Good day. 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 Rollén, CEO. Please go ahead, sir.
Thank you very much. Welcome, everyone, to this Q2 interim report. I suggest that we start on slide number four, overview of the second quarter 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. We saw 21% organic growth in China. That was mainly driven by demand from the electronic sector in China and our success with Smart City Solutions in the quarter. PP&M organic growth negatively impacted by a one-time revenue adjustment of EUR 5 million that follows the review of ongoing projects. We did see underlying improvements, and if you reverse this one-time revenue adjustment, the underlying negative organic growth was 6% compared to 11% in Q1 negative.
We saw especially North America coming back. We expect PP&M to return to growth towards the end of the year. Profitability-wise, growth margin came in at 61.1%. That is almost 1% up compared to the corresponding period last year. EBIT margin 23.8% versus 23.5%. We have an NRI, the so-called haircut of EUR 8.8 million in the quarter related to the acquisition of MSC. Slide five, seasonality and profit. Just a reminder, this year, as always, Q2 and Q4 are strong quarters, Q1 is our weakest quarter, Q3 is our second weakest quarter. Key figures, slide six. Operating net sales, i.e. Hexagon as a going concern, amounted to EUR 873.7 million. That is 10% recorded or 3% organic growth. Operating earnings, EBIT1, amounted to EUR 207.8 million, which corresponds to an EBIT margin of 23.8%.
Earnings per share, excluding non-recurring items, amounted to EUR 0.46, or a 12% change over the corresponding period last year. First six months, I will not go through that chart. It's obviously Q1 plus Q2. Let's go to cash flow, slide eight. Operating cash flow amounted to EUR 128 million. That is a growth of 18% over the corresponding period last year. We see significant improvements in working capital compared to the previous year, both in the quarter as well as for the first six months. A strong quarter cash flow-wise. Our guidance is 80%-90% cash conversion. We had 82% in the quarter and 89% for the first six months. Results bridge second quarter. There are a lot of moving parts in this quarter, you need to reconcile the reported and the operating results.
We will start from left on slide nine and look at the underlying results. We can see that sales amounted to EUR 878.7 million in the quarter. We do a reversal of the revenue in the quarter of EUR 5 million in the PPM division, bringing us to what we call the operating sales that amounted to EUR 873.7 million. We need to cut the acquired deferred revenue. In this quarter, that amounts to a negative EUR 8.8 million, and thus we arrive at the reported revenue of EUR 864.9 million. I just want to comment and take the opportunity to comment that we expect the revenue haircut to amount to EUR 8 million in the third quarter and EUR 7 million in the fourth quarter. We are done with the revenue haircut in connection to MSC.
We then look at the cost line. We had gross costs or underlying costs in the operations of EUR 667.9 million in the quarter. We reversed or released a provision, an earn-out provision of EUR 15 million. We wrote off EUR 13 million of costs in the PPM division, and that gave us a +2 impact on the cost within the PPM division. When you take it all together in PPM, with the negative impact from sales of EUR 5 million and the positive impact of cost reversals net of EUR 2 million, you arrive at a negative EBIT for PPM for this review of our projects of -EUR 3 million. Thus you arrive at the operating result that we present today, EUR 873.7 million in sales and EUR 207.8 million in EBIT.
The revenue haircut obviously falls straight through the P&L statement from sales to the bottom line and hits the bottom line with EUR 8.8 million, and thus the reported EBIT is EUR 199 million. 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, EUR 6.9 million in sales and EUR 2.6 million in operating earnings. The impact from transactions, however, where most of it stems from our accounts receivables, is a negative EUR 6.8 million hitting the operating earnings under other income and expenses in the P&L statement. 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. We can see another impact from another software company, MSC, when we consolidate that into our working capital. 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. We saw a slight reduction in share in Western Europe from 32% to 30%. 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. We saw contraction in South America, Western Europe, and Asia, excluding China. 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 -1% organic growth, and this has to do with the one-time revenue adjustment that actually happened in EMEA for PP&M. 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. 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. Underlying activities showcased good growth for surveying and infrastructure. We saw good growth in Positioning Intelligence solutions, and power and energy-related businesses improved in the quarter. We saw tough comparatives for U.S. mining that had a big quarter in 2016. Adverse weather conditions in April affected the Hexagon Imagery Program, so it's slightly delayed into Q3. We saw a slowdown after several consecutive quarters of strong growth in U.S. Aero 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.
If you exclude Brazil from South America, the rest of the continent was actually growing at 30% organic growth. 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. We saw continued weak development in East Asia, where South Korea and Japan suffered 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. We saw the said slowdown in Aero. PP&M, -11% organic growth, adversely impacted by the one-time revenue adjustment of EUR 5 million that we've talked about. The underlying negative organic growth amounted to 6%. We saw a recovery primarily in North America for the division. Sales amounted to EUR 444 million with an EBIT of EUR 111, 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. We saw U.S. construction recovering, but U.S. mining was negative in the quarter due to tough comparatives.
The mapping business, i.e., the Imagery 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, that was driven by two sectors, agriculture and defense. We continued 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 million and EBIT EUR 104 million, and that's a 24% EBIT margin compared to 22% last year. Slide 23, group growth margins now starting to trend up again after a year of flattish development due to the decline in Hexagon PPM. We report 61% growth margin for the rolling 12-month period compared to 60% previous year.
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 EUR 90 million in a 52,000 sq m state-of-the-art facility in Hongdao in China. That's the Shandong province. The idea is to not only produce and develop in this facility, but also showcase all Hexagon's technologies in one facility in China. We will use our Smart Build software solution to construct the facility. We will use all our equipment to monitor and guide the facility when it's up running. We believe that completion will occur by 2020. Slide 27. VIRES is a German-based company that we acquired in the quarter.
It's a leading provider of simulation software solutions that you use for driver-assisted or fully autonomous driving technologies. We're going to merge that with our current portfolio, and this is going to enable us to develop a comprehensive solution for the automakers when they want to develop autonomous vehicles. Slide 28. We also acquired a U.S.-based company called Catavolt in the quarter. Catavolt 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 Catavolt 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. 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% in China in the quarter. We had two projects in the quarter. Hongdao is a district in the city of Qingdao in the Shandong province in China. They acquired a city management system where Hexagon and Huawei collaborated to install this system. 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 first customer for Smart Build. It's the Swedish-based construction company Skanska and Hexagon that have entered into a four-year partnership to help drive strategic development of Hexagon Smart Build. Slide 31. We strengthened our partnership with AGCO.
Beyond our traditional partnership, we have now introduced our TerraStar satellite correction signals service to AGCO's customers. It's a subscription-based correction service that you can pay monthly or on an annual basis using a system of more than 80 GNSS stations worldwide to provide consistent accuracy. Slide 32. The new Göktürk 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. 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.
Hexagon will provide a data feed from our old customer, New Zealand Police, that uses our computer-aided dispatch system to the National Incident and Event Management System. By doing this, we connect the two systems so they have seamless communication. Slide 34. We launch 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. Look at this picture to the right. You see two pickup trucks parked next to this huge truck. Obviously, if you drive one 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 new Absolute Tracker, AT403, to the Hamburg plant. 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, 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 Asset collaboration module is the first module of PP&M's next generation fleet of zero-footprint, browser-based information management products. That's it for the quarter. 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, we did see underlying improvements within that business. Strong profit development in all businesses, but for PP&M. MSC Software, a leading provider of computer-aided engineering simulations, consolidated as of the 26th of April. With that, I leave the conference open for any questions there might be. Operator, please, we're ready to answer questions.
Certainly. If anyone would like to ask a question at this time, please press the star key followed by the digit one on your telephone. Please ensure that your mute function is switched off to allow your signal to reach our equipment. Again, that's star one if you would like to ask a question via the audio. We'll pause for a brief moment now to allow everyone's signal. 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 PP&M being weak, but you start talking about PP&M stabilizing to even improving at the back end of the year. Do you think that the strength in China is sustainable into the back half, to 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 oil and gas install base. Perhaps, you could outline the potential runway for growth there, and also who you would potentially compete with there, because there are a lot of PDM and PLM players who are trying to sell some of these systems.
Yeah. Thank you. The revenue growth acceleration, 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. Since the first six months have passed, it must happen in the second half. We have launch of new products where we really will see the invoicing in the second half and not the first half. We've seen a trend where things are not becoming worse anymore within PP&M. We've sort of bottomed out, and there is a glimmer of hope among the customer base. That all points in the same direction. Regarding China, we do believe that we have a very good second half of 2017 to look forward to in China. Will we reach 21%? No, probably not.
It's going to be good growth in the second half as well. Regarding SDA, 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. To be able to do that, you need to be able to update anything that happens on the oil rig, for example, and here our laser scanning technologies that we integrate are of course important. I think this is a new market for PP&M, and we're looking forward to seeing the development.
Great. Can I ask one just follow-up on PPM? You obviously had a look at some of the contracts, and you said that there was obviously a sort of one-time effect in the quarter. Have you fully evaluated all your existing contracts, and is there any further risk around any other write-downs on maintenance collection that you think may not happen?
I believe that we've done a comprehensive review, this was what we found.
Great. Thank you.
Thanks.
Thank you. We can now take our next question from Daniel Djurberg from Handelsbanken. Please go ahead. Your line is open.
Thank you very much. Thank you for taking my question. First is regarding PP&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? The second question is regarding Western Europe, corresponding to 30% of sales. You had some negative errors in six or seven segments here, and you also talked about slowdown in Aero and automotive. I understand that you have tough comps in Germany, et cetera, but if you can give any outlook for Western Europe, it would be great. Thanks.
PP&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 a quarter. What's happening in PP&M 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. We're seeing the pipeline building. For the first time in the second quarter, we not only saw promises of order growth, we actually invoiced. That reassures us that we might have turned a corner in these products. That's the reason why we believe that we will see the end of this pain by the end of the year. 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. Just a quick follow-up, if I may, on Q3, in terms of comparatives, what should we look out for? It was [Sitomeca] in Q3 2016, because that gave a big jump on organic growth, I believe.
Yes. It was. Correct.
Yeah. Anything else? Think of?
Not from top of my head.
Fair enough. Thanks.
We might come back to you on that.
Thank you.
We find MSC was definitely a Q3 event last year.
Yeah, thanks.
Thank you. We can now take our next question from Mikael Laséen from Carnegie. Please go ahead. Your line is open.
Yeah, thank you. I have a couple of questions. The first one is about electronics and Smart City. They were quite strong in second quarter. What was really the sales contribution from these two areas? Are they sustainable, or is it sort of a project nature here that we saw?
It's lumpy. Of course, it's not sustainable. We do believe that Smart City is more of a long-term project, where electronics is related to new product launches within the electronic segment. That could decline once the products are launched. 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. They have a definition that you can actually look up on internet what a Smart City is, and that's what we're installing. With the collaboration with Huawei, I think we have a very strong offering. That will probably continue longer.
Okay, great. What is the status and situation now in China regarding these Smart Cities? How many 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 Geospatial margins. They were quite good in the quarter. Can you say something about the key drivers for that? For the mix effects and the potential savings implications from the first quarter 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 replaced.
Okay. Thank you.
We can't really point at one individual factor. Of course, PI, which we tend to forget, which is becoming an increasing part of that division, has really good margins.
Thanks.
Thank you. We can now take our next question from Alexander Virgo from Deutsche Bank.
Hi. Thanks for taking the questions. Actually, have three if possible. First one, automotive and aerospace are 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? As the first question. Could you tell me, secondly, what the impact on costs was of the first quarter restructuring in the quarter? Do we expect that impact to increase in the third quarter? Any other puts and takes that could see the EBIT margin expanding more quickly than we've seen in the first half? 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. Was it more positioning that drove the strength?
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 an aerospace question. Yes, we had tough comps both in North America and Europe in the quarter. 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. Regarding the cost restructuring program in Q1, we saved EUR 5 million in the second quarter, and that's going to accelerate in the second half of the year.
In terms of the margin performance in the third quarter and the rest of the year, and whether the rates of expansion could increase, is that really all hinging on PP&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 PP&M.
Okay, thank you.
Thanks.
Thank you. Again, as a reminder, it's star one if you would like to ask a question over the audio. We can now take our next question from Wasi Rizvi from RBC Capital Markets. Please go ahead.
Hi. Yeah, a few from me. Just going back to the GES margin. We're up two percentage points year-on-year. If growth accelerates in H2, as I think you're suggesting it might, will that year-on-year increase then accelerate as well? Has 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%. 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 2017 and 2021. We're currently at 3% in Q1 and Q2. That means that we're probably not going to achieve the 5% target this year. We're going to see an acceleration towards the target during the latter half of the year. To reach 5% this year, we need to grow at 7% for the second half, and we're not guiding to a 7% organic growth.
Okay. 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 of June, that's what we're going to say about that.
Right. Okay. Just changing tack slightly.
It was a good try.
Just changing tack 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. 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 restrictive rules on who can own mapping data?
Absolutely. As a foreigner, we can't do the Imagery Program like we do it in North America and Europe. We fly across Europe and North America. We collect data. We store data in a central server, we resell that data. That is impossible as a foreign company under Chinese laws. In China, we can sell our technology, we can collaborate with Chinese companies, fly in China, storing the data in China. That is the difference.
Right. That helps. Thanks.
Thanks.
Thank you. Again, as a final reminder, that's star one if you would like to ask a question. We can now take a follow-up question from Daniel Djurberg from Handelsbanken. Please go ahead.
Thank you so much. Just to follow up on the MSC acquisition from April 26th. You've been married with the company for three months. I was thinking if you could give initial comments on the integration on R&D, on products, customer wins, losses, employee turnover, et cetera. Performance so far.
Performance so far has been according to what we expected. I can't say it's been better or worse. It's actually bang on plan. Like all software companies, we're hoping for more activity in the second half of the year
Okay, thank you. Perhaps just a question on Smart Build with really early days with Skanska here, the projects, et cetera. When should we expect to see any evidence of this efficiency gains, et cetera, from the projects like Skanska, for example, and so forth? Can you say anything about it?
It's going to take time.
Yeah.
This is, of course, obviously we start small, as we master certain parts of a construction process, we can roll it out into other parts. It's such a big market. I think the AEC market is the largest market on the planet. 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 Wasi Rizvi from RBC Capital.
Hi. Just to follow up on the restructuring, actually. I think, did you say you've achieved EUR 5 million of savings in this quarter? I think when you originally launched it, you were going for EUR 24 million in 2017. 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.
Thanks.
Thank you. Again, that's star one if you'd like to ask a question. 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.
No, we have no additional remarks. Thank you everyone for calling in and listening and pose these questions. 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 disconnect.