Hexagon AB (publ) (HEXAB) Earnings Call Transcript & Summary

Hello, and welcome to the Hexagon Q4 Report 2020. [Operator Instructions]. Today, I'm pleased to present Ola Rollén. Please go ahead with your meeting.

Thank you very much, and welcome, everyone, to this year-end report for 2020. And if we start at Slide #4, overview of the fourth quarter 2020. As you can see to the right, net sales amounted to EUR 1.059 billion in 2019. And we grew, through M&A, 3% this quarter, but we had 5% negative FX headwind in this quarter, and we grew organically by 1%, thus recording a minus 1% recorded growth of EUR 1.044 billion. Within that growth, we saw Geospatial growing by 7% organic growth, and we saw strong development across all business units within Geosystems, fueled by construction and infrastructure demand. Safety & Infrastructure had also a solid development in public safety. And with its new products, the OnCall products, we saw solid demand in the quarter. Industrial Enterprise Solutions recorded minus 5% organic growth. We saw sequential improvement in Manufacturing Intelligence, and we had a positive book-to-bill in the quarter. PP&M faced tough comparison -- a tough comparison quarter and challenges from the oil and gas markets. China recorded 25% organic growth. And all in all, this comes down to an EBIT of EUR 287 million, which is EUR 10 million more than the same period of last year or a 4% growth. EBIT margin, 28% versus 26% in Q4 of '19. Now if we go to Slide 5, that is just a reminder that the fourth quarter is our strongest quarter in a year, and it was -- the pattern repeated itself in 2020 as well. Moving on to Slide 6, the P&L statement. Operating net sales amount to EUR 1.044 billion. The revenue adjustment is the so-called revenue haircut that we have to do for acquired deferred revenue. Operating earnings, EBIT1, amounted to EUR 287.2 million. And earnings before taxes, excluding nonrecurring items, roughly EUR 280 million. Slide 7 is the full year where we end the year at EUR 3.8 billion with an EBIT of EUR 956 million. Now cash flow was a bit of a surprise for us as well in the quarter, super-strong cash flow, cash conversion of 149% in the fourth quarter. And we had good performance in cash flow from operations before changes in working capital, which increased by EUR 14 million to EUR 334 million. But now look at the change in working capital where we have a EUR 144.5 million in capital release in 1 quarter, pushing cash flow from operations to EUR 479 million in the quarter. And all in all, a very strong cash flow. This has to do with good management in accounts receivable where we traditionally have a very accentuated hockey-sticking invoicing where we invoice a lot in the last 2 weeks of the quarter. This time around, though, we had more even invoicing in the fourth quarter, which enabled us to collect cash. At the same time, we reduced our inventories, and we received large order that we booked in deferred revenues that pushed up liabilities, giving us a positive cash flow. Now moving on to Slide 9, effects of FX movements. We have a very strong negative currency headwind in the quarter primarily stemming from the devaluation of the U.S. dollar and the Chinese renminbi against the euro. But also we saw negative impacts on the cost side from the Swiss franc. And that means that we have a negative effect of EUR 50 million on sales, but EUR 27 million in earnings. So the incremental margin on the FX impact is substantial. If we now neutralize for FX, we would have reached EUR 1.094 million in sales and EUR 314 million in earnings, thus bringing the EBIT margin to 29% or almost 3% better than the corresponding quarter of 2019. Moving on to Slide 10. Coming back to working capital. This is just a visualization, a graph, working capital to sales, and we see the dramatic declining working capital to sales in the fourth quarter. It amounted to 5.3%. Can't promise that we can keep it at this level. We're probably going to see a little bounce-back in Q1, but the long-term trend is definitely there. Market development, we move to Slide 12, the geographic sales mix for the Hexagon Group in the fourth quarter. North America, 29% versus to 32% in Q4 of '19. And China increased to 15% versus 12%. The rest is the same. And let's move on to Slide 13, an overview per geographic region, where we see strong growth, 25% in China and 18% in South America organic growth in the quarter. See good growth in Asia excluding China and in Eastern Europe, Middle East and Africa. And Western Europe and North America are really the regions that still are in negative territory in the fourth quarter. For your reference, on Slide 14, you have the organic growth trend per business segment and geographic region. And let's move on to the various regions, starting by looking at EMEA on Slide 15. Western Europe recorded minus 5% organic growth. It's driven by 2 countries, and it's Germany and France where we saw decline in automotive and aerospace sales in the quarter. But we saw solid growth in surveying and public safety in Western Europe. Russia and Middle East recorded high single-digit organic growth. And we move to Slide 16, Americas. North America, minus 6% organic growth, similar pattern as we saw in Western Europe. Weakness in the manufacturing and power and energy segments. Defense, however, and agriculture recorded robust growth in the region. South America, double-digit organic growth, where Brazil was the engine for growth in the region. Strong development also in mining, surveying and public safety. Finally, Asia on Slide 17. China recorded a record 25% organic growth in the quarter. Broad-based recovery in both manufacturing, infrastructure, construction and even our oil and gas segment grew in China in the quarter. South Korea and Japan, strong single-digit growth fueled by demand in mapping and autonomous vehicle solutions. Southeast Asia and India had a weak quarter. Reporting segments, if we start with Geospatial Enterprise Solutions on Slide 19. Geospatial Enterprise Solutions reported organic growth of 7% driven by Geosystems' 8% organic growth, where we saw strong development across all business units. Mining segment continue to record solid growth. And we also saw good contributions from new products in the quarter. SI, 5% organic growth, and it was supported by the solid development we see in public safety and continued traction for our new OnCall software platform. Autonomy & Positioning, 11% organic growth, positively impacted by demand from both defense and agricultural sectors, was slight adversely impacted by demand in automotive and marine. Sales amounted to EUR 535 million, up from EUR 514.9 million a year ago. EBIT margin improved by 3% to 29.2% versus 26.1% previous year. Moving to Industrial Enterprise Solutions on Slide 20. Minus 5% organic growth but within enterprise solution -- Industrial Enterprise Solutions, we saw MI sequentially improve to minus 2% organic growth and a positive book-to-bill in the quarter. It was supported by a broad-based recovery in China, which is the single-largest market for MI and software growth but hampered by the continued weakness we saw in the quarter for aerospace and automotive in Europe and Americas. PP&M, minus 12% organic growth. Two explanations to that negative growth. We have tough comparisons against Q4 of '19, that was an all-time high, but also a challenging oil and gas market in the fourth quarter. We saw continued solid growth for our AEC portfolio in the quarter. Bookings were positive, and we expect a continuing improvement for this segment going into the first quarter. Sales amounted to EUR 509 million versus EUR 544 million a year ago. And EBIT margin, in spite of the volume drop, stayed at 27%, posting an EBIT of EUR 138 million. Moving on to Slide 21. Our gross margin was 63% for the past 12 months. In the fourth quarter, it was 64%. Slide 22, our rolling 12-month EBIT margin is 25%, same as a year ago, but with a dip in the first half and a record EBIT margin in the second half of 2020. M&A orders some product releases, if we move to Slide 24. We acquired OxBlue, which is a leader in construction visualization technologies. And OxBlue is going to be integrated in our SMART Build product offering. It will strengthen our capabilities to serve the rapidly evolving AEC digital ecosystem. And I think it's going to be a great acquisition. Slide 25. We also acquired PAS Global, LLC in the fourth quarter. Now this is a new cybersecurity-focused business for process industries that Hexagon's PP&M division will provide to its customer base. And it opens up new sales opportunities, not just for PP&M but also for our Manufacturing Intelligence and mining divisions. PAS serves some 300-plus customers across 70 countries today. Slide 26, smart manufacturing for any machining application. We also acquired D.P. Technology, which is a leading developer and supplier of so-called computer-aided manufacturing or CAM technology, in the quarter. It's based in California, and the flagship product is called ESPRIT, which is a smart manufacturing solution for almost any machining application. If we combine D.P. Technology with our production software portfolio, we get a very strong position in the market, and this will also enhance and speed up our so-called smart manufacturing project. Slide 27, semi-automatic machine control solution that reduce fatigue and operational costs. We're launching MC1 software for our Leica machine control solutions for excavators. And it's going to bring a lot of benefit to the operator. He will be able or she will be able to work with less fatigue, less overdigging and reduced operational costs. Slide 28. We participate in deploying robot taxies field tests in Tokyo. It's a Japanese start-up called Tier IV that is using our PACMod drive-by-wire system, testing robotic taxies in downtown Tokyo. Very exciting project. Slide 29. We're also launching a revolutionary GNSS or GPS service, RTK From the Sky that will bring instant GPS accuracy worldwide. Slide 30, resolving key pain points for manufacturing customers. We launched the new product, which is called NCSIMUL 2021.1, which is a simulation software addressing long-suffered 5-axis machine instability so that manufacturers can achieve quality without sacrificing productivity. So this will drive efficiency and productivity throughout setting up of production operations. Slide 31, MSC Apex Generative Design '21 is another product we're launching in the quarter within the MSC portfolio. It's an end-to-end solution for designers of high-precision metallic components. And this is going to improve performance significantly, in some parts, up to 85% faster, less human intervention than any other software in the market. So a great development. Slide 32, more farmers now have access to the latest precision agriculture tools. The HxGN AgrOn platform has met Italian government requirements, and we have now deployed it in the fourth quarter in more than 30 farms in Italy. And we will soon roll it out to other countries in Europe. Slide 33. We've also helped Swiss Rail move and grow in the quarter. We signed a 4-year corporate license renewal with Swiss Rail where we're going to deploy GIS solutions and web and mobile components for the maintenance of the assets of Swiss Rail. Slide 34, empowering cities to fight cyberattacks and respond to emergencies. We got 2 orders for HxGN OnCall in the quarter. One was from the City of New Orleans in the United States and the other one was from the Strathcona County Emergency Services in Alberta that encompass Calgary and Edmonton. Slide 35, multiproduct subscription for the largest open-pit mine in Finland. This was Yara, the Finnish mining company that acquired Hexagon's suite of software products to improve productivity in its mining operations. Slide 36, Collision Avoidance Systems was implemented in Ghana in the Gold Fields mine in Ghana that bought MineProtect and also MineProtect Operator Alertness. Slide 37, we had multiple wins in the quarter for our content program. One of the world's largest automotive manufacturers, who wish to stay anonymous, will use our program in its autonomous vehicle navigation rollout. Intel will also use the HxGN Content Program aerial imagery to create AI-powered analytics and business intelligence. And NAIP, the National Agricultural Imagery Program, in United States contracted Hexagon to refresh 14 states across the United States in 2021. Finally, the Ontario Ministry for Natural Resources contracted Hexagon to provide data for Ontario's Forest Resource Inventory program. Slide 38, aerial data helps create digital twins of South Korea for national government. SHINHAN Aerial Survey will use our CityMappers and our HxMap software to capture a 3D image of the country of South Korea. And that will generate 3D city models that we use to -- will be used to develop the infrastructure in the country. Slide 39, Brussels Airport consolidates construction and infrastructure data. This is our AEC portfolio. And we sold them Bricsys 24/7 as a document exchange platform to keep track of changes within the airport. And that was it for the quarter. Environment, social and governance. We launched targets for ESG in the quarter. So if we move to Slide 41. Our overarching targets are carbon neutrality in our scope 1 and 2 emissions by 2030; carbon neutrality across the entire value chain encompassing both 1, 2 and 3 emissions by 2050; sustainability supplier audits across 100% of our direct suppliers in risk areas by 2023; and at least 30% of our leadership positions filled by women by 2025. Moving on to Slide 42, we do not stop there. The sustainability revolution will continue. So we're revving up plans to accelerate the world's transition to a greener economy. And we will introduce this to you very soon. So stay tuned. And with that, we've come to the dividend proposal from the Board, Slide 44. The Board of Directors proposed a dividend of EUR 0.65, which is a 5% increase over 2020. And the dividend can be paid in euro or Swedish krona. Furthermore, the Board of Directors proposes a share split, 7:1 after the AGM, if the AGM accepts it. In summary, if we summarize things, record operating earnings and margin despite significant currency headwind. Super strong cash flow generation, 1% organic growth, solid growth in China and Geospatial Enterprise Solutions. And we expect a continued sequential improvement in demand for Hexagon going into 2021. The Board of Directors proposed a dividend of EUR 0.65 and a share split 7:1. And with that, operator, I believe we've come to the end of the presentation, and we are now ready for any questions there might be.

[Operator Instructions] The first question comes from Magnus Kruber from UBS.

Magnus here from UBS. A couple of questions from me. Could you comment a bit on the expectations for sequential growth into Q1 in MI? Is that accounting for normal seasonality? I mean normally, Q1 would be weaker, so it would be interesting to see how we should think about seasonality on that basis through the course of 2021.

No. We believe that we're going to see a sequential recovery in auto and aero, which hampered Industrial Enterprise Solutions in the quarter. And that goes for Q1 as well.

Okay. So there is no other -- there is unusual patterns in '21 from a seasonality perspective?

No, I don't believe so. It hasn't happened yet, but I don't think so.

Perfect. That's very good. And could you comment a bit on the product mix overall? I mean you had an adverse mix in IES. But does that mean the positive mix from GES? Or is it a mix between the business areas? I'm just trying to get a sense for the sustainability of the current mix there.

Within IES, you have an adverse impact on margins simply because PP&M, which is pure software, contracted. But within MI, software outgrow hardware, which had a positive impact on our industrial segment. And then if we move to the Geospatial segment, definitely, software services outgrew hardware. Even though hardware grew as well. So you had a very positive impact there that you can see from the margin development.

Excellent. And just a final one there, I think you commented on aerospace is now seeing a sequential improvement there into Q1. Has that got to do with the production restart in some of the airframe manufacturers? Or what do you see there?

No, we see a rebound from very, very low levels in aerospace. I think our comment is more related to auto, where, in the fourth quarter, we saw strong demand for electric vehicles. But in the first quarter, we also expect traditional combustion engine products to require investments and thus driving demand for Hexagon in those areas as well.

The next question comes from Adam Wood from Morgan Stanley.

First of all, just on 2021, I wonder if there's any help you could give us in terms of the shape of recovery. We've obviously got some very large declines in 2020 as a base comparison. But within that, China was good. I mean could you maybe help us out a little bit with what you would say would be a strong recovery for Hexagon versus what would be more muted? So for example, would it be possible to get back to the type of revenue base that you were doing in 2019? Or do you think it takes longer to get back to that level? And maybe just digging in a little bit on the free cash flow. You commented that in Q1, you might have to give something back on the working cap. Could you maybe just broaden that comment out to the year? Do you think '21 runs below the normal conversion because you have to give something back on working cap, given 2020 was so strong?

Giving you an outlook on 2021 is not something we do. So I guess we'll see. But we're definitely not going to hold back. We're going to do our very best. Regarding working capital, I don't think we have to give anything back per se because within the working capital improvement in the fourth quarter were 3 really large deal, software deals, where we booked deferred revenue. And we won't have to give that back. But as we return to organic growth, obviously we have to invest in working capital. Is that clear enough? Or...

That's perfect.

The next question comes from Stacy Pollard from JPMorgan.

This expansion around the industrial division, how do you think of midterm growth potential in that division? And can you kind of break that out for MI and PP&M?

So what we expect is MI to turn around before PP&M. And PP&M could probably see a recovery throughout the year, but maybe with better numbers in the second half than the first half, whilst MI, I believe, are much closer to a turnaround.

And I -- okay. Fair enough. And then just regarding margins. The cost savings program looks to be seeing nice benefits already in Q4. Do you think that means you're on target for the old 27% target? Remember, you had these midterm targets for 27% to 28% for 2021. Do you think that's a possibility? And then at what point would we be getting some new midterm targets?

Well, first of all, we reached our target in Q4. I mean without currency impact, we did 29% and with currency impact, 28%. So I think it's definitely achievable. It's hard to predict what 2021 will bring, but no, definitely, that's achievable. And we are discussing when to update you on our financial outlook, our long-term financial outlook, but it will be definitely during '21.

Okay. No, that sounds encouraging for '21. I mean I know there's some seasonality on the margins. So I hadn't necessarily expected Q4 to be straight out, but that's very handy. Quick last one for me. Just gross margin. Same, I'm going for midterm here. What do you think your midterm target is on gross margins? And I know you'll give them to us eventually. But given this continued mix shift towards software, I mean, I presume that's not going to stop. So it's...

What is midterm for you?

3 to 5 years?

Then you have to wait for a Capital Markets Day to get to it.

The next question comes from Alexander Virgo from Bank of America.

So I had -- I wanted to go through, I guess, a little bit more detail, the demand dynamics in the software and various elements of software business that you're seeing. China obviously north of 20% growth. I'm wondering if you can talk a little bit about the demand dynamics in China -- in software in China. I wonder if you could give us a little -- be a little bit more specific around software versus hardware in MI. I'm just trying to understand how that plays out for the balance of the year, particularly given your comments around the positive bookings in IES and the start to the year in China. And then the second question, just on that margin question that Stacy had there. Can you give us any indication of your expectation for FX headwinds for the year, maybe for EBIT? Just to give us some idea of how we can break down the, I guess, near on a couple of hundred basis points of improvement you need on an LTM basis to get from -- to get up to that 27%?

Yes. I think if we start with China demand, and I think it was -- was it more towards software? Or was it general demand you were querying about?

Well, I guess, a little bit of both would be helpful. I mean the question was directed at software. But I mean if you're talking about China more generally, then it would be helpful to understand the broader dynamics as well, given how strong it was and given the comps are pretty easy in this calendar quarter.

No. I mean first of all, 65% of MI is software and services, and China is the largest market. So obviously, our software portfolio was benefiting from the recovery in demand in China. But what we saw in China was a broad-based recovery across the board. We saw our construction and infrastructure products growing significantly. We saw our auto, aerospace, electronics products growing. So both electronics, aero and auto grew. Oil and gas grew in China and infrastructure and construction. So I don't know if that's enough but -- and software versus hardware in MI, as I said, 65% software services.

Okay. So software would be growing above that 20% number, presumably?

Yes. Correct. And then FX, I mean, we don't have a crystal ball on FX. But if you apply the current exchange rates on 2021, we would have a negative impact on sales of 3.3% for fiscal '21.

And we should be applying a similar sort of drop-through that you saw in Q4 to that number for impact on EBIT?

Yes. Unfortunately, since it's the wrong currency, so to say, moving in the wrong direction.

The next question comes from Daniel Djurberg from Handelsbanken.

I have 3 questions. I will ask 2 first and then the last one. Can you comment more on the planned cost savings that you've implemented in the 2020 program? How much of this is fully in place when entering 2021, i.e., they are planned cost savings and not the COVID cost-savings-related? And the second question was really on FX, you mentioned is -- was a hurdle of EUR 27 million on EBIT in the quarter. Can you say how much of this has been mitigated by temporary OpEx savings on the back of COVID-19?

Thanks. I would say the planned cost savings were around 90%, 95% at the moment. And temporary cost savings have definitely played a role, but it's very hard to say what's temporary and what's longer-term right now. If -- I mean, we have a different behavior in the group today when we look at marketing expenses and travel expenses. And I think that we're going to keep the lion's share of those savings. All in all, we think the cost savings were in the range of EUR 10 million in the fourth quarter.

Very helpful. And then lastly, on ESG, you screen well the EU taxonomy, I think, and I like your ESG targets and so on. And also your speech at the HxGN LIVE in 2019 was, of course, really, really good. I was thinking a little bit if you can comment on your -- for example, if you look at Brazil, you have good growth in South America and just to understand how you can secure fully ESG responsibility. For example, in surveying in Brazil with regards to, for example, rainforest deforestation, for example, how far do you go and when -- on your responsibility there, for example?

I think you have to develop your question a bit because I'm not sure what you're alluding to.

No, I'm not alluding. And for that -- if you look at the next step, of course, there, deforesting something, you will use, I guess, the surveying equipment to build bridges, houses, whatever in this land. And just thinking more broadly on how you think about your -- where your responsibility ends, so to say.

Yes. No, it's an interesting and very, very difficult question to ask. But in general, first of all, our airborne mappers are mapping the deforestation in Brazil. So we are a prerequisite to basically tell the authorities how severe is it, where has deforestation happened and what can you do about it. So I think there, we're on, let's call it, the good side. Obviously, you can use our survey equipment if you build a bridge or a road through the jungle. And you would have to cut down trees if you build a road. It's a bit hard for us to do anything about that. But I think the biggest problem with the rainforest is really that it's turned into agricultural land. And it's banned. So the quicker we can deliver reports to government bodies about -- or illegal deforestation occurring, the better. And that's where we put our emphasis right now.

The next question comes from Mikael Laséen from Carnegie.

Yes, one question here. You completed 3 acquisitions in Q4. And I was just wondering if you can comment on your acquisition pipeline and how much financial resources you have available for acquisitions going forward.

We have a good pipeline, like always. Prices are at record levels. So you have to be very careful making acquisitions at this moment in time. And yes, it might be the peak in the pricing cycle. But our headroom in -- with their own targets, we have EUR 2.6 billion, and that is to be below 2.5x net debt to EBITDA. We have EUR 2.6 billion in our own balance sheet. And then obviously, we can borrow on the acquired entity -- sorry, EUR 1.2 billion to reach 2.5x, EUR 2.6 billion for 3.5x, which is our covenant.

Yes, okay. Got it. Just one more, if I may. On North America, industrial segment was down 13%. Is this reflecting the market development in total? Or have you seen any changes in the competitive situation?

No. It's the market, and we are late in the cycle in MI. So I think this comment goes for both what you saw in Western Europe, i.e., France, Germany, and United States that typically our order intake turns around and starts to grow before we see it in invoice sales. And that's where we're at the moment.