Ladies and gentlemen, welcome to the presentation of the Hexagon Interim Report Q1 2014. Today, I'm pleased to present Ola Rollén, President and CEO. For the first part of this call, all participants will be in listen-only mode, and afterwards there will be a question and answer session. Mr. Rollén, please begin.
Thank you very much, welcome to this first quarter of 2014. If we flip forward to slide number four, an overview of the first quarter. The organic growth in the core business was 5% in the quarter. We saw solid growth in the Americas, where South America excelled, we saw a bit of a slowdown in North America, probably affected by the harsh weather conditions in Canada and U.S. Geosystems, solid organic growth supported by an improving European construction market. Metrology growth accelerated in the quarter from a somewhat weaker second half of 2013. PP&M, solid growth despite a large software order of EUR 8.3 million in the first quarter of 2013. S&I turned a corner and reported slight growth for the first time in five consecutive quarters. NovAtel reported a weak quarter finally, due to delays in the UAV market.
Strong profitability, growth margin 57%, EBIT margin 22% in MT. If we move to slide five, just to remind you of the seasonality in our business. Q1, Q3 usually weak quarters, whilst Q2 and Q4 are the strongest quarter in the year. Slide six, key figures. Net sales amounted to EUR 595 million, which in an organic structure is 5% increase over last year. Operating earnings by EBIT1, EUR 123.4 million, EUR 2 million up over the corresponding period last year. This corresponds to an EBIT margin of 20.7% in the first quarter. We also reported non-recurring items in connection to the disposal of other operations and the acquisition of Veripos of EUR 17.4 million. Thus, the earnings before taxes amounted to EUR 97.8 million, which is a decline of 12% over the corresponding period last year. Cash flow, slide seven. Cash flow from operations before changes in working capital amounted to EUR 160.5 million.
Taxes paid up by EUR 1 million, 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 EUR 136.4 million. Changes in working capital were more normal levels in the first quarter of minus EUR 35 million compared to the train wreck that we saw in the first quarter of 2013 of minus EUR 60 million. Thus, cash flow from operations increased from EUR 62 million to EUR 101 million. Ordinary investment activities are running at a slightly higher level due to the real estate project that we run in Huntsville, Alabama, EUR 51 million, EUR 10 million more than the corresponding period last year. Thus, we had 150% increase over the first quarter last year in operating cash flow.
Talking about cash flow, if we look at slide eight, 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 continuous effort to convert non-recurring revenue into recurring revenue. Slide nine. This has been an overriding theme in the quarter, currencies. The main currencies, Swiss franc, US dollar, and Chinese renminbi all depreciated against the euro in the quarter. If you take the EUR 10.7 million that you see in profit impact and divide it by the EUR 24 million, which was the sales impact, you can see that it's more than 40% incremental margin in these numbers. 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, we've taken the exchange rates that were valid by the end of April, we would have a currency impact `of - 5% roughly in Q2. It would be reduced to minus 3% in Q3, and then in principle, gone by the fourth quarter 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 EUR 690 million, and we would have reported an EBIT margin of almost 22%. 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 a percent, 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, mid-single-digit growth, 5% organic. Western Europe, low single-digit growth. Middle East, same thing. Then we've highlighted the UAV market as well as Africa, which is going the other direction.
The UAV market is simply a delay, Africa is comparisons since we had 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 now we start fresh and compare against the first quarter of 2013. What we've highlighted here are the more important trends. Several segments in North America reduced its organic growth compared to previous quarters, we've highlighted the yellow arrows in the center. 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.
We saw accelerated growth in Asia for 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. 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 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.
Africa 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 first quarter. 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, then Korea and Japan. Australia, underlying markets 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 UAV market grew in North America, this means that we, for the first time in five 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, South America reported strong double-digit growth in the quarter, organic growth. An overview of 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 struggles, and it's still below the corresponding level, volume-wise, in the first quarter of 2008. Segment information. We move to slide 20.
Measurement Technologies report invoice sales of EUR 582 million, operating earnings of EUR 128 million, which corresponds to an EBIT margin of 21.9%. If you adjust for the currency impact in the first quarter 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 & Technology are now gradually improving their growth rate sequentially, whilst Geosystems that had strong above 10% growth in the second half of last year, has a somewhat weaker growth in the first quarter. Gross margin for Measurement Technologies. The gross margin came in at 57%, which is the same percentage as in the first quarter of last year. Here you have to remark that currency has had an impact of roughly 1.5%-2% on the gross margin, and that filters through the P&L statement.
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 Mintec. 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 MineSight. This will provide a comprehensive flow of data across all mining operations when we connect MineSight's technologies to the other technologies we have in mining. Talking about mining on slide 26, we also added SAFEmine, which is a Swiss-based provider of solutions for collision avoidance and fatigue management.
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 Arvus. 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're buying Aibotix, a German-based UAV manufacturer. This is a so-called hexacopter, it fits very well with us, 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 Intergraph SmartPlant technologies.
Slide 30, Eni adopts SmartPlant, 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 two important contracts in our mining segment in the quarter. One came from Kazakhmys, 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. 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, that is the single largest iron ore project in history. They will use Intergraph SmartPlant Suite, including SmartPlant Materials and SmartPlant Construction to refine the iron that they extract from the iron ore. Slide 36. This is the reason why we acquired Veripos. NovAtel is now releasing what we call the TerraStar Correction Services solution, which will be available for surveyors, construction companies, agricultural farms, and so forth worldwide. We start now marketing this solution.
Talking about Veripos' own core business, the so-called offshore business, slide 37, had a positive start for the year and received notable orders with Seabed Exploration new technique, among others. Slide 38. South Sound 911 in the Washington State, U.S., 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. They've been using a Hexagon Metrology arm to optimize sled design. You can see, I don't know what you call them. I guess it's not a driver, but the sportsman, Kristan Bromley, he's the world champion in what's called skeleton, and skeleton is basically the sled he's riding on.
Apart from bob and other things, they actually go with head first down. This is a daredevil sport, and we try to optimize his aerodynamic profile, as you can see. Some really interesting news, slide 41. If last year was Geosystems' year with the launch of the MS50 and so forth, this is really Metrology's year where the first revolution is what we call the 360° Smart Inline Measurement Solution, or SIMS. It's an in-line automated measurement system that can sit next to the assembly robots in, for example, an automotive line. We're going to talk much more about this in connection to our Capital Markets Day. Slide 42 is the second little 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. Another very important step in the history of metrology for Hexagon to be continued in Las Vegas. In summary, slide 44, we report another strong quarter, 5% organic growth, 57% growth margin, 22% EBIT margin in MT, despite significant currency headwinds. High M&A activity in the quarter to be continued and a strong cash flow generation. I've tried to sneak in some promotional messages here about our User Day and our Capital Markets Day, June the 2nd in Las Vegas.
I'll bluntly show you a slide on slide 45, where anyone that is interested to participate in our Capital Markets Day and our user conference is most welcome to Las Vegas MGM Grand on the 2nd of June. Thank you so much for listening, and I think we've reached the Q&A session.
Ladies and gentlemen, if you'd like to ask a question, please press 01 on your telephone keypad. Our first question comes from Mr. Guillermo Pena from UBS. Please go ahead.
Hi. Good afternoon, gentlemen. It's Guillermo Pena from UBS. I have a couple of questions, actually. First, regarding growth from acquisitions going forward, can you just maybe a bookkeeping exercise here, how much should we basically forecast going forward in terms of acquisitional growth? Maybe I do the follow-up questions later.
The run rate in the third quarter was 2%.
That is to be continued that way going forward?
I think that's a question you can't really answer, because it depends on what we acquire, and if we acquire in the quarters to come.
Okay. Thank you. Then regarding, well, two things actually, SmartPlant Cloud and Smart Solutions. Could you disclose what was the revenue like for SmartPlant Cloud during the first quarter?
No, I can't disclose that. I'm sorry.
Yeah.
Regarding Smart Solutions, they are embedded within the current divisions. Now when we've disposed of other operations, we're considering how to report the financial structure going forward. 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.
Maybe I can ask it differently. Did you grow sequentially on SmartPlant Cloud and Smart Solutions? Yes or no?
Absolutely.
Thank you. 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 Metrology will have a good year. We've said that we won't give forecasts, and that would be a forecast if I told you, but the one who lives will see.
Okay. My last question is regarding negative impact from currency in your EBIT. Can you guide us towards second quarter and onwards or not possible?
Second quarter, I gave you a guidance on the FX slide, and we believe the second quarter to be similar to Q1 in terms of percent.
In terms of EBIT?
Yeah, same thing on EBIT.
Okay.
The unfortunate situation is that the wrong currency is moving right now.
Yeah
for us at least. Then we will see a gradual easing off in Q3 and onwards.
This is, of course, with the caveat that nothing moves further than where we are today.
Yeah. Thank you very much.
Thank you.
That's all. Thank you. Have a nice day.
Our next question comes from Ms. Stacy Pallant from JPMorgan, please.
Thank you. Just a couple from 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, so far so good.
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 streams from our cloud activities.
Okay. Fair enough.
Yeah. I don't think a single customer would be comfortable with us communicating what they're doing.
Sure. Sort of digging in on some of the previous questions around Metrology. I understand you're not going to give guidance specifically, 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 catalyst to get them to upgrade their tech?
It's a very expensive technology in the beginning. 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. As this technology gains momentum, we will be able to lower the cost for it. Of course, we can spread it to more and more applications. In a longer, let's say if you look ahead, let's say five years into the future, I believe that this is going to be a standard technology.
Okay. Just last one from me. Could you please speak about your midterm 2015 targets and how confident you feel about meeting those?
Stacy, I invite you to Las Vegas. I don't want to take away the thrill of listening to our presentations in Las Vegas.
No hints?
You have to buy that airline ticket.
Okay, see you there.
See you.
Our next question comes from Mr. Mikael Laséen from Carnegie. Please go ahead.
Yeah. Hi, a couple of questions. First of all, can you maybe explain why there was a breather in Europe, and more info about that, please?
No, I can't. It just happened, 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, the segment, especially the automotive segment, we received some significant orders from European manufacturers. I can't give you an educated guess on why that happened.
Okay. Sales were quite weak, order intake improved. Book-to-bill was down one, or is that?
Mm-hmm. Correct.
All right. Maybe can you break out the technology segment in terms of PP&M growth and SG&I, how those performed in the quarter?
PP&M, 67%, maybe slightly less.
Okay, that much.
Yeah. SG&I, positive, but 1% or so, minus 25% for NovAtel.
Okay. The outlook for NovAtel?
Q2, still quite weak, but as from Q3, in the second half, we should see a good recovery.
Okay. My last question is regarding R&D and cost on the capitalized side. It increased quite a lot in 2014, how should we think about this ahead? 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 2013 and 52% in Q1 this year. 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 one year ago.
Okay. All right. Thanks.
Thanks.
I remind you that if you'd like to ask a question, please press 01 on your telephone keypad. Our next question comes from Mr. Björn Andersson from Danske Bank. Please go ahead.
Thank you. Yes, a few questions on the romance situation. In China, you report some 5% growth. Could you give some color on that, if that is something holding back that growth? Also, in South America, you're quite bullish comment on that development in the quarter. If you can give some comments about what driving that growth, I guess this is Intergraph. Thank you.
Mm-hmm. Correct. 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 Petrobras, and so forth, the energy and the mineral sector in Brazil. Other countries that are contributing to growth are Chile, Colombia, and Venezuela, which are all raw materials connected. That's South America. We move on to China, we had 5% organic growth for the entire business in the quarter, what we saw was a slowdown in infrastructural activities.
We also saw an acceleration from the engineering sector, what drove that was aerospace, automotive, and electronics. When I say electronics, I really mean smartphones. You have a virtual explosion of smartphone manufacturers in China today.
Okay. Thank you. On profitability, I guess you have a pretty decent profitability now in Metrology. Correct me if I'm wrong, is there something we should think about when it comes to Metrology, which is holding back or boosting profitability right now? Is this a normal profitability in that segment?
There are pros and cons, they're actually two sides of the same coin, so to say, that is we are going to see a growth margin expansion in Metrology due to these 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&D that we've spent on developing these things that will have an adverse effect on EBIT margin for Metrology.
Sure. Okay, on Geosystems, very good growth numbers. I guess Europe is still holding back that a little bit and I guess also on profitability. Something to add there?
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 first quarter. We have a somewhat better underlying business climate, but it's still not as hot as we would want it to be.
Heading into the second half, one should be a little bit worried that comps are getting tougher.
Technology-wise, yes. Hopefully we will see a further acceleration in the construction market.
Yeah
primarily in Europe and North America, that should actually be a more important driver to growth than our own generated technology growth.
Perfect. Thank you.
Thanks.
Our next question comes from Mr. Mohammed Moawalla from Goldman Sachs. Please go ahead.
Thank you. Two questions. First, Ola, can you comment on the marketplace in PP&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? 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 in that organic growth out of the 5% you've done over the last two to three quarters?
I believe you could answer yes to both. I do believe Q2 will be better for PP&M than Q1. You will see a sequential growth in Q2 over Q1, 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. It's back-end loaded definitely.
Right. 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 would be disappointed if we didn't see improvement quarter on quarter, the significant growth, given that PP&M is expecting an increase in the second half, Metrology is launching its new technologies, 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. As another comment, every year is back-end loaded. I think we invoice 53%, 54% of our sales in the second half of the year.
Okay. Then secondly, just on the M&A environment, 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 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.
Okay.
I can't give that free of charge. I'm not going to comment on what we're looking at. As a matter of fact, it's not enough with one beer to have an answer on that, if you want an honest answer.
Okay.
Right. Any more questions?
I remind you that if you'd like to ask a question, please press 01 on your telephone keypad. We have one more question from Mr. Ben Maslen from Bank of America. Please go ahead.
Yeah. Thank you. Good afternoon, Ola. Firstly, just on the agreement on the machine control with CASE. Is this a major change in your approach to this market to start aligning with an OEM, as other companies have done? Do you think we'll see more such partnerships either on the construction or agricultural side? That's the first one. Thank you.
I believe there is a change, 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. I think we're going to see more and more OEM agreements between Hexagon and large manufacturers of hardware. 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 not too distant future, even maybe automotive.
Okay, got it. Thank you. Then on currency. Last quarter, I think you mentioned that you were 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 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. Quarter on quarter, we believe that it's going to start biting. 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.
Got it. Thanks. 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? 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, first of all, short term, it's definitely a geographic issue because we make more money in the U.S. than we've done in the past. There is a geographic angle to it. I think more longer term, look, if you go back in time five or six 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 revenue. It's becoming increasingly difficult to have a significantly lower tax rate than the average.