Earnings Call: Q3 2014

Oct 22, 2014

Good day, and welcome to the Hexagon Interim Q3 2014 Report Conference Call. At this time, I would like to turn the conference over to President and CEO, Ola Rollin. Please go ahead. Thank you. Good morning, good afternoon everyone and welcome to this Q3 interim report from Hexagon. If you turn to Slide 4, we have an overview of the Q3. Organic growth amounted to 8% and was primarily driven by metrology. Geosystems organic growth slowed down despite strong development in North America and certain parts of the EMEA regions. And this weakness stems from the Chinese construction industry as well as the mining sector in Australia. Overall, strong profitability, gross margin of 58 percent and an EBIT margin of 22% for the group in the quarter. If we go to Slide 5, I'd like to highlight that we've now detected and confirmed a change in our seasonality and profit. And this has to do with our increased exposure to South America and Asia. From now on, we're going to state that Q1 is our weakest quarter followed by Q3, while Q2 and Q4 are our strongest quarters. Slide 6, key numbers in the 3rd quarter. Net sales amounted to $648,600,000 And it's important to remember that we have a revenue haircut of $1,800,000 in the quarter in these numbers stemming from the acquisition of Mintech and Vero Software. Operating earnings amount to $140,700,000 corresponding to an EBIT margin of 21.7%. Earnings before taxes excluding non recurring items amount to €132,000,000 which is a 20% increase over the corresponding period last year. And this corresponds to an earnings per share of €0.25 or excluding nonrecurring items €0.29 in the quarter. Key figures for the 1st 9 months. Net sales now amount to 1,879,000,000, which is a 6 percent increase organically over the corresponding period last year. And our operating margin for the 1st 9 months is now at 21.5%. Slide 8, cash flow. Cash flow from operations before taxes paid and interest received amounted to $177,000,000 And if we look at cash flow from operations, including taxes paid and interest payments, interest costs, we actually have an increase of roughly 26% in the running operating cash flow. The big negative in the quarter compared to the previous Q3 in 2013 is really what's highlighted here. It's the change in working capital where with this organic growth, we simply have to invest in working capital. Ordinary investments is also highlighted, and it's just to highlight that we have €7,000,000 for the new campus in Huntsville, Alabama where we yesterday inaugurated the premises. And that's €5,000,000 more than the corresponding period for 2013. So if we exclude and we back out the cost the investment cost for the campus in Huntsville, we actually have a declining investment activity. Working capital, Slide 9. In spite of the negative number in the cash flow statement as a relation to sales, we still have a positive trend where it's trending downwards and it's significantly below 20% for the quarter. Slide 10, just to highlight that we refinanced the group in the Q3. We have a new €2,000,000,000 RCF financing in place as from Q3 2014. And the average cost for that new facility is roughly 1%, and it represents 62% of our borrowings. Another thing I'd like to stress and highlight in this slide is the bond loan, which expires in the Q4 of Slide 11, currency impacts in the 3rd quarter. We saw EBIT being reduced by $3,200,000 in the quarter and sales $1,400,000 And the reason why the EBIT is larger than the sales reduction is simply because of the Swiss franc that was strengthened during the quarter. And for the 9 months, we can see the corresponding numbers are €24,000,000 negative for the EBIT and €51,000,000 for sales. But from here on, we expect that in the Q4, we will have a slight positive effect from currency going forward. If we summarize from an operational point of view the extraordinary events, financial events in the Q3, we should go to Slide 12, where we can see the Q3 as reported operating earnings and net sales. The so called haircut impact is minus 1.8 on sales and the corresponding minus 1.8 on earnings, resulting in a negative EBIT margin impact of 2 percentage points. And then you have the FX impact that in the quarter was negative 1.4% for sales and minus 3.2% for earnings, which had a negative 0.5% impact on operating margin. So if we back these two effects out, we could have reported a 22.4 percent EBIT margin as a going concern. And for the half year, it would have been 22.2 rather than 21.5. We will have haircut impacts even in the Q4, but as from Q1 of 2015, these haircut impacts stemming from Vero and FinTech will be taken. Moving to Slide 13. What did the sales mix look like in the 3rd quarter geographically? North America expanded its share to 30%. Western Europe reduced its share to 29%. And all the other regions but Asia, excluding China, were flat. Slide 14, analysis of organic growth per geographic region. We can see that North America, China, South America, Middle East and Africa, Southeast Asia all grew above 8% organic growth in the quarter. Western Europe, single digit growth. Russia, slight negative growth in the quarter and we've highlighted the UAV market and Australia. The UAV market for military applications contracted in the quarter and so did Australia. The market was simply reduced because of lack of demand from the Australian mining market. Slide 15, an overview of segments and geographic regions where we if we first look at the regions, we can see that North America is now growing above 8% and China is once again growing at double digit growth. Actually North America also grew double digit in the quarter. So both are the 2 positive trends. And then we see Asia, a yellow arrow, arrow, which represents 0% to 8% growth, Asia without China. If we look at the segments, we can see strong activity backing up the metrology numbers at the bottom, Automotive, Manufacturing and Aerospace and Defense. If we move to Slide 16, EMEA. Western Europe recorded low single digit growth, 3% organic growth in the quarter. Italy and Spain, however, saw double digit growth rates from low levels where we can see the Italian and Spanish markets starting to grow again, but still below the 2,008 levels. Demand in Western Europe was primarily driven by automotive and aerospace. Infrastructure related activities slowed down partly due to the strong development seen in the Q3 of 2013. Russia weakened significantly going from strong double digit growth in the second quarter to slight negative growth in the 3rd quarter. But Eastern Europe and Middle East continued to see double digit growth in the quarter. And that is the oil and gas activities in Middle East continuing as well as automotive manufacturers and other engineering companies in Western Europe investing in their Eastern European plants. Africa recorded strong growth in the quarter partly due to a large project order in South Africa. Asia, Slide 17, 12% organic growth in China driven by primarily the automotive and electronics and power and energy sectors in the Chinese market. Surveying recorded another weak quarter due to the slowdown in infrastructure and construction. Southeast Asia, solid growth, primarily driven by Indonesia, Singapore and Vietnam. Growth was held back in the region by Australia, which saw another weak quarter due to poor demand in mining. Americas, Slide 18. Growth was driven by continued strength in the construction infrastructure sectors in North America and strong demand in automotive and aerospace in the engineering sectors. Activity increased in the defense segment apart from the earlier mentioned UAV related business, which is done conducted by Novotel. South America, strong double digit quarter, another strong quarter for South America and for more or less all our businesses in the region. Slide 19 give you an overview of the organic growth since the financial crisis Q3 of 2008. And we can see that all regions are now above the pre crisis levels of 2,008. And Asia is already 60% larger than the previous peak in 2,008. Organic growth by application area, Slide 20. We can see the acceleration in growth in technology and metrology again and the slowdown in geosystems related to the mining and the Chinese construction sectors. Gross margin, Slide 21, The quarterly number no, sorry, the 9 month number is now 58% gross margin and that is 1 percentage point higher than the corresponding period last year. If we move to Slide 22, we have the 12 month rolling, which is of course, a very rigid curve when we now add quarters. But the 12 month rolling operating margin is now 23% for Measurement Technologies. Mergers and acquisitions, orders and product releases. It was a big quarter for mergers and acquisitions. We consolidated Bureau Software and MINTEC and we're going to come back to that. But let's turn to orders. We've got an order from the Crossrail project, a new order. This is Europe's largest infrastructure project and it's to monitor an automated monitoring system for Paddington Station in London. We also maintain G and S's positioning in challenging locations via a partnership with Locata Corporation. It's an ideal combination where we use this technology in so called GNSS denied environments such as deep pits and against high walls. And it was implemented in Chile and Australia in the quarter. Slide 26, the first bathymetry underwater solution is now sold in China. A little more than a year ago, we acquired Airborne Pedrography in Sweden And we've now launched the next generation so called LiDAR system that can detect underwater structures and activities. And the new product is called Shireoptera 2. And we launched that and it's now installed in the Fujian province in China, maybe something for the Swedish Navy. Slide 27. Hexagon helped Georgia, United States to expand its road network. It's an $840,000,000 investment in the so called Northwest Corridor in the state of Georgia in United States. Slide 28, we're also supporting Brazil's infrastructure. We've installed the high technology touring and imaging sensors in the Sao Paulo Metro over the quarter. It's the 65 stations and 4,000,000 passengers per day. CHES, which is another Brazilian high technology company installed our sensors to monitor the Paulo Alfonso dam in the state of Bahia in Brazil. Slide 29. We also supported tectonic monitoring in Southern Italy and it was an installation that was performed in the quarter in collaboration with the Italian National Institute For Geophysics and Volcanology. And what this system will do is simply creating alerts for civil protection in case of movements or any worsening of the conditions in the volcano. Slide 30, Hexagon's airborne cameras are flying high. This is the launch where we combine with our partner Swiss drones, the Dragon 50 UAV with the Leica RCD 30 camera. And we've sold several of these systems to JUPEM in Malaysia for mapping and emergency response services. And we also got an order from the government of Trinidad and Tobago for mapping and special projects in the Caribbean. I think this is a must have. It looks really Slide 31, smart plant gives further competitive edge to EPCs in China. We continue our expansion in the Chinese design and CAD market with our Smart Plant suite of products. This time it was China Chengdai Engineering, which is the leading EPC in China that renewed its strategic alliance with Integraff Corporation. Slide 32, ST Topographia is a Brazilian based engineering company that offers services and is consulting the infrastructure, shipbuilding and offshore industries in Brazil. And we have signed an agreement to provide them with smart modular assembly, which is a new product for us. And this during the manufacturing and assembly process of these large structural projects such as shipbuilding, infrastructure and offshore construction. Accidents in the quarter. New Zealand Transport Agency, NZTA, has bought a system where we provide crash analysis systems to manage map and analyze traffic collisions in New Zealand. And Mississippi Department of Transportation bought a similar system that will manage a 100,000 mile road network, averaging 125 plus accidents per day. Slide 32, Evonik looks to Hexagon for industrial security solutions. This is a security installation and software system, which was installed in Evonik's facilities in Darmstadt, Weiterstadt and Vorems in Germany in the quarter. Slide 35, we also help Lesotho in Africa to prepare for the 2016 sensors, where we combine sensors and geo spatial software and so called smart client solution, where we work with the Lesotho Bureau of Statistics to basically tally up the population of Lesotho. Slide 36. Hexagon Metrology got an order from its strategic partner Zimmer. The goal is to scan and measure knee replacement joints. And it's a collaboration with Zimmer Orthopaedics in Ireland. And they installed several of our systems just to make sure that they don't compromise the quality in these implants. Slide 37. GeoMaxx Pad for Google Glass was a new so called wearable technology that we launched in connection to the GeoMax XPAD product. It will allow a surveyor to do a stakeout and survey operation via hands free voice commands rather than do it physically. And the information is directly visible on the screen in the glass. It's a super cool application. Slide 38. New sensor series leverage the newly acquired company Viripos that we acquired. We launched a land based positioning service called TerraStar and we're now launching the hardware to go with this subscription service in the 3rd quarter. An update on Hexagon's so called smart content program, content as a service. We've received strong interest and and strong growth in the quarter financial growth in this service in the quarter. We received an award from a non disclosed United States. And we started invoicing that account in the 3rd quarter. We also received an order from organization with a multiyear subscription contract to utilize this data that we're collecting for decision making processes. And we've completed more than 3,000,000 square kilometers of data capture, well, sorry, by the end of 2014. So a huge expansion and a promising project for us. Slide 40. Simi360 had 2 successful installations in the 3rd quarter. We've deployed the technology within the Volkswagen Group and we also delivered a multi cell installation in North America with an additional OEM that wants to remain anonymous. Slide 42. We've come to the summary. And Hexagon reports yet another strong quarter, 8 percent organic growth. Metrology and Intergraph PPNM is showing strong development in the quarter. Group gross margins amount to 58% on the gross margin and 22% EBIT margin. Strong cash flow generation enables pursuit of attractive acquisition targets. Thank you very much. And we've concluded presentation. So I'm now open to take any questions from the listeners. Thank you. Thank We will now take the first question from Sid Meera sorry from Gerard Voss, Barclays. Please go ahead. Your line is open. Hi. Thanks for taking my question. It's Gerardus from Barclays. Just two questions, if I may. First of all, I think you've bongfuded quite a few people in the market with a very strong kind of quarter, so congratulations on that. I was just wondering what do you see out there? You have a very kind of wide exposure both from a regional and from a vertical exposure. What do you see there from a macro perspective? And how do you see that to evolve in Q4 and 2015? And then secondly, on the margin, very strong margin development despite the good growth in metrology, which is the lower kind of margin business. Could you just perhaps give us a bit more kind of granularity? What was driving that kind of leverage during the quarter? Thank you. Thank you and thanks for the congrats. That's a pretty tough question you're asking, what do we see in Q4 and 2015. But let me take a step back and try to make sense to the slides we've just reviewed. What we see is continuous good growth in America related to housing. U. S. Housing starts continue to be in positive territory and we see the construction sector here in North America expanding. We also see this continuous trend that we first started seeing early in 2013 that jobs are coming back, manufacturing jobs are coming back to America. And we've seen an increased interest in investing in productivity tools for the manufacturing sector in North America. If we move to South America, we're heavily related to the investments that companies like Vale and Petrobras in Brazil are committed to do in spite of the downturn, which is beneficial for us. The automotive sector is actually it's on quite high investment levels in Brazil, but still doing well for us. So the Brazilian auto industry has invested heavily, and we believe that to continue into the next year. If we then move to Western Europe, we see a slow but steady improvement in the big five economies of the European Union, primarily U. K. We're a bit concerned with France, but we do see a positive trend in Italy, Spain and Germany. Scandinavia, a bit slower. Eastern Europe is benefiting from companies such as Airbus, Volkswagen Group and others, either outsourcing to sub suppliers in the Eastern European Union or investing in capacity and productivity in their plants in Eastern Europe. If we then move to Asia, we think Southeast Asia right now is quite exciting with countries like Indonesia, Malaysia, Vietnam. We see good growth prospects going into 2015 in those areas. We've seen a bit of a slowdown in Korea and Japan, but I don't think it's anything dramatic. And then the big giant in Asia for us is obviously China, where we see good growth from aerospace, manufacturing, electronics and automotive. We see double digit negative growth for the 4th consecutive quarter from the infrastructure and construction industries. But we think that we've reached the bottom for the Chinese infrastructure investments. And gradually, we could see a slow but steady improvement from these low levels going into 2015. When it comes to mining, which is a big drag on our growth in Asia, and I'm now thinking about Australia, we believe that with the newly formed Hexagon return to growth for our mining related business. Is that a good overview? That's fantastic. Thanks for the granularity. And if we then move to your margin question. Metrology is improving its margins. So from having the weakest margins in the group, they're now closing up on Geosystems and Technology margin wise. So that's actually improvement margin wise. But we had really good growth from PP and M with 9% organic growth and that's also always helpful. And the underlying trend moving from more hardware related to software related products is once again proving to lift the margins. Okay. Thanks for clarity. Thank you. Sorry, we will now take our next question from Sid Mehta, Morgan Stanley. Please go ahead. Your line is open. Great. Thank you very much for taking the question. I'd just like to come back a little bit on the metrology business. I mean, the growth there was really stellar. And I guess when we think about some of the performance in the industrial space, this growth comes as somewhat of a surprise. So firstly on metrology, just some extra granularity on what's going on there and then potentially on the sustainability of that level of growth would be very interesting. And then secondly, on technology within PPNM, you reported again another quarter of very solid growth there. This again comes as a pretty strong contrast to your main competitor in the space. Could you talk about what you're seeing there? Do you think this is an effect of market share gains? Or is or do you just not see the demand environment as weak as the competition is flagging? Thank you very much. Thank you. We will start with metrology. All of you that participated in our Capital Markets Day saw the product launches that we did in the metrology field with the fiber optical probe and SIM360 and so forth. And it's fair to say that a large chunk of the organic growth in metrology is stemming from new products now gaining traction in the market. Another trend is that in 2,008, we acquired a technology to move into electronics or more specifically, tablet, computers, wearables and smartphones. And we've gained traction. We've developed this technology and we've now gained traction with several large OEMs in that space. And if you know the slightest about the wearable technologies and the smartphone growth, you know that it's strong double digit growth for both products. If that is sustainable, I think that's very much a question for yourselves to say do you think wearables will go away or will they be further developed? Will smartphones go away? We think it's a new 3rd leg for Hexagon Metrology along side with Aerospace and Automotive. If I move on to PPNM, we're watching the oil price like everybody else carefully. But up till now, we haven't seen a slowdown from our customers underscored by the 9% organic growth that we report. We think we're in a good space where we last year launched Smart Plant Fusion. We launched Smart Plant Cloud. We launched a set of new products and technologies, which excite our customer base. So we will see for the future. But right now, we feel that we had a really good quarter. Great. Thank you very much. Thanks. We will now take our next question from Gil Pelas from UBS. Please go ahead. Your line is open. Hi, good afternoon, everyone. I was wondering whether you could help me in terms of acquisitions for the Q4. Is it fair to assume that Vero should actually contribute more than it contributed in the 3rd quarter? I will ask my questions more questions afterwards. That is a fair statement since Vero was consolidated 2 out of 3 months. So we were lacking 1 month of Vero sales in the 3rd quarter. Thank you. And very positive, is it fair to assume that the contribution was a little bit weaker than in previous quarter? No. The opposite stronger. Okay. Then in terms of operating leverage, obviously, I think around 40%. Is it fair to assume that that continues? Is there any investments that you're going to put in place to continue to grow at this level? We're always putting investments in place. So you can assume almost whatever you want. It's your prerogative. Okay. And then in connection to previous question, would you say that the difference between you and your competitors in the oil and gas markets, if you could give a little bit more color, is it mostly driven your resilience and your growth is mostly driven by new products? Or it's just by just basically haven't seen it on your overall operations? I think what we see right now, first of all, we don't run our company looking at our competition. We look at the market and our customers. And what we've been lucky well, I wouldn't say pure luck. But what we managed to do is, I think we managed to launch a set of products recently that is gaining traction from our customers and they really see the need to invest in this technology in spite of a somewhat slower CapEx cycle in the sector. Thank you. Thank you very much. Thank you. We will now take our next question from Mohammad Mowala from Goldman Sachs. Please go ahead. Your line is open. Thank you very much and well done on a good quarter Ola. Two questions if I may. Number 1, your performance in Brazil and sort of Latin America and more general seems to really stand out especially given some of the performances you've seen by your competitors, but broader software companies. There were concerns clearly with the elections in the quarter, but do you feel that this is kind of all share gain or company specific to Hexagon? Can you give us a sense of when you expect could you expect this market to kind of further accelerate? And then secondly on Smart Solutions, can you remind us what the contribution to growth was in Q3? I believe it was about a point in Q2. And when should we expect that to really accelerate as the products are rolled out? Thanks. Let's start with Solutions. It was another percent contribution to organic growth in the 3rd quarter. Well, when it comes to our Brazilian business, I think it would be hard to accelerate growth from the levels where we're at where we're not reporting Brazil specifically, but we grew by 23% organic growth. So I can't promise you that we can accelerate from that level. But we have a broad based demand from several groups and customer groups in Brazilian market. Where we span from automotive, aerospace, engineering, power, utilities, oil and gas and so forth. And I think we have a really good position in South America, not just Brazil. So I'm positive about our future development in the South American market. Okay. That's great. Thank you. Thanks. We will now take our next question from Stacy Pollard, JPMorgan. Please go ahead. Your line is open. Hi. Thank you. Can you just give us an update on new product areas? So I think you've mentioned a few, but maybe a bit more detail. So cloud, smart solutions, a little bit more on what kind of traction you're seeing on content as a service and maybe 3.60 That's the first question. The second one would be, can you give us the recurring revenues by division? So what the differentials would be between geosystems, metrology and technology? And then finally a quick one, what percentage is Russia? Let's start with Russia because the other questions are much more difficult. Russia was 3% of sales in the Q3. But new products that are contributing to growth is definitely content as a service in the geosystems space. We're actually beginning to see Geosystems. If we move to metrology, Geosystems. If we move to metrology, it's the fiber optical probe. It's the SINs360. It's our new PLM product, MMS, that has gained traction with Chinese customers in the quarter. And if we then talk about recurring revenues, technology is roughly at 70% deal system 20% and We will now take our next question from Bjorn Eernarson, Danske Bank. Please go ahead. Your line is open. Yes. Thank you. Looking a little bit into technology and SG and I and Novatel, could you give an update on what you're seeing right there? I guess Novotel should have had pretty tough comps also in Q3. But could you give us some color on that? Thank you. Novotel had negative growth in the quarter and that stems from the comments I made on UAVs, the UAV orders not be determined. When it comes to SG and I, we've turned a corner and we report 2% organic growth in the quarter. And we see a slow but steady improvement in both margins and growth for SG and I. Are Novartel making losses right now? No. It's above 20% EBIT margin. So And SG and I is close to that level I guess now? 20, you mean? Yes. No. SG and I is still in its teens. Still has to grow up. Okay. And Novatelli is that continues to slide? Or are we at the low lever stabilizing? Or any trends there? Now the trend if we talk about longer term trends for Novotel, Novotel had roughly 70%, 80% of its business with the surveying community selling to companies like like Geosystems and so forth. And that market has over the past 6, 7 years been under price pressure even though it's been volume growing in terms of volume. And we made strategic shift in Novotel, which looks very promising, and we're now launching product for 2 new segments. So I think we're at the bottom when it comes to Novotel's top line growth and that from here on, we're hopefully having 2 quite exciting years ahead of us where we will see Novotel coming back and excelling again. Okay. Thank you. And you've been pretty clear on metrology, but could you say anything about the backlog there? [SPEAKER STEPHEN ROBERT BINNIE:] The backlog is at all time high and the book to bill rate show was positive. Thank you. Thanks. We will now take our next question from Daniel Smith, SEB. Please go ahead. Your line is open. Yes, hello. Good afternoon. I just wanted to know on the technology side, could you say anything about the pickup in revenues coming from the Shell contract in Q3? And also what we should expect in the coming quarters? I'll start with that. We saw a the planned ramp up is that Shell would introduce 3 projects to our cloud based solutions, and that's been done. And we see a gradual ramp up in activity using the cloud. What we should expect is the continued growth in our cloud based business. We have great expectations for that business. But can you say anything about the E and I and floor contract when that's going to be online in terms of revenues for you guys? And how much could be by quarter in 2015, you think? We don't disclose the numbers by quarter. I'm not sure if we will start to see activity in Q4 or early in Q1 from Eni. Okay. But if you look at the Shell contribution in Q3, it was marginal, but it will move up from here basically. Is that what you're saying? Yes. Yes. Okay. Good. And then the second question on the Sims 360. You said you had 3 installations in Q3 and one was anonymous. What kind of sort of lineup in terms of potential customers do you see in your sort of in your work with selling this product? How much installations or how much growth do you expect in the coming year or so? Going from 0, we expect exponential growth, of course. But the interest we've seen so far has been fantastic. And in the Q4, we launched the next generation Sims. And I don't want to spoil the show. So I want to be able to talk about something come February. But all the major auto manufacturers have now viewed this new technology and they are excited. So we are excited since they are excited. Yes. Okay. Interesting. Thank you so much. Thank you. We will now take our next question from Ben Maslin from Bank of America. Please go ahead. Your line is open. Yes. Thank you. Hi, Ola. A couple for me please. Firstly on Geosystems. Can you give us a sense on how machine control is developing within Geosystems compared to traditional surveying? Is there any difference in the outlook or the growth rates? And then just coming back to the metrology growth, how does that growth break down across the key different verticals auto, aerospace and electronics? Any big difference? Or is it fairly similar across those end markets? Thank you. Let's start with machine control. Machine control is roughly growing at double the rate of traditional surveying. We're mostly focused in Europe. So of course, we suffer a bit from the lack of activity in the European market, but still double digit growth. What's happening in the longer term with machine control is that it's becoming more and more of an OEM based game, where it's game where it's important to land a few strong and prominent OEMs. And then it becomes an aftermarket service business for us. And I think we're doing that trend shift fairly well. If we then move to metrology, the big shift for metrology in terms of exposure to end markets is that electronics, which was a fairly small market for us last year is now growing to represent roughly 10% at the moment of total sales. And we expect that continue to grow as a share of total sales within metrology. And what's driving this is my previous comment, it's wearables and it's smartphones. Otherwise, I think auto and aero is fairly stable. Got it. So would you give us a figure on just on how fast electronics is growing within metrology? I mean coming from nothing. And you can do the math yourself. It was 3% last year and it's 10% at the moment. Got it. Okay.