fall in the value of these currencies against the euro is likely to have a negative impact on accounts. Its impact on profitability is limited, however, since the cost base of these subsidiaries is essentially in the same currency as their revenues.

c. For some of Thales’s business activities (civil avionics, tubes, civil space), the Us dollar is the reference currency for transactions. For business activities outside the dollar zone (in-flight entertainment business is based essentially in the United states and is therefore largely immune to this risk), a specific exchange risk hedging policy is implemented.

O/N to 1 year 1 to 5 years Longer Total

fixed variable fixed variable fixed variable fixed variable

Financial liabilities -69.6 -453.6 -1,502.4 -38.6 -59.5 -26.4 -1,631.5 -518.6

Financial assets 2,059.3 2,059.3

Net position before hedging -69.6 1,605.7 -1,502.4 -38.6 -59.5 -26.4 -1,631.5 1,540.7

Off-balance-sheet -1.4 1.4 758.2 -758.2 -21.2 21.2 735.6 -735.6

Net position after hedging -71.0 1,607.1 -744.2 -796.8 -80.7 -5.2 -895.9 805.1

19

>> �Risk factors



• For equipment transactions (avionics, tubes), this policy is defined on the basis of sales forecasts in UsD, after accounting for corresponding purchases in UsD. For these transactions, net exposure to dollar risk repre-sents around 3% of total revenues.

• For longer-term programmes in markets traditionally denominated in UsD (primarily in civil space and simula-tors), each bid or proposal is examined for profitability in the light of the effect of currency fluctuations, after accounting for corresponding purchases in UsD, and, if necessary, is hedged either through market transac-tions (forward exchange-rate contracts and options) or by reinsurance with private insurance companies, in particular Coface.a similar approach is applied when necessary in any other market segment if a customer requires a contract denominated in UsD.Overall, net exposure for these programmes at end-2009 represented around 3.5% of total revenues.

• as well as this direct dollar risk, which concerned around 6.5% of consolidated revenues in total at end-2009, Thales is also exposed to indirect dollar risk, on some contracts denominated in currencies other than the dollar. This occurs when the company is bid-ding against companies that benefit from a cost base in dollars. analysis by product lines and geographic areas shows that an estimated 15% to 20% of total revenues may be exposed to this indirect dollar risk.

Dollar risk is thus the main currency risk that Thales needs to hedge. The figures corresponding to the hedging of busi-ness-related dollar risk are as follows:

• Us$2,140m to hedge net firm commitments (UsD risk against eUR, CaD and GBP) at 31 December 2009, com-pared with Us$2,158m at 31 December 2008,

• Us$299m to hedge bids and proposals at 31 December 2009, compared with Us$1,480m at 31 December 2008.

Operating receivables and payables denominated in foreign currencies are covered by exchange rate hedges and are not therefore exposed to foreign currency risk.

The change in value of financial instruments used as cash flow hedges is recognised in shareholders’ equity. a de-crease (respectively, an increase) of 5% in the rate of the dollar against the main currencies (eUR, GBP and CaD) would positively (respectively, negatively) impact sharehold-ers’ equity by approximately €70m at 31 December 2009, compared with €95m at 31 December 2008.

The change in value of the financial instruments, matched with portfolios of sales offers, which are not eligible for hedge accounting, is recognised in profit and loss. a decrease (respectively, an increase) of 5% in the rate of the dollar against the main currencies (eUR, GBP and CaD) would positively (respectively, negatively) impact profit and loss by approximately €2m at 31 December 2009, compared with €9m at 31 December 2008.

Foreign currency-denominated financial debt does not gener-ate any exposure in profit and loss, as it is either denomi-nated in the functional currency of the entity in which it is recognised, or is used as a net foreign investment hedge.

1.3.2. Management of risk relating to foreign currency-denominated assets

Thales hedges a limited part of its foreign currency-denomi-nated assets, mainly those assets likely to be disposed of at some future date. The main criteria for determining whether or not a given foreign currency-denominated asset should be hedged are as follows:

• the nature of the business involved,• the structure of Thales’s commitment with respect to joint-

ly held companies, in particular the specific features of the shareholders’ agreement in each joint venture.

In general, hedging is achieved by loans or currency swaps in the same currency as the assets to be hedged. The actual application of this policy, however, also depends on:

• the objective of optimising hedges in the light of market conditions (availability of foreign currency, interest rates, cost of hedges, etc.),

• the risks inherent in the future value of the assets being hedged and the nature of the business of the correspond-ing subsidiaries.

GBP USD AUD

Assets 2,512.0 965.3 721.1

Liabilities 1,663.1 449.7 401.4

Net position before hedging 848.9 515.6 319.7

Off-balance-sheet - 37.0

Net position after hedging 811.9 515.6 319.7

Summary of risks relating to foreign currency-denominated assets at 31 December 2009 (in €m)



1.4. stoCk market risk

Thales is not exposed to any significant stock market risk at end-2009.

1.5. off-BalanCe-sheet Commitments

1.5.1. Pension commitments

Defined-benefit pension schemes are in place for certain Thales employees, mainly in the United Kingdom and the Netherlands, and are externally funded by the company un-der the provisions of the applicable national legislation.

New employees in the United Kingdom no longer have access to these pension plans. however, obligations with respect to current, former and retired Thales employees in these two countries stood at €2,860.8m at 31 December 2009, of which €2,447.1m was covered by plan assets. This rep-resents an unfunded status of €413.7m. at 31 December 2009, plan assets were invested as follows:• 40.6% in equities,• 42.2% in fixed-rate bonds,• 2% in property,• 9.1% in inflation-indexed funds,• 0.2% in cash,• 5.9% in alternative funds.

Changing market parameters can affect the unfunded status and the annual costs of defined-benefit plans. In order of importance, at 31 December 2009, the main variables are as follows:

• a reduction or increase in the discount rate applied to li-abilities, which can increase or reduce the unfunded sta-tus; this variable is partly offset by changes in the value of fixed-rate bonds held as plan assets and interest rate swap transactions,

• changes in the total return on investments held in equities and property,

• changes in the forecast inflation rate,• a substantial change in mortality tables,• exchange rate fluctuations (mainly the pound sterling

against the euro).

Thales has introduced quarterly reporting on its pension plan positions and makes regular deterministic and stochastic projections measuring the sensitivity of the unfunded status

to possible changes in market parameters and incorporat-ing correlation factors. In countries like the United Kingdom and the Netherlands, Thales is committed to defined-benefit pension schemes, but plan assets are managed by trustees, in accordance with applicable regulations and in consultation with the company. Plan assets are allocated with regard to the long-term nature of the commitments they cover.

1.5.2. Parent company guarantees

Thales, as the parent company, issues guarantees on com-mitments undertaken by its subsidiaries on commercial con-tracts. These guarantees are centralised by the Corporate Financing & Treasury department.

Guarantees are limited to an overall amount of €3bn under authority granted on a half-yearly basis to the Chairman by the Board of Directors. The Chief Financial Officer informs the Board of Directors of the use of this authority, which is monitored by the Corporate Financing & Treasury depart-ment, before the authority is renewed.

at 31 December 2009, guarantees issued by the parent company in support of its subsidiaries stood at €8,771m. This figure includes all commitments in relation to Thales ale-nia space (matched by a counter-guarantee from Finmeccani-ca in proportion to its 33% interest in Thales alenia space).

Thales manages risk connected to these parent company guarantees and optimises the financial conditions of the transactions guaranteed. The main objectives of this risk management policy are as follows:

• to limit risks to those corresponding to normal commit-ments on commercial contracts in terms of volume and duration,

• to guarantee commitments made by wholly owned subsidi-aries only, with guarantees on commitments by consortia or joint ventures made in proportion to Thales’s interests in those consortia or joint ventures,

• to enable its subsidiaries to benefit, when appropriate, from the credit quality of the parent company by monitor-ing the financial conditions of the operations guaranteed.

1.6. Customer Credit

Credit risk relates to the risk that a party to a contract will default on its commitments or fail to pay what it owes.

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>> �Risk factors



1.6.1. Risk relating to failure of a private-sector customer

Civil customers (business and industry, civil aerospace and private infrastructure operators) account for approximately 25% of Thales’s revenues. These customers may encounter major and/or prolonged financial difficulties that could lead to payment defaults or order cancellations. such occurrences could have a negative impact on Thales’s revenues, profit-ability and financial position.

To mitigate these risks, Thales conducts regular analysis of the ability of customers to meet their obligations. When nec-essary, Thales may request bank guarantees or corporate guarantees, or may alternatively use credit insurers.

1.6.2. Credit risk relating to public-sector customers

Government and institutional customers account for around 75% of Thales’s revenues. Thales works with a large number of countries. some of these could present a significant credit risk, particularly the emerging nations. a country could, for example, suspend an order in production, or be unable to make payment on delivery, as agreed under the terms of the contract. To limit its exposure to these risks, Thales can take out insurance with export credit agencies (such as Coface in France) or private insurers.

at 31 December 2009, only two customers accounted for an-nual revenues in excess of €500m: the French government (approx. €2bn) and the UK government (approx. €1bn). at that date, both states were rated aaa by standard & Poor’s.

2. LEGAL RISKS

2.1. ComplianCe with legislation and regulations

Many of Thales’s business activities, particularly in the de-fence, security and space sectors, are exercised in a com-plex and stringent legal and regulatory environment, which is constantly evolving both at national and international level.

The legal and regulatory framework in which Thales operates covers a broad range of areas, relating in particular to com-pany law, labour law, export control and measures to combat corruption and money laundering.

Thales monitors developments within this legal and regulato-ry framework through its international network. The company is not always able to anticipate them in advance, however, and in this respect its business activities can be affected.

Despite the steps taken by Thales as a company to comply with all applicable legislation, risks nonetheless exist due to their inherent nature, the interpretative powers of regulatory agents and changes in legal/judicial precedent and sanction-ing powers.

In most cases, regulators in conjunction with the judicial au-thorities have the right to pursue legal proceedings, which could lead to civil, administrative or even criminal rulings. such a ruling could, if applicable, involve a temporary order to cease activity, which would in turn have an adverse impact on Thales’s profitability and financial position.

To manage this complexity, Thales has set up a Risks & In-ternal Control Committee, which uses legal and regulatory risk-mapping to evaluate and monitor the implementation and continuous improvement of compliance action plans at each unit. actions to ensure compliance are supported by networks of compliance officers, which include specialists in such areas as export control, as well as a dedicated organisation for is-sues connected with international trade (see below).

The Risks & Internal Control Committee assists with regular controls in the area of compliance, conducted by the Internal au-dit Department, and monitors the conclusions of these controls.

Regular reports are submitted to the audit and accounts Committee of the Thales Board of Directors, which may in turn issue compliance control directives applicable to the or-ganisation as a whole.

2.1.1. Management of commercial activities

Due to its many geographic operations and the diversity of its markets and sectors of activity, Thales is subject to a broad array of national and international laws and regulations governing commercial activities (OeCD Convention and its national implementation laws, Foreign Corrupt Practices act in the United states, etc.).

Infringement of these laws can lead to severe legal conse-quences for the individuals or entities concerned. It can also have a serious impact on the image and reputation of the company as a whole.



Thales had a specific organisation in place for many years and has developed a cohesive set of directives, which are written into the company’s reference system, as well as in-dependent monitoring and control procedures.

In support of this organisation, Thales attaches particular importance to employee awareness and the provision of rel-evant training for new employees, including specific training for those who will be directly involved with these issues in their line of work. Three e-learning modules were launched in 2009 to raise awareness of ethics-related issues and en-sure that all employees understand the Thales ethical com-pliance system and how it works.

In addition, Thales strictly controls its use of business ad-visors or service providers through a detailed procedure, which includes comprehensive due diligence checks as well as appropriate representations and commitments from such advisors or providers.

Thales also continues to disseminate and promote best practices among its suppliers and subcontractors, and re-quires them in particular to subscribe to the terms of its Purchasing & Corporate Responsibility Charter. This initia-tive was commended by the United Nations in the UN Global Compact 2008 annual Review. Thales formally renewed its commitment to the Global Compact in 2009.

Finally, Thales is closely involved in the relevant professional bodies at national level (MeDeF, BeRR, aIa, etc.) and inter-national level (asD, ICC, etc.) as well as in various working groups of intergovernmental organisations (OeCD, etc.). The company actively contributes in various ways to efforts to prevent corruption, in particular through the transatlantic initiative in the aerospace and defence sector to establish and ratify the Global Principles of Business ethics.

2.1.2. Export control

exports account for a significant proportion of Thales’s busi-ness. Many of the company’s products and systems are de-signed for military or dual-use applications. Consequently, the export of these products or systems to customers locat-ed outside Thales’s domestic markets where they are manu-factured, particularly in the defence sector, may be subject to limitations, export licences or specific export controls (im-posed by the countries in which Thales operates as well as by other countries where the suppliers of component products or technologies are based, most notably the United states).

There are no guarantees that (i) the export controls to which Thales is subject will not be tightened, (ii) subsequent gen-erations of Thales products or systems will not be subject to similar or more rigorous controls, and (iii) geopolitical fac-tors will not make it impossible to obtain export licences for certain customers or make it more difficult for Thales to execute previously signed contracts. Further limitations on access to military markets would thus have a negative im-pact on Thales’s revenues, profitability and financial position.

Thales has put in place systems and formal procedures to ensure compliance with applicable regulations and controls, and reinforces these measures through information and awareness programmes. In addition, operating units have access to a network of specialists who provide assistance with the application of compliance rules determined at Group level as well as with the necessary authorisations.

2.1.3. Competition

Thales’s business activities are subject to a wide range of national and international regulations to combat anti-com-petitive practice.

Infringement of these rules can lead to severe sanctions, such as fines, payment of damages, sales restrictions and legally binding prohibitions. They can also have a serious im-pact on corporate image and reputation.

To avoid any such infringements, Thales has initiated an infor-mation and awareness programme to ensure employees are properly informed about these rules, in particular through the rollout of a dedicated e-learning programme.

2.1.4. Intellectual property

Thales is exposed to two main types of intellectual property risks: dependence on third-party technologies, and third-party actions against the company for alleged infringement of their intellectual property rights.

To reduce the risk of reliance on third-party technologies, Thales has designed and implemented an ambitious policy to control critical technologies and outsourcing. This policy is updated each year.

Given the nature of its activities and the specific features of its products, Thales conducts most of its research and develop-

23

>> �Risk factors



ment work in-house and controls the technologies that are criti-cally important to its businesses. Thales’s extensive intellectual property portfolio (14,000 patents, as well as software and know-how) and its position throughout the value chain (equip-ment, systems, systems of systems) reduce reliance on third-party technology licenses. as a result, Thales’s dependence on licences granted by third parties can be considered as very low.

To reduce the risk of third-party actions for alleged infringe-ment of intellectual property rights by Thales entities, the company identifies and analyses its risks of technological de-pendence on third-party patents, as part of the procedures for filing its own patents and/or when launching technical studies or product developments.

In the event of a third-party infringement claim against a Thales company, the legal and technical analysis of the prod-ucts concerned and associated intellectual property rights is conducted centrally by Thales experts, with the assistance of specialist external consultants where needed.

2.2. litigation

Due to the nature of its business activities, Thales is ex-posed to the risk of technical and commercial litigation.

To prevent disputes or limit their impact, Thales policy is to increase recourse to alternative methods of dispute resolu-tion. These recommendations are reviewed on a regular ba-sis to take account of changes in the company’s core areas of business and are backed by training programmes.

In addition, Thales implemented a procedure several years ago to centralise all civil, commercial and criminal litigation and claims. These are handled by the Group legal depart-ment, with the support of the divisions concerned.

The request for arbitration submitted by the Republic of China Navy (Taiwan) for an amount of Us$599m in damages, arising out of the execution of a contract, signed in 1991, for the supply of equipment and systems in conjunction with an industrial partner, continued in 2009 and the arbitration Panel declared the arbitration procedure complete on 10 No-vember 2009. at the date of publication of the present docu-ment, no award had been handed down. Thales considers that an award could be handed down in the first half of 2010.

In June 2005, the adverse party, in the context of this proce-dure, increased its request to Us$1,119m, to which inter-

est for late payment would be added. It reduced its request to Us$882m in april 2006 (interest for late payment ex-cluded). If an unfavourable award were to be issued, Thales’s share of any amounts due would be limited to approximately 30%, being a proportion corresponding to its share in the equipment supply contract.

Thales, in conjunction with its industrial partner, has con-stantly opposed this request.

On the basis of the information at its disposal at the end of 2009, Thales has carried out a review of the financial risks to which the company could be exposed as a result of this proce-dure. In the absence of any new significant information, Thales has, in consequence, decided to maintain at 31 December 2009 a reserve for this litigation identical to that recognised in its 2008 financial statements. In application of paragraph 92 of Ias 37, no detailed disclosure is provided for this amount.

No other governmental, legal or arbitration proceedings (in-cluding any such proceedings which are pending or threat-ened of which the company is aware) have had significant effects on the company and/or group’s financial position or profitability in the last 12 months.

3. RISKS RELATING TO THALES ACTIvITIES

3.1. unfavouraBle trends in the Civil aerospaCe market

The commercial aviation market has proved to be inherently cyclical over recent decades. air transport demand appears to correlate closely with general economic trends, but is also subject to certain specific factors, such as the character-istics of aircraft fleets in service, regulatory developments (new environmental standards, deregulation, etc.) and the ability of airlines to access bank or market financing. In addi-tion to its cyclical nature, however, the commercial aviation market is also susceptible to the effects of an intensification (real or perceived) of terrorist activity as well as the out-break of armed conflicts or epidemics.

The difficult economic conditions, particularly in North amer-ica and europe, may persist in 2010. To maintain liquidity in this unfavourable market environment, combined with limited access to financing, airlines may be forced to cancel or de-fer orders, which would lead aircraft manufacturers to scale



down production rates. This in turn could have a negative impact on Thales’s profitability and financial position.

To limit the impact of this risk, Thales is pursuing action on two fronts: (i) continuous improvement of its competitive performance and industrial flexibility in order to better man-age variations in the level of business over the course of the cycle, and (ii) a comprehensive strategy to achieve a more closely balanced portfolio of businesses (with exposure to the civil aviation market reduced to around 10% of revenues).

3.2. programme management

a major proportion of Thales products and systems present a significant degree of complexity, due to their high technology content, the harsh environments in which they operate, which demand a high level of reliability, and also because of the con-tractual arrangements involved in the sale of these products and systems (comprehensive prime contractorships for large-scale systems, public-private partnerships and equivalents, etc.).

The actual cost of design, development and manufacture may therefore exceed initial cost estimates, which in turn may adversely impact Thales’s results and financial position, es-pecially considering that the associated contracts are gener-ally based on a fixed selling price. In addition, many contracts include demanding performance and/or delivery schedule provisions. If Thales is not in a position to deliver the prod-ucts or systems in line with the contractual performance and/or schedule provisions, customers can demand penalty payments or even decide to terminate the contract. These lines of action can have a considerable impact on Thales’s results and financial position.

In 2009, Thales booked significant exceptional expenses re-lated to difficulties in the execution of several aerospace pro-grammes (a400M, Meltem maritime patrol aircraft and civil avionics most notably) and security programmes (ticketing, simulation). although Thales believes that the cost and rev-enue estimates included in the financial statements are a fair reflection of the Group’s current situation, the complexity of the programmes and uncertainties surrounding the outcome of discussions that are currently ongoing could have a signifi-cant positive or negative impact on the overall profit or loss on completion of these programmes over the coming years (see Note 16 to the consolidated financial statements).

Bid and programme management is therefore subject to a detailed risk management and assessment process.

since bids include technical, schedule and cost performance commitments, contractual risk assessment is part of the bid preparation procedure. Depending on the complexity of the bid, this procedure comprises a number of steps to progressively specify the expected level of profitability and evaluate associ-ated risk. The authorisation to validate the bid prior to submis-sion to the customer is determined on the basis of criteria re-lating to project scale, profitability, cash requirement and risk.

Particular attention is paid to long-term sales contracts that include fixed prices valid for the duration of the agreement.

Certain contracts can run for several years and involve prod-ucts and services with a high degree of complexity. Conse-quently, regular reviews are organised in order to monitor technical and financial status. Risk reviews are conducted at the same time and serve as the basis, when necessary, for the booking of the management reserves. These are subse-quently included in the calculation of programme margins for the company’s financial statements.

Given the difficulties encountered on several programmes, Thales stepped up in 2009 the action plan initiated in late 2008 to drive improvements in bid and programme manage-ment as well as in engineering and the supply chain.

actions aim in particular to:

• ensure tighter control of commitments at the bid phase, which are the cause of many subsequent difficulties, par-ticularly if technical complexity and associated develop-ment costs and risks are underestimated. Measures in-clude systematic recourse to independent peer reviews as well as bid reviews to justify technical choices and associ-ated risks, closer involvement of the purchasing, produc-tion, legal and quality assurance functions, combined with a transition review prior to programme launch in order to implement risk reduction plans,

• implement proven practices in programme management and integrate the supply chain more closely with programme management processes. Measures include more system-atic implementation of alert reviews at launch, indicators to monitor the correct application of procedures in pro-gramme management, engineering and purchasing, rapid deployment of the Primavera programme management tool and increased training, with the objective of joint accredita-tion with the International Project Management association.

In addition, critical bids and programmes are subject to more stringent review at corporate level.

25

>> �Risk factors



3.3. politiCal unCertainties

Thales generates a significant proportion of its revenues in emerging markets and countries that can be politically or economically unstable. These markets can therefore present risks, with the potential to adversely affect the company’s profitability and financial position.

In particular, a change of government, major political event, armed conflict, act of terrorism, social movement, strike or protest could lead to various types of risks. These include:

• more restrictive currency controls, with limitations or ex-clusions on the transfer of currency from a client country, preventing it from honouring its financial commitments with respect to Thales,

• expropriation (by confiscation, nationalisation, requisition, etc.) or forced sale of Thales’s interest in a local company, or discriminatory measures more broadly that compro-mise Thales’s operations in that country,

• a security situation that makes it difficult or impossible for Thales to deliver on its contractual obligations, or that re-stricts or prohibits the use of its local industrial facilities,

• an unexpected breach of a contract or commitment,• a unfair call on a bond or a guarantee,• the non-certification of documents eligible for payment or

the failure to make payments as and when due under a contract, preventing contract execution as anticipated.

To limit the financial impact of these risks, Thales uses gov-ernment and/or private-sector insurers when necessary to provide the appropriate cover. It may also transfer non-re-course receivables to financial institutions.

3.4. relianCe on puBliC spending

Thales conducts most of its business with government cus-tomers, particularly in its defence markets and in France (around 25% of total revenues) and the United Kingdom. In these markets, public spending is dependent on politi-cal and economic factors and is therefore susceptible to fluctuations from one year to the next. a significant medi-um-term reduction in French or UK defence budgets, how-ever, particularly as part of a more restrictive budgetary policy, could adversely affect the company’s future business and revenues.

Thales bases its strategy on a balanced mix of businesses between defence (approx. 55% to 60% of revenues) and civil

(approx. 40% to 45% of revenues). The overall solidity of the company’s portfolio is underpinned by a diversified base of orders with a unit value of less than €100m. In addition, the broad geographic spread of Thales’s business activities, par-ticularly through its international operations, ensures further diversification of its customer base.

3.5. management of supplier risk

With a business model based on both equipment and in-tegration of large systems, Thales’s activities incorporate a growing proportion of purchases in the industrial sector, technical and support services and equipment. Thales is therefore exposed to the risk of industrial, technical or finan-cial default by any one of its suppliers, which in turn could affect the company’s profitability and performance.

a key factor in competitiveness and innovation, Thales pur-chasing policy is backed by a risk management process, based on careful control of its supplier portfolio and individu-alized monitoring of critical suppliers.

Careful control of supplier portfolio

For many years, Thales has implemented measures through its divisions to streamline its supplier portfolio in order to bet-ter match the actual requirements of its units with the market offering while at the same time avoiding any overdependence.

In conjunction with a supplier relationship management proc-ess, this commitment to rationalisation has concentrated ef-forts to improve supply chain security on a limited number of target and strategic suppliers.

From initial selection and qualification through to recurrent use of each supplier, Thales identifies and maps all types of associated risks (industrial, financial, etc.). This information is shared with all personnel involved in the sourcing/purchas-ing process.

Individualised monitoring of critical suppliers

In addition to risk mapping, suppliers are regularly audited and evaluated with the assistance of operational specialists, in terms of their level of operational performance (punctu-ality, compliance, etc.), technical performance, quality as-surance processes and sensitivity to the external environ-



ment (export regulations, environmental standards, financial health, etc.).

In particular, financial risks that could lead to cash or invest-ment constraints or even the disappearance of a company or its takeover by investors with different interests to Thales, are regularly monitored.

Given the increased risk that the position of certain sup-pliers may be weakened in the current economic climate, Thales has introduced a specific measure in conjunction with its purchasing and finance functions in order to identify any critical suppliers that are particularly exposed to the crisis, define appropriate actions and, when necessary, monitor the progress of those actions.

In addition to this initial and recurrent monitoring, Thales also implements strategies to secure the supply chain through regularly maintained dual sources or alternative sources as well as safety stock plans to cover requirements through to completion of contracts in progress.

These various purchasing policy and risk management ac-tions also contribute to risk reduction at the bid preparation phase as well as throughout programme execution.

3.6. raw-materials risk

Given the nature of its activities, Thales uses few raw materi-als. Its exposure to raw-materials risk is therefore negligible.

4. ENvIRONMENTAL RISK

Due to the nature of Thales’s activities, environmental risks are related to potential adverse environmental and health effects of these activities, impact of the environment on its operations and non-compliance with new regulations applica-ble to products.

For many years, Thales has conducted regular analysis and update of environmental risks in accordance with its busi-ness activities, scientific and technical developments and the broader environmental challenges.

This analysis is used to produce a risks mapping, linked pri-marily to regulatory non-compliance, pollution, asbestos, substances (ROhs, ReaCh, Weee, etc.) and radiation. The aim of this exercise is to:

• ensure that employees and surrounding residents are not exposed to health and environmental risks,

• ensure the compliance of activities and products,• analyze the impact of new regulations, including on product

design,• specify an appropriate organisation and associated action

plans, either at Group level or locally, according to the risk mapping results.

In addition to this risk mapping, an environmental manage-ment system has been deployed at all sites in order to en-sure the control and limitation of the environmental impacts in accordance with Thales’s commitments. By the end of 2009, over 90 sites had obtained IsO 14001 certification.

at 31 December 2009, the amount of reserves for environ-mental contingencies amounted to €6.5 million.

5. RISKS RELATING TO STRATEGIC ACQUISITIONS AND INvESTMENTS

Thales regularly undertakes operations to acquire new com-panies (as well as make strategic investments and combine business activities through joint ventures, etc.) in order to round out its technological portfolio and strengthen its presence in certain markets. Integrating these businesses within Thales can prove more difficult and take longer than envisaged, requiring a more significant involvement by senior managers and the teams concerned and, in turn, negatively impacting the company’s results and financial position.

In addition, there are no guarantees that the newly acquired companies will perform as well as expected in accordance with the initial business plans, which form the basis of the investment decision. This type of variance can lead to ac-counting for impairments arising on goodwill and other intan-gible assets, thereby negatively impacting Thales’s results and financial position.

Before any planned acquisitions, Thales conducts audits and due diligence evaluations, with the assistance of external consultants when necessary, in order to verify the situation of the target company as closely as possible. a review is also conducted at each important stage in the acquisition proc-ess to confirm Thales’s interest and specify the necessary conditions and parameters to ensure a successful conclu-sion. The newly acquired company is then integrated into Thales’s financial reporting system so that its performance can be monitored.

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6. INSURANCE

Thales operates a policy to cover accidental risks – damage to property and civil liability – based on two main principles:

• for risks relating to damage to property and consequential business interruption, transport, general liability, assem-bly/testing and space, Thales is self insured by means of insurance and reinsurance captives for up to a maximum net undertaking of €13.5m,

• cover relating to major / catastrophic losses has been transferred to insurers.

an organisational structure and crisis-management tools are in place to deal as efficiently as possible with the im-mediate consequences of a catastrophic event and take the necessary emergency measures.

Resources are also provided to ensure business continuity in the event of a major disaster.

The programme to improve information system recovery plans was continued in 2009. The Internal audit Department continued its IT security audit plan at major Thales units. In addition, business continuity plans continued to be deployed throughout the year.

The main accident risks are covered by programmes with high-rated international insurance and reinsurance companies.

In 2009, total premiums paid for global cover (excluding spe-cific policies) amounted to 0.35% of consolidated revenues.

The maximum cover limit for damage to property and conse-quential business interruption was set at €1.3bn in 2009.

This amount is greater than the estimated largest loss Thales might incur for direct damage and business interrup-tion to an industrial site.

an active prevention and protection policy for industrial sites aims to reduce the extent and frequency of the Group’s expo-sure to accidental fire or explosion: in 2009, 80% of insured assets were audited for fire safety by an outside body.

levels of liability covers depend on the quantification of a reasonable claim expectancy for Thales, as identified by risk-mapping of the main business activities and at Group level, and on cover capacity available on the insurance market. The insurance cover for aviation liability exposure is provided by a separate programme, which stands at Us$2bn.

Thales has reported claims:

• to the aviation programme insurers, who cover, without de-ductible, the financial consequences of Thales aviation liabil-ity in connection with the air France aF447

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