Earnings Call: Q2 2017

Jul 27, 2017

Good day, and welcome to the Hexagon Q2 Report 2017 Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ola Rolon, CEO. Please go ahead, sir. Thank you very much, and welcome everyone to this Q2 interim report. And I suggest that we start on Slide number 4, overview of the Q2 2017. As you might have read in the report, organic growth amounted to 3% and the operating sales growth 10% in the quarter. We saw strong growth in Manufacturing Intelligence, Geosystems and Positioning Intelligence, And we saw 21% organic growth in China. That was mainly driven by demand from the electronics sector in China and our success with Smart City Solutions in the quarter. PP and M organic growth negatively impacted by a onetime revenue adjustment of €5,000,000 that follows a review of ongoing projects. But we did see underlying improvements. And if you reverse this onetime revenue adjustment, the underlying negative organic growth was 6% compared to 11% in Q1 negative. We saw especially North America coming back and we expect PP and M to return to growth towards the end of the year. Profitability wise, gross margin came in at 61.1%, and that is almost 1% up compared to the corresponding period last year. EBIT margin, 23.8 percent versus 23.5%. We have an NRI, the so called haircut of €8,800,000 in the quarter related to the acquisition of MSC. Slide 5, seasonality and profit. Just a reminder, this year, as always, Q2 and Q4 are strong quarters, Q1 is our weakest quarter and Q3 is our 2nd weakest quarter. Key figures, Slide 6. Operating net sales, I. E, Hexagon as a going concern, amounted to €873,700,000 and that is 10% recorded or 3% organic growth. Operating earnings, EBIT1 amounted to $207,800,000 which corresponds to an EBIT margin of 23.8%. And earnings per share, excluding nonrecurring items, amounted to EUR 0.46 or a 12% change over the corresponding period last year. 1st 6 months, I will not go through that chart. It's obviously Q1 plus Q2. But let's go to cash flow, Slide 8. Operating cash flow amounted to EUR 128,000,000 and that is a growth of 18% over the corresponding period last year. And we see significant improvements in working so a strong quarter cash flow wise. Our guidance is 80% to 90% cash conversion. We had 82% in the quarter 89% for the 1st 6 months. Results bridge 2nd quarter. There are a lot of moving parts in this quarter, So you need to reconcile the reported and the operating results. So we will start from left on Slide 9 and look at the underlying results. We can see that sales amounted to 878 $700,000 in the quarter. And then we do a reversal of the revenue in the quarter of $5,000,000 in the PP and M division, bringing us to what we call the operating sales that amounted to $873,700,000 And then we need to cut the deferred the acquired deferred revenue. And in this quarter, that amounts to a negative $8,800,000 dollars and thus we arrive at the reported revenue of 864,900,000 dollars Now I just want to comment and take the opportunity to comment that we expect the revenue haircut to amount to $8,000,000 in the Q3 $7,000,000 in the Q4. And then we're done with the revenue haircut in connection to MSC. If we then look at the cost line, we had gross costs or underlying costs in the operations of EUR 667,900,000 in the quarter. We reversed or released a provision, an earn out provision of €15,000,000 and we wrote off €13,000,000 of costs in the PP and M division. And that gave us a plus 2 impact on the cost within the PP and M division. And when you take it all together in PP and M, with the negative impact from sales of $5,000,000 and the positive impact of cost reversals net of $2,000,000 you arrive at a negative EBIT for PP and M for this review of our projects of minus 3,000,000 dollars And thus, you arrive at the operating result that we present today, dollars 873,700,000 in sales and $207,800,000 in EBIT. And then the revenue haircut obviously falls straight through the P and L statement from sales to the bottom line and hits the bottom line with 8,800,000 and thus the reported EBIT is €199,000,000 If we turn to Slide 10, impact from FX movements in the second quarter, and this is the first time we show you the full impact where we have the translation impact, which was positive in the quarter, dollars 6,900,000 in sales and $2,600,000 in operating earnings. The impact from transactions, however, where most of it stands from our accounts receivables is a negative $6,800,000 hitting the operating earnings under other income and expenses in the P and L statement. And adjusted for FX, Q2 2017 would have been slightly lower on sales but slightly higher on earnings. Working capital to sales, Slide 11. We can see the huge impact that the consolidation of Intergraph had back in 2010, And we can see another impact from another software company, MSC, when we consolidate that into our working capital. And this obviously has to do with the prepayment structure of the cash flows in a software based subscription model. Market Development, Slide 13, the sales mix globally for Hexagon, North America, South America and Asia Pac didn't move quarter over quarter. So we saw a slight reduction in share in Western Europe from 32% to 30%, and we saw a corresponding increase in the rest of EMEA and China that had a very strong quarter indeed. Slide 14, analysis of organic growth per region. China was the shining star in the quarter with 21% organic growth. Eastern Europe, Middle East and Africa also saw good growth. North America was growing at weak single digit numbers. And then we saw contraction in South America, Western Europe and Asia, excluding China. And on Slide 15, we have our popular arrow slide where our IR department has become really creative. And I leave this for you to dwell over when the call is done. You have the old and traditional arrow slide on Page 16 that shows the trends. If we move to Slide 17, I'm going to comment the different regions. EMEA market trends Q2. Western Europe recorded minus 1% organic growth, and this has to do with the onetime revenue adjustment that actually happened in EMEA for PP and M. But we saw good growth from infrastructure and construction. We had tough comps for our manufacturing business in Western Europe. The Middle East recovered after last year's negative development, and we saw continuous good growth in Eastern Europe and Russia. We move to Slide 18, Americas. North America recorded 0% organic growth in the quarter, and underlying activities showcased good growth for Surveying and Infrastructure. We saw good growth in Positioning Solutions and Power and Energy related businesses improved in the quarter. But we saw tough comparatives for U. S. Mining that had a big quarter in 2016. And adverse weather conditions in April affected the Hexagon imagery program, so it's slightly delayed into Q3. With those slowdown after several consecutive quarters of strong growth in U. S. Aerospace in the quarter as well. In South America, we recorded flat organic growth, which was still hampered by the continuous decline in Brazil due to its political turbulence. But if you exclude Brazil from South America, the rest of the continent was actually growing at 30% organic growth, and it was primarily impacted by order wins in the mining sector. Asia, Slide 19, China, 21% organic growth, impressive growth within electronics and increased traction for our smart city solutions within the Chinese mainland. We saw strong growth in New Zealand, driven by order wins within public safety, and we saw continuous weak development in East Asia, where South Korea and Japan from declines in manufacturing and shipbuilding, and India was weak in general. Reporting segments, Slide 21, Industrial Enterprise Solutions. The segment grew by 1% organic growth. Mi reports 6% organic growth, and this is where we see the impressive growth from the Electronics segment. We did see a slowdown in the quarter in Automotive, primarily in Western Europe, but also in North America, and we saw the sub slowdown in Aerospace. PP and M, minus 11 percent organic growth, adversely impacted by the onetime revenue adjustment of €5,000,000 that we've talked about. The underlying negative organic growth amounted to 6%. And we saw a recovery primarily in North America for the division. Sales amounted to €444,000,000 with an EBIT of €111,000,000 and that corresponds to an EBIT margin of 25% compared to 26% last year. Slide 22, Geospatial Enterprise Solutions, organic growth of 4%. Geosystems increased its organic growth to 5%, strong growth in EMEA and China, and its increased demand from both infrastructure and construction markets. Before U. S. Construction recovering, but U. S. Mining was negative in the quarter due to tough comparatives. The mapping business, I. E, the Midri program, was negatively affected by bad weather conditions in April. SI 1% organic growth hampered by poor demand from U. S. Defense, but we saw good demand for public safety and smart city solutions in all regions. Positioning 7% organic growth, and that was driven by 2 sectors, agriculture and defense. And we continue to see weak demand from the oil and gas offshore related business where we do positioning services for oil vessels. Sales amounted to EUR 430,000,000 and EBIT EUR 104,000,000 and that's a 24% EBIT margin compared to 22% last year. Slide 23, group gross margins now starting to trend up again after a year of flattish development due to the decline in PP and M. We report 61% gross margin for the rolling 12 month period compared to 60% previous year. And if we move to Slide 24, our EBIT margin 12 month rolling is now 24% compared to 23% this time last year. Orders and product releases, if we start on Slide 26. We're leading the way towards the future of smart manufacturing. The Board of Hexagon has taken the decision to invest €90,000,000 in a 52,000 square meter state of the art facility in Hongdao in China. That's the Shandong province. And the idea is to not only produce and develop in this facility, but also show case all hexagon technologies in one facility in China. So we will use our smart build software software solution to construct the facility. We will use all our equipment to monitor and guide the facility when it's up running. And we believe that completion will occur by 2020. Slide 27. Verus is a company a German based company that we acquired in the quarter. Is a leading provider of simulation software solutions that you use for driver or fully autonomous driving technologies. And we're going to merge that with our current portfolio, and this is going to enable us to develop the comprehensive solution for the automakers when they want to develop autonomous vehicles. Slide 28. We also acquired a U. S.-based company called Catawalt in the quarter. Catavault is, if you so wish, the final step in our IoT Vision Smart Convergence. It offers an end to end platform for mobile applications, and it's a secure cloud orchestration and edge computing software. We believe that we can use Catawalt's technologies to provide an open architecture and a solid foundation for realizing what we believe is the immense potential we see for our own solution called smart convergence. And you're going to hear more about smart convergence in the future. Slide 29, smart city solutions. One of the reasons why we grew by 21 percent in China in the quarter, we had 2 projects in the quarter. System where Hexagon and Huawei collaborated to install this system. And it shortened response time for all sorts of emergency resources in the city. Shenzhen was another city that adopted our technology, and here is the emergency management department in Longgang, which is another district within the city of Shenzhen. Slide 30, we got our 1st customer for SmartBuild, and it's the Swedish based construction company Skanska and Hexagon that have entered into a 4 year partnership to help drive strategic development of Hexagon Smart Build. Slide 31, we strengthened our partnership with AGCO. So beyond our traditional partnership, we have now introduced our TerraStar satellite correction signals service to AgCo's customers. So it's a subscription based correction service that you can pay monthly or on an annual basis using a system of more than 80 gs and stations worldwide to provide consistent accuracy. Slide 32, the new Gerturk satellite. We've sold Hexagon software that will provide geo correction and analysis for reconnaissance, homeland surveillance, intelligence and natural disaster damage assessment from this satellite based platform. We'll also support civilian projects, including environmental monitoring, cadastral surveys and identifying illegal construction sites from space. So you're not safe anymore. Slide 33, keeping New Zealand on the move. The New Zealand Transport Agency is implementing something they call a National Incident and Event Management System, And Hexagon will provide data feed from our old customer, New Zealand Police, that uses our computer aided dispatch system to the National Incident and Event Management System. And by doing this, we connect the 2 systems so they have seamless communication. Slide 34. We launched a new product in the quarter called Mine Vehicle Intervention System. Hexagon mine vehicle intervention system detects and prevents collisions by automatically slowing down or stopping vehicles if an imminent collision is detected in a mine. And look at this picture to the right. You see 2 pickup trucks parked next to this huge truck. And obviously, if you drive 1 of these big trucks, it could be hard to see and spot the cars next to you. And that's why these systems are becoming critical or almost compulsory in certain areas. Slide 35, Our long standing partnership with Airbus took another step in the quarter where we delivered our absolute tracker AT403 to the Hamburg plant. And the Hamburg plant will standardize on our trackers, and it will be a key part of the final assembly of the A320 family. Slide 36. We're collaborating with ExxonMobil, and this is also another product launch of the product SDA, which stands for Smart Digital Asset. It's all about keeping a virtual digital twin in sync with the physical asset for access anytime, anywhere on any device, mobile, stationary, desktop, tablet. Smart Digital Assets Collaboration Module is the first module of PPNM's next generation suite of 0 footprint browser based information management products. And that's it for the quarter. So in summary on Slide 38, we saw growth driven by strong development from Manufacturing Intelligence, Geosystems and Positioning Intelligence, Impressive organic growth in China, 21% in the quarter, driven by electronics and smart city solutions. Growth was hampered by a continuous weak oil and gas sector, but we did see underlying improvements within that business. Strong profit development in all businesses, but for PPNM. MSE Software, a leading provider of computer aided engineering simulations consolidated as of the 26th April. And with that, I leave the conference open for any questions there might be. So operator, please, we're ready to answer questions. We can now take our first question from Mohammed Moala from Goldman Sachs. Please go ahead. Your line is open. Great. Thank you very much. Ola, I was wondering if you can comment on sort of the pace of revenue growth acceleration. We've seen a slight acceleration in Q2 despite PPNM being weak, but you're sort of talking about PPNM stabilizing to even improving at the back end of the year. What gives you the confidence that it will happen in PPNM? And do you think that the strength in China is sustainable into the back half to kind of drive the group wide acceleration? My second question was actually around the smart digital asset. It sounds like that could be potentially a significant opportunity in the kind of oil and gas installed base. So perhaps you could outline the potential runway for growth there and also who you would potentially compete with because there are a lot of PDM and PLM players who are trying to sell some of these systems? Yes. Thank you. The revenue growth accelerations, there are several reasons why we only reached 3% organic growth in Q2. You got the imagery program that is delayed, but we know it's going to happen in the year. And since the 1st 6 months have passed, it must happen in the second half. We have the launch of new products that will where we really will see the invoicing in the second half and not the first half. And we've seen a trend where things are not becoming worse anymore within PPNM. We've sort of bottomed out, and there is a glimmer of hope among the customer base. And that all points in the same direction. Regarding China, we do believe that we have a very good second half of twenty seventeen to look forward to in China. Will we reach 21%? No, probably not, but it's going to be good growth in the second half as well. Regarding FDA, I don't think that we've seen any single competitor in this field. What we do is we use our current design tools and bring them into maintenance. And the key word is really to have an updated digital twin. And to be able to do that, you need to be able to update anything that happens on the oil rig, for example. And here are laser scanning technologies that we integrate are, of course, important. So I think this is a new market for PPNM, and we're looking forward to seeing the development. Great. And can I ask one just follow-up on PP and M? You obviously had a look at some of the sort of the contracts and you said that there was obviously a sort of one time effect in the quarter. I mean, have you fully evaluated all your kind of existing contracts? And is there any further risk around any other kind of write downs on sort of maintenance collection that you think may not happen? I believe that we've done a comprehensive review, and this was what we found. Great. Thank you. Thanks. Thank you. We can now take our next question from Daniel Dernberg from Hansel Bank. Please go ahead. Your line is open. Thank you very much and thank you for taking my question. First is regarding PP and M and the recovery you expect to see. You said that you expect to see growth at the end of the year. Should we expect a full quarter growth? Or is it more or less December or something like that? And the second question is regarding Western Europe, corresponding to 30% of sales. You had some negative aero in 6 or 7 segments here and you also talked about slowdown in aero and automotive. And I understand that you have tough comps in Germany, etcetera. But if you can give any outlook for Western Europe, it would be great. PP and M, it's hard to say. I think we need to come back in connection to the Q3 report to say if it's a full quarter or if it's going to be a few months within the quarter. What's happening in PPNM is they're branching out into new applications. We got the SDA. We got Ecosys that we acquired in 2015, which is a cost control program. And we're seeing the pipeline building. And for the first time in the second quarter, we not only saw promises of order growth, we actually invoiced. And that reassures us that we might have turned a corner in these products. So that's the reason why we believe that we will see the end of this pain by the end of the year. And your second question was Western Europe. There is nothing fundamental pointing at Western Europe slowing down. Actually, the sentiment is quite good in Western Europe. We have some restrictions with certain customers that are not allowed to invest right now in Western Europe. But I think we will see growth coming back in Western Europe in the second half. Yes. And just a quick follow-up, if I may, on Q3 in terms of comparatives. What should we look out for? Was Sitomeka in Q3 2016? Because that gave a big jump on organic growth, I believe. Yes. It was. Correct. Yes. Anything else to think of? Not from top of my head. Fair enough. Thanks. We might come back to you on that. Thank you. If we find but Mecka was definitely a Q3 event last year. Yes, thanks. Thank you. We can now take our next question from Michael Lesson from Carnegie. Please go ahead. Your line is open. Yes, thank you. I have a couple of questions. And the first one is about electronics and smart city. They were quite strong in the second quarter. And what was really the contribution sales contribution from these two areas? And are they sustainable? Or is it sort of a project nature here that we saw? It's lumpy. Of course, it's not sustainable. But we do believe that we have a few smart cities more of a long term project where electronics is related to new product launches within the electronics segment. So that could decline once the products are launched. But there are always new products, so it's a bit hard to say. Smart Cities, actually, it's a long term commitment from the Chinese government to make more than 300 cities in China smart, and they have a definition that you can actually look up on Internet what a smart city is. And that's what we're installing. And with the collaboration with Huawei, I think we have a very strong offering. So that will probably continue longer. Okay, great. What is the status and situation now in China begun? Is it small cities? I mean, have you delivered to? It's only just begun, and it's a 10 year commitment. Okay. I have another question and it's regarding the year spatial margins. They were quite good in the quarter. And can you say something about the key drivers for that? So the mix effects and the potential savings implications from the Q1 program? There were some savings, but the main driver was mix. You had good revenue from these smart city solutions, which is booked under Geospatial and you had product rejuvenation within Geosystems that we've launched earlier in the year with more software content and higher margins than the products they replace. Okay. Thank you. We can't really point at one individual factor. And then, of course, PEI, which we tend to forget, which is becoming an increasing part of that division, has really good margin. Thanks. Thank you. We can now take our question from Alex Howes from Deutsche Bank. Hi, thanks for taking the questions. Actually, I have 3, if possible. First one, automotive and aerospace looking pretty weak in Europe and North America. Could you just describe what you're seeing in those markets, whether they're difficult markets, that there's some kind of cyclical slowdown there? Or was it more execution on your own part is the first question. Could you tell me secondly what the impact on costs was of the Q1 restructuring in the quarter? Do we expect that impact to increase in the Q3? And any other puts and takes that could see the margin expanding, the EBIT margin expanding more quickly than we've seen in the first half? And finally, on construction, you said that Western Europe construction was strong, but I saw from the Slide 16 that surveying was declining in the quarter. So was it more positioning that drove the strength? And do you see what happened in surveying as any kind of lead indicator around the health of construction in Europe? Thank you. Let's see. I think that if we start with your last question, I think that's wrong. We might have made a mistake because surveying is not declining in Western Europe. I think construction, we're expecting a healthy market for surveying and construction in Europe in the second half. Moving on to Euro Water and Aerospace question. Yes, we had tough comps both in North America and Europe in the quarter, but it is true that we do see a slight slowdown more in auto than in aerospace. Are we worried about the long term outlook? No. I would rather categorize it as a breather where we see new car programs being launched late this year, early next year. And regarding the cost restructuring program in Q1, we saved $5,000,000 in the Q2, and that's going to accelerate in the second half of the year. In terms of the margin performance in the Q3 and the rest of the year and whether the rates of expansion could increase, is that really all hinging on PP and M? Or are there any other significant puts and takes to take into consideration? No. We're probably expecting more contribution from other divisions than the PPNM. Okay. Thank you. Thanks. Thank you. We can now take our next question from Wasi Reza from RBC Capital Markets. Please go ahead. Hi. Yes. A few from me. Just going back to the GES margin, so we're up 2 percentage points year on year. And if growth accelerates in H2, as I think you're suggesting it might, will that year on year increase and accelerate as well? Or is that mix been quite favorable and maybe you don't get quite the same leverage? No. I would hesitate to say that, that would accelerate. When we say acceleration in the second half, we refer to the organic growth of 3%. And to put it in context, we had a Capital Markets Day in December last year where our long term ambition is to grow organically at 5% between 20172021. We're currently at 3% in Q1 and Q2. And that means that we're probably not going to achieve the 5% target this year, but we're going to see an acceleration towards the target during the latter half of the year. And to reach 5% this year, we need to grow at 7% for the second half. And we don't believe we're not guiding to a 7% organic growth. Okay. And then just the next one. I guess it's the first time we've had an analyst call since we had the statement that you regularly evaluate various opportunities to optimize your positioning and shareholder value. I guess what I'm interested in is your thoughts on whether you are evaluating them more or less seriously than you would do in previous years and what the reason behind that might be? We're not going to comment on that. You have to read the press release from the 14th June, and that's what we're going to say about that. Right. Okay. So and then just changing tax slightly on That's a good try. And then just changing tax slightly. I've been reading a bit around China laws on mapping data and the ownership of that data, how that might be a hindrance for autonomous vehicles. So could you help me in understanding how that might affect Hexagon and whether that might have any impact on what you might be able to do with the Hexagon imagery program in China if there are restricted rules on who can own mapping data? Absolutely. As a foreigner, we can't do the imagery program like we do within North America and Europe. We fly across Europe and North America. We collect data. We store data in a central server, and then we resell that data. That is impossible as a foreign company under Chinese laws. So in China, we can sell our technology and we can collaborate with Chinese companies flying China, storing the data in China, and that is the difference. Right. That helps. Thanks. Thanks. Thank you. We can now take a follow-up question from Daniel Dernberg from Hansel Banken. Please go ahead. Thank you so much. Just a follow-up on the MSC acquisition from April 26. You've been married with the company for like 3 months And I was thinking if you could give any initial comments on the integration, R and D, on products, customer wins, losses, employee turnover, etcetera, performance so far? No. Performance so far has been according to what we expected. So I can't say it's been better or worse. It's actually bang on plan. And like all software companies, we're hoping for more activity in the second half of the year. Okay. Thank you. And then perhaps just a question on Smart Bill. I know it's really early days with Skanska here, the projects, etcetera. But when should we expect to see any evidence of this efficiency gains etcetera from the projects like Skanska for example? Forth. Can you say anything about it? It's going to take time. This is, of course, obviously, we start small. And then as we master certain parts of the construction process, we can roll it out into 2 other parts. But it's such a big market where I think the AEC market is the largest market on the planet. So it's going to take a very long time until we see an impact from this project. That's great. I'll be waiting. Thank you. Thanks. Thank you. We can now take another follow-up question from Wazee Rizvi from RBC Capital. Just a follow-up on the restructuring actually. I think did you say you achieved CHF 5,000,000 of savings in this quarter? And then I think when you originally launched it, you were going for $24,000,000 in 2017. So the pace of savings will pick up in the balance of the year. Is that right? That is correct. Okay. Right. Brilliant. That's all I wanted to confirm. Thanks. Thank you. We have no further questions in the queue at this time. Gentlemen, I'd like to turn the call back over to you for any additional or closing remarks. And no, we have no additional remarks. So thank you everyone for calling in and listening and post these questions. And we'll talk next quarter. Bye. Thank you. That will conclude today's conference call. Thank you for your participation. Ladies and gentlemen, you may now