Earnings Call: Q1 2014

May 9, 2014

Ladies and gentlemen, welcome to the presentation of the Hexagon Interim Report Q1 2014. Today, I'm pleased to present Ola Rolien, President and CEO. For the first part of this call, all participants will be in listen only mode and afterwards will be a question and answer session. Mr. Ola, please begin. Thank you very much and welcome to this Q1 of 2014. If we flip forward to slide number 4, an overview of the Q1, the organic business organic growth in the core business was 5% in the Americas where South America excelled. And we saw a bit of a slowdown in North America probably affected by the harsh weather conditions in Canada and United States. Geosystems solid organic growth supported by an improving European construction market. Metrology growth accelerated in the quarter from a somewhat weaker second half of twenty thirteen. PP and PP and SG and I turned the corner and reported slight growth for the first time in 5 consecutive quarters And Novotel reported a weak quarter finally due to delays in the UAV market. Strong profitability, gross margin 57 percent EBIT margin 22% in MT. If we move to slide 5, just to remind you of the seasonality in our business. Q1, Q3 usually weak quarters, while Q2 and Q4 are the strongest quarter in the year. Slide 6, key figures. Net sales amounted to €595,000,000 which in an organic structure is 5% increase over last year. Operating earnings by EBIT1 123,400,000 euros 2,000,000 up over the corresponding period last year. And this corresponds to an EBIT margin of 20.7% in the Q1. We also reported non recurring items in connection to the disposal of other operations and the acquisition of Iripos of €17,400,000 Thus the earnings before taxes amounted to €97,800,000 which is a decline of 12% over the corresponding period last year. Cash flow slide 7. Cash flow from operations before changes in working capital amounted to 160,500,000 dollars Taxes paid up by $1,000,000 and interest cost was reduced compared to the first quarter in 2013 due to our continuous amortization of our net debt. Thus cash flow from operations including taxes and interest costs or expenses amounted to €136,400,000 euros Changes in working capital were more normal levels in the Q1 of minus €35,000,000 compared to the train wreck that we saw in the Q1 of 2013 of minus €60,000,000 Thus cash flow from operations increased from €62,000,000 to €101,000,000 Ordinary investment activities are running at a slightly high 11 due to the real estate projects that we run-in Huntsville, Alabama €51,000,000 €10,000,000 more than the corresponding period last year. And thus we had 150% increase over the Q3 last year in operating cash flow. Talking about cash flow, if we look at slide 8 just to remind you that we are seeing a long term working capital to sales reduction in the group, which has to do with our continued effort to convert non recurring revenue into recurring revenue. Slide 9. This has been an overriding theme in the quarter currencies. The main currency Swiss franc, U. S. Dollar and Chinese renminbi all depreciated against the euro in the quarter. And if you take the €10,700,000 that you see in profit impact and divide it by the €24,000,000 which was the sales impact. You can see that it's more than 40% incremental margin in these numbers. And this has to do with that we have the unfortunate situation that high profit margin currencies are the ones that are mostly affected and that would be countries like Japan, Brazilian reais, Indian rupees, Australian dollars. Looking forward and we've taken the exchange rates that were valid by the end of April, we would have a currency impact of minus 5% roughly in Q2. It would be reduced to minus 3% in Q3 and then in principle gone by the Q4 of 2014 minus 1%. If we look at the currency impact on the group slide 10, we can see that had we had the same exchange rates of the corresponding quarter last year, we would have invoiced €690,000,000 and we would have reported an EBIT margin of almost 22%. And so it's a significant impact in the quarter, but we do think that it's going to ease off in the second half of the year. Market Development. If we move to slide 12, the sales mix in the quarter, the geographic mix, we can see that both North America and Western Europe lost 1% compared to the corresponding quarter last year. South America gained 1% and so did Asia excluding China. China remained at 15% and so did EMEA excluding Western Europe. 42% of Hexagon sales are now outside of Western Europe and North America. Slide 13, quick analysis of where the organic growth occurred. South America was a strong driver for growth in the quarter. North America contributed to growth as well. East Asia and by East Asia, we mean Korea and Japan significant growth in the quarter. China, single digit growth, mid single digit growth, 5% organic. Western Europe, low low single digit growth Middle East, same thing. And then we've highlighted the UAV market as well as Africa, which is going the other direction. The UAV market is simply a delay and Africa is comparison since we have the very large order to the utility company Eskom in South Africa in Q1 of 2013. Slide 14, analysis of organic growth per geographic region and business segment. What we've done here is we basically neutralized everything. So we do now we start fresh and compare against the Q1 of 2013. And what we've highlighted here are the more important trends. Several segments in North America reduced organic growth compared to previous quarters. And that's highlighted we've highlighted the yellow arrows in the center. And it's so disparate industries such as power, energy, infrastructure, automotive, manufacturing and so forth. In Western Europe, we saw a decline in sales quarter on quarter for Automotive and Manufacturing. We don't believe that this is a trend. We think it's more the European engineering market taking a breather in the quarter. And then we saw accelerated growth in Asia several segments in China as well as the rest of Asia Pac. Moving on to the various geographic regions. If we start with EMEA on slide 15, we report moderate growth adjusted for the large software order that we recorded in Q1, 3% growth excluding that order. Contributors to growth were U. K, Germany and France in Western Europe, while Spain and Italy reported negative growth in the quarter. So still a negative trend in Southern Europe. Demand for infrastructure as well as automotive and aerospace increased compared to a year ago, but weakened sequentially. This is where the comment on the breather breather, sorry, comes in. Eastern Europe and Russia recorded record growth in the quarter despite a weak finish, which has to do with the turmoil in the region. Patrick had declined year on year simply because of this large software contract that we received in the quarter. The underlying growth though was almost 40% organic growth. Asia trends in the Q1. All of Hexagon's application areas recorded growth in China in the quarter, largely due to favorable demand in both manufacturing sectors such as automotive and aerospace. But also power and energy is growing for us in the software segments. China reported 5% organic growth in the quarter. Several other markets were growing at strong double digit levels, among others, India, which seemed to have a good year ahead of it in the aftermath after elections and then Korea and Japan. Australia underlying market still suffering from a weak demand from the mining sector, but we received a large order in the quarter that saved the day. America's market trends Q1 all segments apart from the UAD market A. D. Market grew in North America. And this means that we for the first time in 5 consecutive quarters saw growth from the U. S. Defense segment. Growth numbers were somewhat hampered by the harsh weather conditions in the beginning of the year, which had an impact on housing starts and the construction industry. The automotive sector, however, returned to growth and South America reported strong double digit growth in the quarter organic growth. An overview how the various regions have performed over the past few years, slide 18, you can see Asia continuing to grow and outgrow the other regions. Americas has recovered from the crisis and is now delivering solid growth over a longer period of time, Whilst EMEA still struggle and it's still below the corresponding level volume wise in the Q1 of 2008. Segment information. We move to slide 20. Measurement Technologies report invoice sales of €582,000,000 operating earnings of €128,000,000 which corresponds to an EBIT margin of 21.9%. And if you adjust for the currency impact in the Q1 this year, we would have reported a 23% EBIT margin in the quarter. If we move to slide 21, the various segments within measurement technologies, we can see that metrology and technology are now gradually improving their growth rate sequentially, whilst geosystems that had strong above 10% growth in the second half of last year had a somewhat weaker growth in the Q1. Gross margin for Measurement Technologies. The gross margin came in at 57%, which is the same percentage as in the Q1 of last year. Here you have to remark that currency has had an impact of roughly 1.5% to 2% on the gross margin. And that filters through the P and L statement. So if you look at slide 23, it had a similar impact or a slightly smaller impact on the EBIT margin since we have a positive impact on OpEx due to FX. Mergers and acquisitions orders and product releases, if we move to slide 25. We've begun to become much more active on acquisitions. And in the quarter, we've announced that we are going to buy Mintech. It's a U. S.-based mining software company selling modeling and developing modeling and mine planning software. It's a well known brand. The brand is called MineSite. And this will provide a comprehensive flow of data across all mining operations when we connect MineSite's technologies to the other technologies we have in mining. And talking about mining on slide 26, we also added SAFEMINE, which is a Swiss based provider of solutions for collision avoidance and fatigue management. And this is an important investment for Hexagon in our efforts to construe autonomous vehicles and semi autonomous vehicles in mine operations. More about mining, we will present our business case and our business plan for mining in connection to our Capital Markets Day next month. We also expanded our agriculture portfolio. We acquired a Brazilian based company called Airbus. It's once again a strategic step to develop what we call smart agriculture solutions within the new business segment Hexagon Solutions. In the quarter slide 26, we also announced that we are buying Ibotix, a German based UAV manufacturer. And it's got a huge potential if you think about utilities surveying security and safety installations where all our businesses are active. Slide 29. Saipem, one of the largest EPCs in the world standardizes on Integra Smart Plant Technologies. Slide 30, ENI adopt Smart Plant. So this is now the second customer that adopts our SmartPlant cloud service and is going to use our engineering software in the cloud. Slide 31, we got 2 important contracts in our Mining segment in the quarter. 1 came from Kazakh Minsk, which obviously is based in Kazakhstan and from Antofagasta which is a mine in Chile. Leica Nova MS50 which was launched in connection to our user conference in Las Vegas last year was used to measure the Mont Blanc Glacier on Europe's highest peak. And it was a true success and the mountain is indeed the height the French claim it is. CNH stands for Case New Holland, slide 33. Case New Holland's industrial Construction Equipment division has chosen Leica Geosystems as their strategic partner to standardize on so called machine control solutions. NASA on slide 34 is using our Leica, VIVA and MS50 technologies to provide new opportunities for scientific and human exploration beyond Earth's orbit. Slide 35. Vale, the Brazilian miner has started to extract the iron ore in what's called S11D and that is the single largest iron ore project in history. And they will use Integral's smart plant suite including smart plant materials and smart plant construction to refine the iron that they extract from the iron ore. Slide 36. This is the reason why we acquired Viripos. Novotel is now releasing what we call the TerraStar correction Service solution, which will be available for surveyors, construction companies, agricultural, farms and so forth worldwide. And we start now marketing this production. And talking about Virepoix, Virepoix's own core business, the so called offshore business, slide 37, had a positive start for the year and received notable orders with Seabird Exploration, New and Technit among others. Slide 38. South Sound 911 in the Washington State, United States bought our dispatch system and is now standardizing on Intergraph CAD for their call takers. Slide 39 Transport for London is using Intergraph's cloud based solution in order to improve their GIS performance in the metropolitan area of London. Slide 40, this is actually somewhat crazy, but fascinating example. It's they've been using a hexagon metrology arm to optimize flood design. And you can see the I don't know what you call them. I guess it's not a driver, but the sportsman Christian Bromley who represents he's the world champion in what's called skeleton and skeleton is basically the sled he's riding on. And apart from Bob and other things, they actually go with head first down. So this is a dad Urban Sport and we try to optimize his aerodynamic profile as you can see. Then some really interesting moves Slide 41. If last year was Geosystem's year with the launch of the MS-fifty and so forth, This is really metrology's year where the first revolution is what we call the 360 smart inline measurement solution or SINCE. It's an in line automated measurement system that can sit next to the assembly robots in, for example, an automotive line. And we're going to talk much more about this in connection to our Capital Markets Day. Slide 42 is the 2nd lithium revolution that metrology is launching this quarter. It's a fiber optical probe as opposed to the traditional tactile probe that the metrology industry has been using up till now. It's significantly faster and it enables for example aircraft engine manufacturers to measure the blades and the blisks that are crucial in their manufacturing processes to achieve the kind of performance that you need in the next generation of turbines that we will see on commercial airliners. So another very important step in the history of metrology for Hexagon to be continued in Las Vegas. So in summary, slide 44, we report another strong quarter 5% organic growth, 57% gross margin, 22% EBIT margin in MT despite significant currency headwinds. High M and A activity in the quarter to be continued and a strong cash flow generation. I'd like to do I've tried to sneak in some promotional messages here about our User Day and our Capital Markets Day, June 2 in Las Vegas. But now I'll bluntly show you a slide on slide 45 where anyone that is interested to participate in our Capital Markets Day MRU conference is most welcome to Las Vegas MGM Ground on the 2nd June. Thank you so much for listening. And I think we've reached the Q and A session. Our first question comes from Mr. Guillermo Pena from UBS. Please go ahead. Hi, good afternoon, gentlemen. It's Guillermo Peigne from UBS. I have a couple of questions actually. First regarding growth from acquisitions going forward. Can you just maybe bookkeeping exercise here? How much should we basically forecast going forward in terms of acquisition or growth? Maybe I do the follow-up questions later. The run rate in the Q1 was 2%. And that is to be continued that way going forward? I think that that's the question you can't really answer, but of course it depends on what we acquire and if we acquire in the quarters to come. Okay. Thank you. And then regarding well, 2 things actually smart plant cloud and then smart solutions. Could you disclose what was the revenue like for smart plant cloud during the Q1? No, I can't disclose that. I'm sorry. And regarding solutions, they embedded within the current divisions. And now when we dispose on other of other operations, we're considering how to report the financial structure going forward. But we've said that we're going to be clear on that at the Capital Markets Day or at least give you a hint on how we think it looks like. So maybe I can ask it differently. Did you grow sequentially on SmartPlan Cloud and Smart Solutions? And yes or no? Absolutely. Thank you. And then last question, metrology growth going forward, is it fair to assume that accelerates from here given the fact that comps become somewhat easier? We believe that, maturely we will have a good year. We would say that we won't give forecasts and that would be a forecast if I told you. But the one who lives will see. Okay. And then my last question is regarding negative impact from currency in your EBIT. Can you guide us towards Q2 and onwards or not possible? Q2, I gave you a guidance on the FX slide and we believe the Q2 to be similar to Q1 in terms of percent. In terms of EBIT? Yes. Same thing on EBIT. Okay. The unfortunate situation is that it's the wrong currencies moving right now for us at least. And then it we will see a gradual easing off in Q3 and onwards. And this is of course with the carriers that nothing moves further than where we are today. Yes. Thank you very much. Thank you. That's all. Thank you. Have a nice day. Our next question comes from Ms. Stacy Pollard from JPMorgan. Please. Thank you. Just a couple for me. First of all, can we get an update on the progress with the Shell Cloud? Yes, you can. The first project has been kicked off and so far so good. Ed, at what point will you in the future provide revenue streams from this for us? I'm not sure if we will provide revenue streams specifically from the Shell Cloud, but we will probably be able in the second half of this year to comment on revenue stream from our cloud activities. Okay. Fair enough. Yes. And I don't think a single customer would be comfortable with us communicating what they're doing. Sure. And then sort of digging in on some of the previous questions around metrology. I understand you're not going to give guidance specifically, but do you think that what you've spoken about today that most manufacturers will actually replace their tactile measurement tools with optical sensors. Is that going to be a big tell us to get them to upgrade their tech? It's I mean, it's a very expensive technology in the beginning. So I think that the aerospace and turbine blade possibly powertrain applications and so on will be the first targets for us, because it's such a big productivity improvement for those applications that you can justify the cost. But as this technology gains momentum, we will be able to lower the cost for it. And then of course, we can spread it to more and more applications. And in a longer, let's say, if you look ahead, let's say, 5 years into the future, I believe that this is going to be a standard technology. Okay. And just last one for me. Could you please speak about your midterm 2015 targets and how confident you feel about meeting those? Well, Stacy, I invite you to Las Vegas. I don't want to take away the thrill of listening to our presentations in Las Vegas. So So no hints. You have to buy that airline ticket. Okay. See you there. Our next question comes from Mr. Niklas Zyan from Carnegie. Please go ahead. Yeah. Hi. A couple of questions. First of all, can you maybe explain why there was a breeder in Europe? And more info about that please? No, I can't. It just happened. And sometimes you just have a slowdown in the sequential growth in certain geographic regions. Right now, we don't see a cause for alarm, because in April these segments, especially the automotive segment, we received some significant orders from European manufacturers. So I can't give you an educated guess on why that happened. Okay. So sales were quite weak, but order intake improved, so book to bill was down 1 more, is that? Correct. All right. And maybe can you break out the technology segment in terms of PPNM growth and SG and I, how those performed in the quarter? PP and M, 67%, maybe slightly less. Okay. That much? Yes. And SG and I positive, but I mean 1% or so and then minus 25% for Novotel. Okay. And the outlook for Novotel? Q2 still quite weak, but as from Q3 and the second half, we should see good recovery. Okay. And my last question is regarding R and D costs on the capitalized side and it's increased quite a lot in 2014. And how should we think about this ahead? And first of all, what was it in Q1 capitalized development cost? I'm not sure if it increased in 2014. I think we did 49% in Q1 of 13% 52% in Q1 this year. And it's just when you kick off projects 1% up or down is not the trend. I'd say we have the same situation as 1 year ago. Okay. All right. Thanks. Thanks. Our next question comes from Mr. Bjorn Andersson from Danske Bank. Please go ahead. Thank you. Yes, a few questions on the demand situation. In China, you report some 5% growth. Could you give some color on that if that is something holding back that growth? And also in South America, your quite bullish comment on that development in the quarter. If you can give some comments about what's driving that growth, I guess, is this Integraff? Thank you. Correct. If we start with South America because that's the easy part. What was driving growth right now is the fact that the Brazilian government is late in construing all the football pitches and the infrastructure you need to cater for all the tourists they're going to receive this summer in connection to the World Cup. On top of that, we have significant orders from Vale, from Petrogas and so forth, the energy and the mineral sector in Brazil. And then other countries that are contributing to growth are Chile, Colombia and Venezuela, which are all raw materials connected. So that's South America. If we move on to China, we had 5% organic growth for the entire business in the quarter. And what we saw was a slowdown in infrastructural activities. But we also saw an acceleration from the engineering sector. And what drove that was aerospace, automotive and electronics. And when I say electronics, I really mean smartphones. You have the virtual explosion of smartphone manufacturers in China today. Okay. Thank you. Then on profitability, I guess you have pretty decent profitability now in metrology. Correct me if I'm wrong, but is there something we should think about when it comes to metrology, which is holding back or holding back or boosting profitability right now? Or is it a normal possibility in that segment? What's there are pros and cons and there are actually two sides of the same coin so to say and that is we are going to see a gross margin expansion in metrology due to the product launches that we announced today. We have significantly better growth margins on those products than we have on the technologies that they will replace. On the other hand, we will start to amortize the capitalization of the R and D that we've spent on developing these things. And that will have an adverse effect on EBIT margin for metrology. Sure. Okay. And on GEO Systems, pretty good or very good growth numbers, but I guess Europe is still holding back that a little bit and I guess also some profitability. So something to add there? I think what's driving half of what's driving the growth in Geosystems is our products that we launched during the second half of last year, which still show very good momentum in the Q1. And then we have a somewhat better underlying business climate, but it's still not as hot as we would want it to be. So we're heading into the second half. 1 should be a little bit worried that comps are getting tougher? Well, technology wise, yes. But hopefully, we will see a further acceleration in the construction market, primarily in Europe and North America. And that should actually be a more important driver to growth than our own generated sort of technology growth. Perfect, thank you. Thanks. Our next question comes from Mr. Mohammad Noella from Goldman Sachs. Please go ahead. Thank you. Two questions. First, Ola, can you comment on the marketplace in PP and M more widely? Have you seen any sort of impact on deal closures or order flow as a result of the slowing oil CapEx environment? And then secondly, as we think about the acceleration in organic growth for the overall group, you alluded to sort of activity at Shell and obviously smart solutions coming through as well later in the year. Is this likely to be more back end loaded or could we progressively see an increase as early as Q2 and that organic growth kind of out of the 5% you've done over the last 2 to 3 quarters? I believe you could say you could answer yes to both. I do believe Q2 will be better for PPNM than Q1. So you will see a sequential growth in Q2 over Q1. But it's still going to be back end loaded because these cloud solutions even though we've kicked off a few projects within the cloud solution. The activity and the way we price it is the number of engineering hours in the cloud. And the number of engineering hours will only go up as the year proceeds. So it's back end loaded definitely. Right. And for the overall group, do you think the 5% can accelerate as early as Q2 or is it going to be more back end loaded? It's difficult to say. I do I would be disappointed if we didn't see improvement quarter on quarter. But the significant growth given that PP and M is expecting an increase in the second half. Metrology is launching its new technologies and one could expect maybe a couple of months until we start selling these new technologies and so forth. It's probably fair to say that the year is going to be back end loaded. And that's another comment. I mean every year is back end loaded. I think we invoice 53%, 54% of our sales in the second half of the year. Okay. And then secondly just on the M and A environment that you've done a number of sort of bolt ons. What are your thoughts given wider activity in the marketplace and something more sizable for Hexagon? Is that something kind of closer on the horizon now at least the average size of the kind of deals you're doing, is that likely to accelerate? Or should we just anticipate more of these tuck in type deals progressively? To get an honest answer on that question, you need to buy me at least a beer in Las Vegas. I'm not going to comment on what we're looking at. As a matter of fact, it's not enough with 1 beer to have an answer on that, if you want an honest answer. Right. Any more questions? We have one more question from Mr. Ben Maslow from Bank of America. Please go ahead. Yes. Thank you. Good afternoon, Ola. Firstly, just on the agreement on the machine control with Caisse. Is this a major change in your kind of approach to this market to start aligning with an OEM as other companies have done? And do you think we'll see more kind of such partnerships either on the construction or agricultural side? That's the first one. Thank you. I believe there is a change. And the change stems from the fact that the OEMs themselves have realized that this is not an option anymore. It's a standard feature. And it needs to be built into the dashboard of the vehicle. So I think these OEM agreements are we're going to see more and more OEM agreements between Hexagon and large manufacturers of hardware. And secondly, you could take it as proof that the technology is now maturing and entering into more and more markets. I think we're going to see this in not only construction and agriculture, but mining probably even in well in the not too distant future even maybe automotive. Okay. Got it. Thank you. And then on currency last quarter, I think you mentioned that you in some of these developing countries where currency had moved against you fairly sharply, you were looking to raise prices to offset some of that. Just a comment maybe on how successful that's been and whether that will those price increases if accepted would start to boost margins a bit as we go through the second half of the year? We've started to increase prices. You can't say that we've been successful given that we report a negative currency impact this quarter as well. But quarter on quarter, we believe that it's going to start biting. And in most of these markets, there is no local competitor with a completely local cost base. And therefore, it's more understandable and it's more accepted if you so wish to increase prices based on currency movements. It. Thanks. And then finally just on the tax rate, which is a bit higher than it has been. Just what's the driver of that going up? Is that a geographical mix thing? And is the aim still to try and bring the tax rate down over time? Or does that look more difficult than you thought? Thank you. I think that, 1st of all, short term, it's definitely a geographic issue because we make more money in the United States than we've done in the past. So there is a geographic angle to it. But I think more longer term look, if you go back in time 5 or 6 years, you strove to optimize the group tax rate. Now, I think we work very hard to maintain the tax rate and the low rate that we got, because on the other side there are several governments that are fighting hard to increase tax revenues. So it's becoming increasingly difficult to have a significantly lower tax rate than the average.