Hensoldt AG (OTCPK:HAGHY) Q2 2024 Results Conference Call July 26, 2024 8:00 AM ET
Company Participants
Veronika Endres - Head of Investor Relations
Oliver Dorre - CEO
Christian Ladurner - CFO
Conference Call Participants
Ross Law - Morgan Stanley
Carlos Iranzo Peris - Bank of America
Aymeric Poulain - Kepler Chevreux
Christophe Menard - Deutsche Bank
Simon Keller - HAIB
Christian Cohrs - Warburg Research
Operator
Ladies and gentlemen, welcome to the H1 Results 2024 Analyst Conference Call. I would like to remind you that, all participants may be listen-only mode and the conference is being recorded. The presentation will be followed by Q&A session. [Operator Instructions]. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Veronika Endres, Head of Investor Relations. Please go ahead.
Veronika Endres
Good afternoon, everybody, and welcome to Hensoldt's H1 2024 results call, which we are holding at our ESG site in [indiscernible] today. Thank you for joining us. I'm Veronika Endres, Head of Investor Relations at Hensoldt. With me are our CEO, Oliver Durbin and our CFO, Christian Ladurner. Oliver and Christian will guide you through this presentation today, which will be followed by Q&A session.
And with that, I hand over to you, Oliver.
Oliver Dorre
Thank you very much, Veronika, and a cordial welcome from my side as well. I'm very excited to lead you into today's presentation after having passed the 100-day mark as CEO and the 200-day mark as a Hensoldtian two weeks ago. When I briefly summarize the first half year at Hensoldt, I can say with conviction that, this company excels in many areas. My three key observations are: Firstly, our technology is really impressive. For example, we received high praise from the air defenders in Ukraine, where our TRML-4D show outstanding detection, performance and high reliability.
Secondly, the entire Hensoldt team is extremely motivated and determined to provide our customers with much-needed capabilities. And thirdly, we enjoy a very solid support by our anchor shareholder, the German Government and our stakeholders in the political domain.
To drive our company from great to excellent, I have already outlined my three focus areas for the medium-term, operational excellence, digitalization and internationalization in our 3M call. We have defined clear and tangible action plans, which we are now implementing with rigor. Let me outline a few of the measures we are putting in place. In operational excellence, we are focusing on delivery capability in both quantity and quality. We are taking care of the expansion and stabilization of the supply chain, initiating a transformation in engineering and optimizing our approach to bits and project management.
Further, synchronization of the ongoing transformational programs is another focus. We are also assessing our international presence with the intent to better align market potential and resource investment. Our clear goal is to do around 50% of our business in Germany, around 30% in Europe and with NATO partners, and beyond that 20% in deliberately selected markets. We will also develop a consistent approach when it comes to sensitive countries and a standardized framework for export regulations, keeping the government-to-government agenda of the German anchor shareholder in mind.
We are also developing a conscious focus on establishing our industrial presence. Internationally, a first step is an improved governance to better integrate our national entities, South Africa, France, and the UK. And last but certainly not least, we will make sure that our portfolio will become smarter, more digital and software-enabled connectivity, system or system architectures, networking and AI are elements that will support the transformation of hand thought from a hardware-based to a software-defined provider of integrated sensor solutions. All these measures serve as a means to an end, and I will outline our path towards the handhold 2.0 at the end of today's presentation.
It was very rewarding experience for me to meet some of you our investors at our US and Canada roadshow in June. The most frequently asked question at all meetings addressed in defense is the defense spending in Germany. So, let me give you some color on this topic. The special fund introduced in 2022 mainly served as startup financing for several important and strategic defense procurement projects.
This trend now stabilizes and is reflected in the midterm budget planning of the German government with a mix of budget increases, finance authorizations, and the special fund the German has government has sent a clear signal for its commitment to spend 2% GDP for defense reaching approximately 80 billion in 2028, and this commitment is underpinned by very concrete procurement plans. For example, the order of 20 additional euro fighters that Chancellor Shaw announced at the Berlin Air Shaw, or two additional F100, 26 figures that have recently approved by the parliament as well as 105 additional leopard tanks also already approved by the parliament.
I mentioned this in our 3M analyst call and I can only repeat defense procurement in Germany is no longer a question of if, but how. Naturally breaking up the long-established mechanics of the cameralistic system takes some time. And yet I am confident that we see a continuation of the current dynamics in German defense procurement, and let us not forget that the European market remains favorable as well. Clear shift against Europe, European NATO members plus Austrian Switzerland will spend an additional €700 billion to €800 billion on defense by 2028 and 23 of the 32 NATO nations have reached the 2% GDP defense spend target this year.
The alliance reconfirmed its commitment to Ukraine and its recent summit in Washington, authorizing a €40 billion support package and pledging strongly for enhanced air defense capabilities in Ukraine.
Let me now have a look at some business highlights. Order remained strong in the second quarter, driving our total order intake for the half year 2024 to more than €1.3 billion and our order backlog to almost €6.6 billion. We reinforced our excellent position both in the Ground Based and Naval Raider segment with orders for further TRML-4Ds within the SE initiative, SPEXER radar for SkyRanger 30, self-propelled antiaircraft gun and the additional two F126 frigates for the German Navy.
ESG also contributed to our strong Q2 order intake with a contract for A400M material management worth €45 million. In the second half of this year, we expect further dynamics in the armored vehicle segment, benefiting our optronics division. Our German customer is preparing to order boxer infantry fighting vehicles that will be equipped with a Puma turret, featuring Hensoldt optronics and self-protection as well as also the already mentioned 105 additional Leopard 2 tanks, of course, also featuring Hensoldt Digital optronics.
The Eurofighter business once again proves to be a solid contributor to our order intake with another capability enhancement of the Mark I contract worth almost €300 million. ESG has very recently signed the already eighth installment of its contract to operate the Central German Armed Forces spare parts logistics at least at 2028, called ZEBEL.
Talking about ESG. Let's have a look at the status of the post-merger integration. I can make this quite short. The PMI is a resounding success, and I see a lot of potential. We have achieved all day 100 milestones and will even advance the integration of central functions from end of the year to October 1. It is important that, our central functions from a strong supportive backbone for the new divisional setup that we communicated a few days ago.
As mentioned, I see a huge potential in the integration of ESG and I'd like to have a quick look at the unique capabilities of ESG that will contribute strongly to our multi-domain solutions offering. ESG supports the German Armed Forces helicopters from introduction into service to phase out, offering full product lifecycle support. The portfolio includes the CH53, NH90, Tiger, SeaLink, SeaKing and the future CH-47 Chinook.
In 2023, Germany has ordered 60 CH-47F Chinook helicopters, which will form the heavy lift rotorcraft backbone for the Bundeswehr from '27 onwards. In partnership with Boeing, ESG is in charge for several integration service around these helicopters, guaranteeing their seamless integration into the infrastructure of the German Armed Forces. Let's not forget, this is only the first phase, where a new platform is introduced into service with the armed forces with a lifespan of at least 30 years for a platform like the Chinook or the F-35 system support and service business provide us with enormous potential and high visibility of revenues. The strong partnership of ESG with U.S. primes like Boeing, Lockheed Martin is a strong asset for ESG and for Hensoldt, opening new business potential on different platforms.
And with that, I hand over to Christian to guide us through the financials.
Christian Ladurner
Thank you very much, Oliver, and everyone welcome also from my side. I'm happy to provide you now with our financials for the first six months of 2024. To begin with, I'm pleased with our financial performance. The first half year has been very strong and is total in line with our expectations. As we have successfully closed the acquisition of ESG beginning of April, and I'm happy to report that ESG contributed as planned to our group performance. Rupert intake developed strongly with orders summing up to more than €1.3 billion an increase of 27%. As mentioned by Oliver, main drivers were the NMBS air defense systems, TLM-4D and SPEXER radars. And as part of the European Skyshield Initiative, as well as our TRS-4D radars for the F126 frigates.
Also, ESG contributed strongly to our order book, for example, with the material management contract for the A400. Overall, the distribution of incoming orders was again well balanced between our home market, Germany, and Europe. Revenue reached €849 million in H1, mark an increase of 17%. This development was driven by sensor and especially TRLM-4D radar. ESG delivered as plan two with a contribution of €82 million. The level of pass revenue further declined by 26%, resulting in an improved quality of revenue with a figure close to €6.6 billion or the backlog again reached a new record level in our history. This continues to provide us with an excellent business visibility.
The strong performance of our top line is also reflecting our profitability. Adjusted EBITDA increased to €103 million leading to an improvement of the adjusted EBITDA margin of 1 percentage points to 12.2%. Our core margin, excluding pass revenues further improved to 13.2%. The increase was driven by the accelerated production or radar business leading to further economies of scale. This was partly offset by investments in our growth and into our product portfolio of the electronics business. Adjusted EBIT also benefited from the increased volume and up to €52 million with an adjusted EBIT margin of 6.1% respectively, 6.6% excluding pass through business. This increase was partly offset by amortization of capitalized R&D expenses.
Cash generation the first half of 2024 was fully in line with our plan and following our usual seasonal profile. With an adjusted free cash flow of minus €145 million. Despite the growing business volume, we were able to realize a year-on-year improvement and has already teased in our last analyst call. We have received first prepayments of our German customer in April and we expect more to come.
To sum it up, our bottom-line further increased and developed as planned. Let's now have a look at our segments. In the Sensors segment, the strong momentum in order intake continued in the second quarter with orders summing up to nearly €1.3 billion exceeding the previous year's figures by 53%. Organically, the year-on-year increase amounted to 33%, driven by TRML-4D inspector radars within SE as well as our radars for the 1F-126 freeways. As previously mentioned, the contribution from ESG was strong as well with €166 million, which corresponds to a book-to-bill of 2 times for ESG. Revenue in the Sensors segment increased significantly by 23% to €745 million. Again, I want to highlight that, due to declining share of pass-through revenue, core revenue increased even stronger by 16%.
Key growth drivers were the accelerating dynamics in air defense and our strong baseline business. Revenue for ESG developed as planned and contributed €82 million to group sales. The margin performance of the Sensors segment was again excellent with an increase in adjusted EBITDA of 36% to €117 million. The uplift in absolute margin of 150 basis points was driven by further economies of scale in our Radar business, in particular for 4TRML-4D and the decline of pass-through revenue.
In the Optronics segment, order intake developed in line with our expectations and amounted to €139 million. As a reminder, previously included major contracts for armored vehicles as well as for periscopes and optical mask systems for the Norwegian Ula class submarines. In terms of order intake, we expect to put several key orders for the Leopard and BOXER RCT30 in the second half of the year as outlined by Oliver. Sales came at €108 million. Main revenue drivers were ground based systems business and high precision optics FSM in Germany. This was offset by the South African entity, where we are currently conducting a technology change and the realignment of its market strategy. Adjusted EBITDA in electronics summed up to minus €15 million. This development was driven by lower volumes in the South African entity.
Let us be clear. We are not yet there where we wanted to be. We have a strong backlog and further orders are expected to come. Nevertheless, in terms of execution, we have to improve. Therefore, we have full management attention on that. First, we are running a monthly steer call with the Optronics leadership team to monitor the progress closely.
Second, we are in close communication with our OEMs and the end customer to align on development and production plans. Third, we laid the foundations with our investments in the digitalization of the products as well as internal logistics and sites for further ramp up. We now see first movement in the right direction, and I will give you some color on this now backed with concrete facts and figures.
We are building the basis for transforming the record order backlog of €900 million into sustainable growth. The production plans are set up, approved and closely monitored. On this slide, you can see the planned increase in production units in our ground-based systems business in Germany for this year. These are only three examples of many.
As mentioned, the business is already growing year-on-year per H1. However, the seasonal profile is rather wait the second half of the year, where we'll see accelerating growth of the German business. For the full year, we expect a double-digit production increase of our land vehicle sites as well as for the M1 Abrams laser range finder. And as you can see in the middle chart, we'll also produce and deliver the first batch of our See-through Armor system to our launching customer KNDS for the remote-control harvester.
With the initial integration, we are equipping our first customer with this revolutionary sensor solution, which provides us 360-degree Citral awareness picture for every crew member inside the vehicle.
My key message on this slide is our existing order book paired with the current ramp up of our production capacity in Germany, give us visibility and that's a high competence in the business development. And on top of that, the move to the new product side of a [indiscernible] early next year will further support and accelerate the growth from 2025 onwards.
Let's now have a brief look at our net debt development reflecting the partial funding of the ESG acquisition by new debt of €450 million. Net leverage increase to 2.8 times in H1 2024 as expected. Excluding a new debt for the acquisition, net leverage will be at 1.5 times. This shows that we are operationally on track and that we'll further the leverage to around 2 times by year end 2024 as outlined in our guidance.
Let me now come to our guidance for 2024, including the contribution of ESG as introduced in April. First and foremost, we are fully on track to meet our targets and therefore confirm our guidance for this year as well as our guidance for the midterm for all KPIs for 2024, we expect a book to build between 1.1 and 1.2 revenue to grow around €2.3 billion. And please be reminded with a continued stronger growth in core revenue and a smaller share and pass through sales than in years before. Adjusted EBITDA margin before pass through between 18 times to 19 times.
And let it be more specific in this regard, we expect the margin to be at the mid to upper end of the guidance range. For adjusted free cash flow, we see a cash conversion of around 50% net leverage at a level of 2 time and dividend payout ratio between 30% to 40% of adjusted net income.
Coming to a conclusion, let me mention the following key financial takeaways. Our impressive order intake of over €1.3 billion leads an order backlog at an all-time record level of €6.6 billion. This provides us with an excellent revenue visibility for the years to come. Our efficient project execution supports our excellent profitability.
We have received first prepayments from our German customer in April and there will be more to come the integration of ESG's fully on track and we are very pleased with the contribution to our group performance. Therefore, we confirm our guidance for all our KPIs as explained with adjusted EBITDA margin before pass through, expected to be at the mid to upper end of our guidance range.
Our outlook remains promising and we are strongly-positioned for the upcoming growth. We expect further major contracts to be booked in H2, 2024 as explained. We have set a strong basis and good visibility in Optronics to execute the order book. Last but not least, all planned synergies for 2024 with ESG has been confirmed. This and the large-scale increase of defense budgets globally will generate long-term sustainable growth for Hensoldt.
Thank you very much. And I will now hand it back Oliver to give an update on how we will focus on Hensoldt 2.0.
Oliver Dorre
Thanks, Christian. Dear audience, I mentioned in my introduction that, my three mid-term priorities are first stepping stones in a comprehensive strategic and organizational transformation that will safeguard and prepare our future towards the Hensoldt 2.0. The mid-term priorities lay the foundation for us to deliver capabilities at our customers fast and at scale and develop modular cost-effective products and more integrated and software defined solutions.
Together with our leadership team, we decided to use the addition of ESG to the Hensoldt family as an opportunity to also evolve our divisional setup. In the future, we will have four divisions focused on our different types of businesses, Radar, Optronics, Multi-domain Solutions and Services & Training.
Our core product divisions, Radar and Optronics will bundle our entire product business, including electromagnetic warfare and continue to focus on developing innovative defense electronic products and drive synergies through optimized cross-project operations. The Services & Training division will mainly maintain its current structure for stability and growth beyond maintenance, repair and overhaul. For example, including training and simulation as well as new service business models.
We will create a new division to scale solution capabilities as the growth engine, the new growth engine for our company. This clearly signals to our customers the required separation of our product and the manufacturer and platform independent solution business. This Multi-domain Solutions division will be a docking point for our customers who think across domains and we will combine the strength of our spectrum dominance and airborne solutions with ESG.
All-in-all, the changes and challenges in our business environment are nothing but fundamental. And we have launched a project under the name of Northstar to develop a vision for Hensoldt beyond 2030 to support our next strategy cycle. As the name suggests, Northstar will guide us in an increasingly volatile market environment and will prepare us for the next steps in European consolidation that we will continue to actively drive from a position of strength.
Dear ladies and gentleman. Our customers expect us to become an reliable partner, delivering much needed capabilities. Our political stakeholders expect us to become an even stronger player in the dynamic European defense and security landscape and the capital market expects us to continue and even accelerate our growth.
I am confident that the steps I have outlined today will serve as a transformational road map from a trip from which we will all emerge even stronger, more agile and better equipped to face these diverse challenges and seize the manifold and huge opportunities ahead.
Thank you very much for your attention. We will now gladly take your questions.
Question-and-Answer Session
Operator
[Operator Instructions]. The first question is from Ross Law with Morgan Stanley. Please go ahead.
Ross Law
Thanks for taking my questions. A couple for me, please. The first, just on the German defense budget assumption and your confidence in that base budget going from around 50% to 80% over the medium term? And then secondly, on orders, you flagged some key orders in the pipeline for the second half worth almost $700 million. What's the progress on these? And are awards likely to be front or back-end loaded this year? And then lastly, on optronics, you provided some information about issues in South Africa. Can you maybe just give us some more color around what the facility does exactly and what these issues have been. Thank you.
Oliver Dorre
Okay. Thanks, Ros. Of course, glad to answer. So, we will share the answers. Let me start with the German defense budget. So as a matter of fact, as I showed on the slide, I think we're pretty confident going forward because, first, we definitely see that until 2027, where still the extraordinary budget is phasing in, we are on the level of 2% GDP and coming back to many engagements I have currently with politicians. I'm absolutely confident, as I said before, that it's not about the if that we will then switch to sustaining this level of €70 million to €80 million over the time.
What makes me confident, and I think that is actually what is also resonating with you, is first of all, we see, and that is given also my long experience in the German market that is really a paradigm shift. We see that recently, the German Parliament has approved new programs and they're about to run for 100 decisions this year, where we don't see actually the budget lines in the plan, but they are willing to really feed the demand that is clearly articulated from the Minister of Defense on behalf of all the stakeholders of the [indiscernible].
So, the clear evidence is the F126 additional two frigates, which we hadn't planned for this year, but which now came up also with the option deadlines running out. Second evidence is the Eurofighter, which is not yet in the parliament, but with a clear commitment of Chancellor Scholz at the ELA exhibition to buy 20 additional ones. And we have more coming up as far as the vehicles are concerned. And I will come to that with regards to your questions on the orders.
The second topic is that fuels my confidence is that, of course many of the programs that we address, I mean, talking a defense, talking the vehicles for the German armed forces are clearly priorities, where I would say, the main direction has been set with some of the programs looking at NNBS in Germany, where we have more batches to come in the next years. I mean, there's no way back on these ones. As a matter of fact, the customer said, a, we will have to say b, c, d as well. In that regard, I think the decisions that have been taken entering prioritize into air defense, into vehicle buildup with regards to ship submarines that the decisions that were taken in the past are normative also on the midterm to walk the talk they are doing.
Last is what we should not forget probably, and I introduced that our clear ambition of internationalization. We have concluded Phase I of our internationalization midterm priority initiative. Entering Phase II now, where also we are more systematically within account management, shifting focus to Europe, also selling B2B, B2C and secondly have selected targets in global campaigns where we look for strong alignment looking at Singapore, looking at India, looking at the Middle East, looking at Taiwan, for example, where we can secure from the beginning in line with G2G agenda that export issues will not be the case in these ones. That's my take on the question one.
Looking more on the orders. Coming to the land market very clearly, we are in very close discussions with KNDS and of course, also Rheinmetall. But I mean looking at Leopard, looking at Puma, what I've outlined, the infantry fighting vehicles, we definitely see and the 105 Leopard as the first instance. We have the next to come, the Puma BOXER, where we're pretty advanced approaching the decision making.
We have additional batch of Puma, where we have aligned already the schedule of deliveries. We aligned on the specifications, we have taken, which, of course, we see our initial preparations in the team on the operational excellence. I'm pretty sure that in the second half and that is the progress, the maturity of the discussions, we will have the orders coming in and probably with that also some first cash milestones advance payments.
Same applies for the sea. We recently heard on the orders, submarines, Minister of Pistorius demanding for additional submarines. We have pretty mature discussions now where we leverage on a good relation of ESG looking at the F127, where we expect also decisions this year, early next year, where Hensoldt with the support of ESG could play a major role. Last but not least also on cyber, maturing progressing on our deliveries on the PEGASUS program, we have started also with a backup and that started at ELA exhibition as well together with the Chief of the Air Force looking at G2G agendas. We have three customers identified, where with one of them we're already in the RFI stage. That means also we see that, we can multiply the PEGASUS on the midterm.
Christian Ladurner
Yes. Lastly, Ross, thank you for your question. First, maybe in terms of structure, we have to understand when you take the Optronics segment, it's 80% Germany and 20% South Africa. In South Africa, we currently see two topics with a technology change. So, the gimbal technology changes in a generation, that means we cannot now do some revenues until the simple is fully developed. And the second one, and we've wrote and commented, we are currently realigning market strategy. That means we are much more thoroughly than the years before in which countries we export the gimbals and this is how it behaves in South Africa.
Nevertheless, I have to say, when you look at the H1 business and the Optronics German business, and this is a clear driver and Oliver was mentioning, the orders which are coming in, they relate to Optronics, Germany. We see now the first growth. And going forward, with 80% of German electronics business, we will see growth from a segment point of view.
Operator
The next question is from Carlos Iranzo Peris with Bank of America. Please go ahead.
Carlos Iranzo Peris
Good afternoon, and thanks for taking my questions. I actually have two, if I may. The first one on cash flow on PDP. So how should we think about PDPs from Germany in the second half of the year? And then the second one, if you could please remind us the growth outlook for ESG and the midterm margin profile. Thank you.
Christian Ladurner
Carlos. So first of all, cash flow second half. So, you know that in H1, we are at the deepest level of our cash, so we have guided for 50% cash conversion. So, this is quite good in line. So -- and we expect, of course, more advanced payment. There should be in a region of we have seen in H1. So, this continues. But with that, of course, we invest further in working capital to prepare now for the orders we have gone. So, the conversion of the profit into the cash is in the range of the guidance. So, this is forgoing.
ESG. For this year, we see €300 million for 9 months. It means that with the 82 with also a very strong Q4, we are very good in line. And going forward, we see this 10% on ESG, quite similar to our organic business. And when then you recalculate from 9 months to 12 months, and plus the 10%, we see next year around €400 million, which we have guided also for next year. So, this is on a very good track and well in shape.
Operator
The next question is from Aymeric Poulain with Kepler Chevreux. Please go ahead.
Aymeric Poulain
Yes. Good afternoon. I just wanted to go back on the German budget initial question and your forecast for 2025, which just increase compared to the €80 billion. And I suppose in early July, there were third of articles suggesting that the budget could be cut, especially the Ukraine part of it, the €8 billion could be cut by half. Just wanted to have you take on that? And -- is there some offset that you see that we're not necessarily put in the draft budget? And indeed, if the Ukraine help is cut, what would be the consequence for the radar business in particular, and the margin outlook? Is there a sensitivity analysis you could give for this type of scenario? That would be the first question.
The second question, I think you gave the sales number for ESG, but you didn't give the EBITDA contribution for the quarter. Would it be possible to have that? Looking at the structure, four divisions that you plan to have, when do you think you'll be able to provide a pro forma? Indeed, what benefits should we assume from this new structure? Is it a commercial clarity benefit? Are there some specific cost to add to build this type of new infrastructure? Just clarify the rationale for the new division plan? Thank you.
Christian Ladurner
So, first question. hello, Aymeric. Firstly, first question on the budget. We have outlined next year 2025. We still see the €8 billion for Ukraine military support. When you look at Page 4, the €4 billion coming from Germany and the rest of the €4 billion shall be funded by the EU or the G7. There were also some discussions on that, that it would be funded from the frozen funds of Russia. This we still see the €8 billion as quite stable, and I do not see now any impact on air defense. This is still vital and I also expect further batches from the Ukraine in this regard.
With that, we are on a good track with the margin. We have seen it now last year, we did around 19.9%. We are now 1% ahead and this is why we're quite confident that we are at mid-to-upper range of the guidance, so this develops further and we will see how this outline. The contribution of ESG for one quarter was €9 million EBITDA. This was fairly in line with our margin. Normally you see around 14% EBITDA margin. This is how you should model the ESG business.
Last but not least, I think, I've understood it right that, you asked if the new divisional structure will have some additional costs. This is not the case. It's just how we approach the markets and how we organize ourselves internally in order to create value out of the multi-domain solution, what is mainly also customer driven with the new focus also on these topics. Thank you.
Operator
The next question is from Saks Dusa [ph] with Agencies Partners. Please go ahead.
Unidentified Analyst
Thank you very much, indeed. Good afternoon. I've really a follow-up to Aymeric's question, I think. I don't think I quite understand the new divisional structure and specifically the multi-domain part of it. Should we expect a program like PEGASUS to be in this and so separate it out from the core radar business?
Oliver Dorre
This is Oliver speaking again, and great to have you here, Saks. I will give you a bit more insight on the new divisional setup and then Christian will focus a bit more on the reporting segments and all of that. Yes, indeed, as you rightfully say, the multi-domain solutions division, I would say at that stage, and please maybe at an upfront disclaimer, we're in the middle of sorting that out.
That is rather giving the guidelines or guard rails for the future setup, and we actually have clicked that off with our senior leadership meeting, which took place 1 week ago. we are working now with the division as very clearly; this new setup is following three priorities.
First thing is looking at our customers to be closer linked and looking at B2B, B2C customers to have a clear match. And as I outlined already, that is, of course, also reflecting the request of some of the partners of ESG, also growing in solutions where we have to have a stronger interdependency independency, sorry, between the product and the solution business. So, customer is one thing.
Second thing is, of course, the business. And that has, again, two elements, business continuity. Of course, we want to sustain the strong business that we have today, but we also want to open the door strategically to develop the business and agilely answer the dynamics that we see on the market.
And last, of course, I mean, looking bottom line, it's also about cost efficiency. And that are the guiding principles together with this four divisional setup that we have shared with our experts, and we are running that exercise now with a top leadership team in the next week with the ambition to rather start in that direction in next year.
So, coming back to multi-domain solutions, as you rightfully said that there will be, I would say, two sub pillars in that. One is really looking at the customer where we want to leverage on the very strong conceptual and also system integration-wise capability that we have with ESG in the land, in the air, in the sea, in the cyber and the space domain. So that is also the divisional or in our nomenclature will be rather the business unit structure that ESG has today.
And that is what we want to bring in the ESG business units with all their know-how into Hensoldt. That is what we have in this one pillar a very customer-oriented structure, where we look at solutions in the domains and of course, there will be a bracket around that also how do we work multi-domain to get the understanding to interconnect with all the products that we deliver for the various domains.
And indeed, as you said, there will be a second pillar where we would bundle our large programs. Together with some transversal elements that we have today, which we will further cultivate on airworthiness, on cyber, on cloud and IT technologies and all of that, so that we kind of encapsulate that know-how in a very strong structure with, of course, operational mindset on one hand, but also the conceptual and customer mindset in order to deliver solutions in the future effectively.
Christian Ladurner
Yes. First of all, your question on the reporting. So currently, we have two segments, and the Optronics segments we were discussing about that. And in the Sensors segment, we have today, the radar business, and the Despite business, spectrum dominance by PEGASUS is a part of it in the respective service. And ESG is now part of the Sensors segment.
So, going forward for this year, we will not change anything on the segments. With the discussions what Oliver has outlined, we will also do a review regarding segments, technology-wise and if we do an adaption for the time being, it will stay constant. PEGASUS as well as ESG will be part of the Sensors segment. If there are any changes, we will inform end of this early next year, if there is a change.
Operator
The next question is from Christophe Menard with Deutsche Bank. Please go ahead.
Christophe Menard
Yes. Good afternoon. Thank you for taking my questions. I had actually, I think two left. The first one is on the operating leverage in Sensors. I was positively surprised by the good margin performance. The incremental margin or I think we call it the drop through margin on your new business is 27%. Is it something that is only deriving from TRML-4D? What does it correspond to? I mean, you're not finished in the ramp up. Should we expect more of that operating leverage? That's the question. What is the impact on the midterm guidance?
The second question is on the Optronics. I mean, thanks for the detail, the color you provided about the rising volumes. Does it mean that, those Optronics systems, you actually build them when you deliver them? Or is there any progress payment because H1 was actually not great in terms of sales. Should we expect just a bump in revenues as you deliver them, because you're going to build them as you deliver them? Thank you.
Christian Ladurner
Hi, Christophe. Thanks for your question. In terms of operating leverage, nice when you surprise in terms of profitability. I have to say, we are good on-track in this regard. It remains mainly on aid Defense and also in TRML-4D, but also in specs and other products in this regard that we see good margins. We are on a very good track in this regard. But you also know that Q4 is our heaviest quarter and we will see how this develops, but I'm very confident that, we do a good margin also this year.
Going forward, there is potential and we discussed it already several times. For the time being, I stay with that, because as Oliver has outlined that we are a high technology company, I can only reinforce this day-by-day. We have to take thoroughly investments in order to cope with this high technology and stay at the edge. But in terms of operating leverage, we see going forward course opportunities. Let's see how we reinvest this and what is the net impact on the margin.
In terms of Optronics, yes, you're right, the revenue is strongly connected to the deliveries. The deliveries now will ramp up in the second half year. It's the Q4 is also here the business is Q4 loaded, because in terms of deliveries also the customer is still very focused on Q4. With that, we will see a growth in Q4, especially in Optronics German business and this will offset then the reductions of Africa.
Operator
The next question is from Simon Kelleher with HAIB. Please go ahead.
Simon Kelleher
Hi, everyone. Thanks for taking my questions. I have two and they are both on the air defense area. Firstly, in the news, I read that, there are couple of TRML-4D orders pending in H2, for example, by Lithuania, but I think also Switzerland and Austria seem to be likely candidates. Yet, you did not put them on the expected order slide for H2. Am I wrong in assuming that they are likely to come? Or is there any other reason?
And secondly, on the spec or Skyrange opportunity, I was wondering, is your radar always implemented on the platform? Or what's the likelihood that the customer chooses your radar? And maybe can you give some midterm potential like you did in the last call for the TRML-4D, i.e., how many customers are expected to choose the specter radar? And also, how many would they then need? Thank you.
Oliver Dorre
Okay. As a former defender Simon, I will try to answer your questions. This is Oliver speaking again. So first, on the TRML-4D, I think as we had clearly outlined in the introduction, we have today, the German customer, of course, with NNBS, where now after the developments, we have major batches coming in. And of course, based on also a first batch, which is rather dedicated to surveillance, part of an urgent operational requirements, we also see more possibilities.
Then we have Ukraine, as you also know. And yes, indeed, currently, we see that the first customers are moving in on the S. So, this is Latvia, it's Slovenia. It's Romania, we're discussing Estonia. Indeed, also Switzerland has started a tender on a new air defense system, which is, I would rather say orientating in the sense of S. And despite that there is competition out there on the market. I'm proud to claim that our radar is the only one really despite probably U.S. technology. European radar in strong operations day by day, also looking at the quantities we have contracted and deployed to Ukraine.
And in that regard, I'm really confident, and I explained that in one of the previous calls that we see only in the medium segment a rather €2 billion potential to be addressed. We are currently doing the math on our future planning where we more detailedly, as now the various nations are dropping in. We had many discussions at Eurosatory at Berlin Air Show where now we are consolidating this picture and see it moving in.
And a very clear reference for our confidence is also that we are continuing despite that we have increased from three radars to 15, we are continuing to put efforts in how could we scale also strong discussion with U.K., which also raised a strong interest in the medium segment on TRML-4D. And I think that's just a couple of nations where we are in mature discussions. And on top of that, I think it's a market that is just about to be -- to open.
Second question on SPEXER, here at least on the first part, this is linked to the vehicle. And as a matter of fact, as time to market is very decisive today, and we're pretty advanced on the Skyranger, integrating it with Rheinmetall. We saw also in the recent orders that we have announced in the presentation that, yes, there has been a discussion would we choose the Hensoldt radar or are there other options? But when it came to looking at integration risk at time to market, the Hensoldt radar was a natural choice, because it's very well-integrated in the conceptual setup that we see today, and that is what we want to leverage on.
In order to secure that for the future, we have, I would say, a very advanced concept that we can have a full antenna, half antenna, a quarter antenna. That also with that looking at different vehicles, different setups, we are very flexible to integrate our SPEXER technology into this short-range air defense environment, which I think is a very unique and strong selling point going forward.
For the last part of the question, I'm sorry, I can't give an answer at that time, but we will keep that topic and probably address it also through IR.
Operator
The next question is from Jan de Roques [ph] with ODDO BHF. Please go ahead.
Unidentified Analyst
Yes. Good afternoon, everyone. Maybe three left. One maybe on your priority internationalization, because if we analyze your order books, we do not have the full details, but I believe that, Europe and Germany come for more than 80 % of the total order book. I wanted to know whether M&A will be in the future the focus, I would say, to improve the non-European position. Are you targeting 20% of your turnover mid-term? I was wondering if M&A was the option to improve this part of your business. Then a question on ESG. Can you remind me when the earnout will be paid? And what are the main underlying assumptions for this €55 million payment?
Maybe the last one for Oliver, we've seen that Leonardo was, I would say, talking with to dry metal about an alliance in land armaments. I was wondering, if this initiative was changing anything in your relationship with Leonardo and Cingolani? Thank you.
Oliver Dorre
Let me take the first one, internationalization also to put a little bit more meat to the bone. Indeed, you rightfully described the dependencies, I would call it and its positive dependencies on the German and probably Europe now with SE moving in. As I've explained that, indeed, also ESG now with a very high part of the business being related to Germany, I think with Germany, we are at roughly two-third, almost 70% of our business today. The majority of the business despite a couple of customers globally is then in Europe.
When I introduced in my presentation the 50/30/20, that is of course kind of guidance, which I would see on the midterm also to guide my international business development team, which so far successfully, but so far has been acting rather opportunistic. How do we want to do that going forward? I think first thing is more focus. Part of the internationalization initiative that we are also doing with a consultant at the moment is to provide, I would call it, a clear metrics, where we outline to our teams, what are the countries that we want to address?
And what are the solutions that we want to address, which, again, so far has been very opportunistic. And I think if we apply more focus, and that is somebody who has been quite successfully, I would quote and claim VP Sales and Marketing in Thales for 5 years. I think it's all about focus, really tailoring your efforts, which will help us. In the very strong pipeline. As a matter of fact, we just had our order intake review the first initial kickoff 2 days ago. And I think if we really focus on our strength and the strong leads that we have, we will be far more successful than only diluting across a manifold, a multitude of customers.
Second thing, is looking at how do we sell. And I think also coming from Thales, but also with Frequentis before and working a lot in sales and business development. I was very much used to account management. And here is it really about strategic accounts where we go B2C, where we would rather systematically sell and interfacing between a central sales force and divisional sales leads, which naturally have to be with the products and the solutions but I think to bring more efficiency in that cycle and a clear strategy, leading our activities will not only give us efficiency, but also help us to be more successful.
And talking key accounts, I think as a product house with two divisions and strong product business today and still a core business of products in the future, it's more important to systematically address the OEM selling B2B, and I think here we can do better addressing shipyards. I think with the vehicle manufacturers, Rheinmetall, KMW have been mentioned KNDS were also General Dynamics.
So many of them, we have good relations, but I think we can more institutionalize those relations to bring the scale to the sales of our products especially as also on the product portfolio with [indiscernible]. You saw our recent success in U.K. We are also entering new products, cost performance, not only addressing the high end where definitely we can sell by volume if we really systematically develop our channels. And last but not least, yes, indeed, once we have recovered our leverage and everything, it remains that technology and internationalization remain our criteria for M&A.
Christian Ladurner
Yan, your question on earn-out. So, there will be a second earn-out component. It relates to the order intake of the ESG business 2024. And will then be paid if they reach a certain amount of orders by 2025 as opposed in the first quarter.
Oliver Dorre
So, on the last question, I mean, very clearly, it's probably too early to state. We're following the media and definitely, I mean, considering that Leonardo is our shareholder, but also a very good partner since many years. You know Eurofighter, all of that. We are, of course, in close contact close relation. As a matter I can say, I had a good alignment with the management a couple of days ago.
So, we are -- and I think I have stated that in one of the previous calls, we are continuously evaluating what could be the cooperation because it's my true belief -- and I said that we want to actively steer the European consolidation. It's my true belief that, that consolidation should be a means to an end, yeah. It's all about cooperation bringing Europe closer, bringing standardization on the market, making it more modular.
In that regard, I mean, looking at more than 100 tanks that will be delivered to Italy, which are now of course driven by Rheinmetall, let's make sure as we are the incumbent and the major technology provider for the Leopards that we also engage with Leonardo again as a shareholder, our strong partner to make sure that, we support Leonardo in bringing the best tanks to Italy. That is the discussions we're having, of course, not concluded. That is very clearly to say at that stage as a disclaimer.
Operator
The next question is from Christian Cohrs with Warburg Research. Please go ahead.
Christian Cohrs
Hello. Good afternoon. Thanks for taking my question. You're striving for an organizational transformation, you're in the midst of a major integration task with ESG. You are ramping up your business and preparing for future growth. And then your COO resigned a couple of weeks ago, and I assume that the COO is a key management position in the operational phase you are currently in. This, of course, can be a coincidence, but I think it also raises questions and I think it also needs to be addressed. Again, the spectrum maybe you can shed some light on that? Thank you.
Oliver Dorre
Yes, of course, Christian. First of all, and maybe just to repeat what I explained on the divisional setup. The organizational transformation and the ESG integration is, I would say, a seamless transformation that we're doing at the moment. That is actually why we're doing it. I would not see, I would say, separate building lines for that.
Second part of your question was, how does that interfere with the operational excellence with scaling our business in quantity and quality. Again, also here I would say, it doesn't a means to an end. I mean, the operational transformation that we are doing is actually to catalyze many of the efforts that the team before I joined Hensoldt took with Hensoldt Co, which we kind of put in a broader framework now and we're running that in the direction.
Coming back to the COO, I think we put a press release on this one. I would just refrain from entering those speculations, which were also in the media that these things are together. Maybe, it's just worse to note that, the COO position that Celia Pelaz took was newly funded. That means the interaction, as you say, your concern that now putting this function out, could put a threat to the system in the sense of discontinuation is not the case, because it was newly funded.
We're running a couple of activities in operational excellence, which I think were initiated also on my behalf. I can just assure you that, especially with a very strong alignment between me and Christian, we will sustain these efforts that are ongoing. I don't see any disruption on the case. It's rather a personal decision of Salia looking, and we have full and great respect of hair achievements within Hensoldt successes really that the Hensoldt as we see today takes her handwriting in many cases as she was the Chief Strategy Officer, Chief Sales Officer.
But again, now a new setup a very highly motivated team, which we could see at our recent sales leadership team, and I think a very united board here. So, in that regard, no worries, we walk the talk, we run our way, and I definitely think in line with the guidance we have provided. Hensoldt will continue on the success streak.
Operator
Ladies and gentlemen, that was the last question. I would now like to turn the conference over to Veronika Endres for any closing remarks.
Veronika Endres
Thank you all for listening today. As always, should you have any further questions, the IR team is happy to follow up. And with that, have a lovely weekend. Thank you, and goodbye.