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

Hi. Good morning, good afternoon, everybody. It's Adam Wood. I look after tech research in Europe for Morgan Stanley. Very pleased to welcome you all to the conference for this session. I want to get the disclosure out of the way, first of all, before I move on to introducing the presenters. So just very quickly, for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So with the disclaimer out of the way, let's move on to the session. Great pleasure to introduce Ben Maslen, who's the Chief Strategy Officer, for Hexagon. Ben, many thanks for joining us. We really appreciate you taking the time to chat about Hexagon with us.

Thanks, Adam. Thank you. Hi, everybody.

So -- and maybe I'll just take this opportunity. A quick reminder, obviously, please, if there's questions from investors, please write them down, send them in. I'll try and get to as many of those as I can as well as the questions that Ben and I will work through. So maybe just wanted to start off just talking a little bit about how you see the environment now. It was pretty clear for your business that actually, Q2 last year was probably the trading trough, and things have started to improve since then. Could you talk a little bit about where we are today, maybe especially Asia recovered very quickly for you, and you got back to growth very quickly in Asia. Can we learn things from that recovery in that market? Are you starting to see similar things in Europe and the U.S.? Just position a little bit where we are across the regions, and that would be really helpful.

Yes, sure. I mean, you're right. If you cut it geographically, Asia, China, which is around 15% of our revenues, took the full impact of COVID back in Q1 2020. So it was very weak. And then what we saw was an improvement from kind of March onwards in China, it gathered pace. It was pretty broad-based in our Geospatial businesses, surveying tools right the way through the much larger factory business that we have, automotive, aerospace, electronics. And that carried right the way through the kind of back 9 months of 2020 and has carried into this year. No real change there. Europe and the U.S. were, I guess, 3 months later. As you say, it was kind of late March and Q2 where we really saw the downturn on the hardware side of our business. The 60% of our revenues that are software and services were pretty resilient through most of 2020 and actually grew for the year. So where we saw the weakness was on the kind of metrology hardware, Geosystems, the surveying tools, machine control in North America and Western Europe. So that troughed probably April. And then depending on the pace of kind of lockdown and unlockdown and then lockdown again, it recovered through the kind of back end of 2020. I wouldn't say we're back to where we were. It still feels like the manufacturing industries of Europe and parts of the U.S. are still a bit weaker. And there's still some recovery to come. But I think, as we said with the Q4 results, I think we feel optimistic looking into this year that the good growth we saw on the Geospatial side will carry on, and then the industrial side will see sequential improvement as we go through the year. Yes. That's probably the summary.

That's a pretty helpful rundown of the geographies in the regions. I mean I guess one of the other challenges we have is there's the phasing issue. I think there's also the strength of the lockdowns and just the complete collapse of demand in some areas through Q1 and Q2 last year. It's quite difficult to separate out what was factories being closed, things completely stopping. And even if there was demand, people are not ordering. And then as we get back what the kind of underlying CapEx demand is, I mean, again -- I mean whether this is maybe more of an industry question, where you see more aggressive recovery, where you think things are going to be more muted for longer. I guess automotive and aerospace might be 2 areas where we see different outcomes. Could you just try and help us a little bit with that in terms of where you see demand actually bouncing back really strongly because it's just a dislocation issue in areas where actually the demand has been more permanently impaired?

Yes. I think if you do it, electronics has come back very quickly. Nothing stopped people using their mobile phones while they've been sitting at home. So those markets have come back and grow nicely. I think if you look at automotive, automotive was probably a bit weak going into COVID anyway, I would say, through 2019, then that came on top. So you had a very big reset through the middle of last year. I think you can see volumes coming back in terms of the number of cars that the car companies are producing. That takes a little bit of time to feed into CapEx decisions, capacity decisions, decisions about when they'll retool their production lines for new models. So we feel more optimistic looking forward in terms of the pipeline of projects, but I wouldn't say we fully caught up yet in terms of where we are. And obviously, within that industry, as well as the cycle, there's been a shift that's probably been accelerated due to the downturn from traditional combustion engines and powertrain to electric vehicles. So we clearly see much stronger demand from EV customers for metrology hardware, simulation software and all the kind of design tools. Aerospace, we didn't see much change on the simulation side of things, not for MSC. That market held up quite well through last year. So the weakness was more on the metrology hardware and software selling into aerospace. And there, what we find is our sales are less geared to CapEx plans. They're more geared to the actual number of planes that are being produced as they will use our laser scanners to kind of work on the assembly of the fuselage or the wings, for example. So it's more geared to kind of unit volumes. And that's obviously still down in relation to where we were back in '19. And I think your guess is as good as mine as to how quickly traveling comes back, if it ever gets back to where it was. But I think that's the market, probably, where the recovery is lagged the most on the industrial side. Sequentially, some improvement, but still slower to pick up in some of the other markets. And then if you look at the Geospatial side of things, obviously, Geosystems had a pretty strong rebound in growth through Q4. That was fairly broad-based. And I think that it's construction activity picking up again after a lull and feeding into demand for surveying tools and machine control equipment and so forth. Plus, I think the kind of COVID and remote working probably fed into greater demand for tools that you could use to monitor your site remotely. I think that probably is something that structurally gives us a bit of a tailwind coming out of this crisis.

That's perfect. That's helpful. And one of the things that also seems to become a little bit muddled is we've been used to you having reasonably strong product cycles that can impact a quarter or 2 when the product is released. I know that you decided kind of to delay some release here -- well, there were some release delays before COVID. And then obviously, it made less sense to go aggressively with hardware product releases during the pandemic. Could you talk to us about -- talk us through a little bit about where we are now on release cycles, the next period you'd expect to see an impact from that?

Yes, you're right. I mean the -- I guess Geosystems is the most impacted by that. And we normally launch a couple of disruptive products a year, and last year was no different. We had the BLK2GO and the BLK247, so one, a handheld laser scanner to digitize buildings; one, more of a security device for kind of monitoring tunnels, railways, buildings that would light up as opposed to cameras. They kind of ramped up gradually through the year and by Q4 probably adding a couple of percent of growth, but not as much perhaps as previous product introductions have done. And the issue there was it's just very hard to kind of get demo products in potential customers' hands, get them to try it, feed it into their workflow, work out if they want to use it without trade shows, sales guys being able to travel freely. So it was just tougher. But I think what will happen is we'll probably get more of a lagged benefit from those products as things log down as we go through this year. Plus on top of that, we obviously hope to launch new products as we go through 2021.

And then maybe on the software rather than the hardware side of the business. I get asked the question a lot in terms of the more precise mix between recurring software, upfront software and services. Maybe first of all, has that -- how is the resilience of that part of the business been through the crisis? Where are we on kind of rough renewals? Has that changed a lot? And then just give us an update on where we are in terms of business mix for the group?

Yes. I mean overall, there wasn't, I guess, huge impact. Software and services for the group grew over 2020 despite the fact that PPM was visibly weaker as we went through the year. So that was offset by good growth in Safety & Infrastructure and MSC and some of the smaller product lines. We're not -- I guess the weakness, you probably saw more in services, where with new customers, it's more difficult to do the implementations and be on site, particularly affected businesses like Safety & Infrastructure. Perpetual licenses, obviously a bit weaker in those markets that were specifically impacted for PPM around oil and gas. And then as you'd expect, the maintenance and kind of subscription business, which is becoming up a bigger part of the pie, that was more resilient and had good growth. And then the cut of it is, we say roughly, it varies quarter-by-quarter, but roughly 60% is now software and services. Of that, 20% of the 60% is -- 1/3 is services, if you know what I mean. So of the 40% that is software and maintenance, roughly 1/4 of that is perpetual licenses. The rest is maintenance and subscription. And we're not forcing customers towards subscription. It's kind of gradually happening organically.

That's very clear. That's helpful. And maybe just one final one in terms of the kind of shorter-term outlook and numbers. You obviously put a big cost reduction plan through pretty early last year. As you said, you've got a lot of business in Asia. You were quite early to see the impacts on things. Could you maybe help us -- one of the other things, I think, everyone was struggling with is you've got more permanent cost reduction plans, and then you've got the temporary reductions that have come in because people aren't traveling, there's no entertainment, all the stuff we know about. How do you see the phasing of that? And again, I think people probably were thinking Q4, we'd already see a lot more of the variable come back. That probably hasn't happened. What was, in your mind, for 2021 in terms of how those ramp up and down?

Yes. I think the -- I mean, what we said is Q1, you will see the full year-on-year effects of the permanent cost savings. We kind of got to that run rate by 31st of December, but this obviously wasn't for the full quarter. So I would model the full year-on-year effect in Q1. You're right on the short-term savings. They probably peaked in Q2 because obviously, no one could do anything, and then gradually started to kind of come back into the business through Q3 and Q4. But clearly, travel, conferences, marketing, things like that, were still below normal. And I'd say that's probably the case still in most regions during the first quarter. The expectation as we go through the year, hopefully, is that we get unlocked and we come back to good growth. And I don't think we go back to the level of traveling and kind of T&E spend that we did before. I think there'll be some permanent savings for things like this and general efficiencies that we found along the way. But I think some of that short-term costs will come back. But I think our view is that the net of the permanent savings and the reversal of short-term savings can still be a positive for Hexagon. And obviously, we'll get volume growth on top of that and operational gearing, but we would expect to keep margins go in the right way.

Makes sense. That's helpful, Ben. Maybe moving on to a little bit, try and look a bit bigger picture and more strategic. I guess the first thing would be around M&A. And it's been a massive part of what's built Hexagon. Could you maybe just start off the pros and cons of doing M&A in terms of how you get the cultures to come together, how quickly you integrate businesses versus leaving them standalone and not disrupting them. How do you balance those things? I know one of your big responsibilities is around the M&A side. So yes, if you could help us how you think about this rationale and how you work the strategy of M&A as these businesses come in?

Yes. I mean, we do, as you know, 10 to 15 acquisitions a year. There's a good rhythm, good culture around screening companies, working out which ones are going to fit well and then how to integrate them and structure a transaction so it's successful. There's a lot of experience around that. I think the screening is a key part of it. You want to find companies that are going to work within the Hexagon family. They want to be part of Hexagon. The best way to mess something up is to force a company to do something they don't want to do, right? So you need them to buy into a business plan and have clear alignment on how they will fit into Hexagon, the pressures that will be on them, the resources they can draw from. You need to be upfront and have no surprises as a company comes into the group. So a lot of work goes into screening and making sure that's laid out to start with. How fast do you integrate them depends a little bit on how you structure the transaction. If you've done a deal where there's an earnout component, then you need a light touch on the integration because they need the independents to run the business in the way they want to, to maximize their earnout. If there's no earnout, then obviously, you can do a slightly faster integration. And then I think one of the key things is -- and this is, again, part of the screening, is we're looking for companies that are up and running and well-run, that can contribute to the kind of the upward trend in margins that we have. So we're generally not buying businesses that need a lot of change. The strategy is to buy a company that's already doing very well, give them access to Hexagon's sales reach, the technology, core technologies, R&D platform and make them more successful. That's the kind of the bread and butter deal. And if you do those kind of acquisitions, then you give yourself a very good chance to make them successful.

That makes sense. And this may be just an external perception, but I do think some people feel that you've allowed assets to remain more independent than elsewhere. Has that factored into your ability to have executed on that cost-cutting through last year and then also the decision to put some new corporate structure in place, the COO, to maybe do some more of that? Or is that just the kind of people looking in and not understanding how the business really operates?

No, I think the -- in terms of the integration, I think you asked the right question. You could go faster on the integration, but you risk impairing the business in some way or -- and particularly, if you're buying software companies, the value is the people. You disrupt that and people leave, then you don't have as good an asset as you originally acquired. So -- no, I think you have to make sure you go at the right pace, and every acquisition is different. The reason we did the management changes at the end of 2019 was to drive slightly faster integration in some areas. So Norbert Hanke moved from being President of Manufacturing Intelligence to being COO. And there, he's focused a lot on squeezing costs out of Hexagon, so rationalizing legal entities, looking for areas where we could be more effective in things like purchasing. It could be cloud costs, it could be software platforms, leveraging the scale of Hexagon better than perhaps we've done previously. And then obviously, some of his work then fed into the restructuring actions that we took in response to the COVID downturn. So in a way, we were fortunate in the kind of sequence of events that he'd already had a look at where perhaps there were -- there was costs that we could take out. The other change was Jüergen Dold moving from being President of Geosystems to kind of heading almost an umbrella that incorporates Geosystems, Safety & Infrastructure and our Geospatial business. And there, it was more a feeling that, from a customer perspective, it made sense to slightly change the go-to-market and aggregate some of these business lines a little bit better in the offering that we had. And I think if you take -- there was a -- in the Q4 presentation, when we gave the kind of the customer wins and acquisition slide, there was one in there about Swiss Rail, which would be a good example there, where you're selling Geospatial tools and monitoring tools to that customer base that then can be fed into your dispatch solution to kind of help them deal with kind of maintenance crews and call-outs and so forth. And that kind of customer is a good example of where it makes sense for those 3 businesses to work more closely together.

And then we were discussing a little bit earlier on around valuations in the market and where we are. I mean when you look at the ability to do deals in this environment, how challenging is it, how demand -- how much more demanding a company is, given the reratings we've seen? And then if I can be a little bit more specific. Most of what you've done over the last decade has been software-focused. You've obviously really focused on expanding that side. There's an investor question. How do you feel about doing larger M&A? And obviously, one of your metrology competitors has put itself up for sale. I don't know you can comment on that or not, feel free. But what's the rationale around big deals, software versus hardware? And if you've got anything to say on the competitor, very welcome.

Yes. No, no. I mean, I think I can't -- we can't talk about any specific deals, really. As we discussed before this started, the valuations are high and markets are very busy with IPOs and SPACs and M&A and all kinds of things. And it tells you that sellers feel this is a good time to extract value from something that they own, right? As a buyer, that means you have to look through a lens of being a little bit more careful and focusing on those projects that are most synergistic across the group and probably most transformational for the group on a 5- to 10-year view. I think you just have to be a little bit more -- well, the stakes are raised in terms of the risk reward on any project basically. For us, I think I would segment the market. I think that on the small- and medium-sized deals that we normally do, and we had a very busy year last year. We did probably one of the -- despite COVID and banking from your bedroom, you -- we had one of the most successful years that we've had. And I think on those small- and medium-sized deals, the valuation hasn't changed that much. And you're a little -- there's a little bit more flexibility in terms of how you structure deals that you can use to work to your advantage. Bigger, high-profile auction processes, you -- really, those valuations are higher and you have to be super concrete on the synergies and make sure that you're confident that the strategy is the right -- it is without, as Ola said on the Q4 call, a more difficult environment. But for us, the strategy isn't changing, right? The focus is still gradual shift towards software, building that out if there are still some gaps that we have that we need to fill, and then feeding the kind of the hardware and the sensors we have into that software platform. And as it stands at the moment, the pipeline still looks pretty good.

It would be fair to say, though, for Hexagon, the transformation of the company is towards a more software-driven company.

I think so. Yes, absolutely. I think that's the focus Hexagon has had for the last 10 years, and I don't see that changing. And I think the downturn demonstrated the benefits of that, right? I mean if you look at how cyclical Hexagon was back in '08, '09, it was a far less dramatic downturn to negotiate last year. So the benefit of that strategy, I think, is pretty clear.

The performance has been totally different as you described, so that absolutely demonstrates the value of that recurring software base. Maybe let's -- can we talk a little bit about the product strategy. So I guess the other thing that I, from an external point of view, see changing is it's linked a little bit towards -- we discussed M&A integration, but there's also more integration going on around products, I guess. You're trying to move from selling point solutions to selling more connected solutions that have more value, higher pricing, better stickiness. And there's been some type of work underneath that to try to bring that together. Could you just talk us through a little bit about where you are now in terms of being able to bring different technologies together and make solutions out of them and how much more work there is to do on that?

Yes. I mean, in terms of the ability to do it, the -- we launched the platform called Xalt a couple of years ago, which is, for wont of a better description, like an internal IoT kit. So set of tools around connectivity, visualization, file formats, AI, all the things that you need to move information around between hardware and software. And what we've done is embed that in our products gradually over the last couple of years behind the scenes to make it easier to integrate. So I think the ability to do that now is a lot easier. In terms of the kind of the selling part of it, that's more gradual. And you have to go at the pace that different customer groups want. And some want bundled solutions, some want everything to be open. Some move very quickly in terms of technology. And it's different by customer groups, verticals and regionally. Others want to do it kind of very piecemeal and with a very kind of long-term road map. Markets like mining, where you have large customers that want to go quickly on technology, they're willing to embrace some of these hardware and solutions together. Something like aerospace, where the kind of the lifetime of an airline from initial concept production line can be years and years and years, they don't want to make big changes to something that they've already kind of mapped out. So it takes more time basically. But I think what we see is a lot more appetite from customers to look at these, some of these broader solutions. And the example I just gave you on rail is a good one. It's an integration of Geospatial content, its sensors to detect change and where -- maybe where you need to make a correction and then you feed that into your dispatch software and you can go on and solve the problem. That kind of broader solution is something, for rail, that we see more in demand. So it's not -- we're not to kind of overplay it. This is something that will impact Hexagon's growth over the next decade. And in some markets, it's only in its infancy. I think we will, in all markets, see tighter integration between hardware and software into new solutions.

And when you look at that portfolio, because there's a number of these solutions already in the market being sold around smart city, smart build, smart factories. Over the next maybe 3 years rather than 10, I'll bring it back to that, are there 1 or 2 that stand out? It's okay, yes, we think these could make a difference in that shorter-term time frame? Or will it all be over that longer time?

No, I think there will be some in the shorter time frame. I think the security is a market that we haven't really been in. And I think the launch of the BLK247 sensor that we put out there last year, even though it's had a kind of gradual start, I think could be quite impactful for us. It's a new market, so we're starting from 0. But I think it gives us a new and growing market to sell the hardware into. We've also bought a software business that allows you to feed those sensors into, so you can sell to the customer group the software to manage your investment bank building and the sensors. And then from that, you can see -- if there's a crime or an intruder or the sensor detects something, you can feed that completely straight into your dispatch software and call the police without having someone to send a text to pick up the phone. I mean, that kind of market, I think, you can see pick up fairly quickly over the next few years. I think smart build is another one. The development of the product from concept to beta has been relatively slow, but it's now launched. And we have a go-to-market plan that will be rolled out this year. And I think that, that product in -- there's a lot of players in that space, but it's a very underpenetrated segment for digitization of construction, and it's a massive market. And we would hope that in the next 3 years, to use your time frame, that smart build starts to make a difference.

And maybe just digging in because we -- I think that's an area, that smart build area, is an area that a lot of investors are interested in, and as you say, there's competitors. I mean, what's the situation in our industry today? You say there's very low digitization. I mean are they using any type of software to manage processes? Is it all very paper-based? And then in other areas where there has been more process put in place to manage projects being in the design phase has helped. How do you see those 2 things playing out for you in smart build side?

I think like a lot of markets, the design part of the industry is relatively well penetrated. It's the more mature piece, right? You see that in the screen manufacturing. We see it in PPM, in process industries. I'm sure Autodesk or whoever sees it in, in AEC. So the journey for everyone is to move downstream from that. That's the piece of it that is undigitized, if you like, and where the most upside will come from. And there, I think what you see is that the customers are using parts of solution or point solutions to do a certain task on a construction project. We don't necessarily have a whole kind of end-to-end workflow even fully mapped out yet. And I think that there are a lot of products in the market. They're all quite different. They all do slightly different things. I've seen a map of how smart build maps against other companies' products. And there's some overlap here and some there, but no one does exactly what our workflow does. And I honestly think there's room for everybody to have very good growth in this industry over the next 10 years. Where we're different, I think, is that we're -- I mean we have a CAD in that segment. We bought a business called Bricsys a few years ago. I'd say it's growing faster than the industry, offer a much smaller base, admittedly, but it's growing very quickly. Smart build is CAD-agnostic. So there could be some benefit to some customers for using our CAD and platforms and to kind of manage their construction project, but doesn't have to be Bricsys into smart build. It could come from another provider. What we're trying to offer is a tighter integration between that workflow and taking a CAD platform, breaking it into work packages to digitize your construction process, and then they're reporting back into the platform of the tools to measure progress on the job side, just coming from Geosystems, laser scanners, surveying tools, progress documentation tools and so forth. And that -- we feel in that part of it, we have an advantage compared to other companies.

Again, it's that combination of assets that you bring that is very different to what other players bring to bear in the space. I guess, similar -- I mean, again, the other area we probably get asked most about by investors is the smart factory side. And again, you have this array of technologies that I think is relatively unique. I mean we're bumping up against time, but I think that is an interesting space. Maybe just say a few words on your vision of the factory of the future and how you think about that?

Yes. I mean, absolutely. I think, we, like lots of companies, have a smart factory concept. And I think from the outside, a lot of people think they're the same thing, and they're not really. I think our focus is -- our historical expertise is on metrology, hardware and software, right? So it's measuring the good at the end of the process than what you've actually made. Dimensional accuracy, we can scan inside a mobile phone to see if there are any infections inside of 3D printed products. It's what you've actually made. And our vision is how do you use that information upstream to make your process more effective? And there are 2 things you can do there. One is you feed the actual information back into the design suites. And we have projects to feed that in to make the next design better. Or how can you, in real time, feed that information into your -- sorry, Adam, I got cut off there.

Yes, we can hear you again now.

How do you feed into your production machinery to optimize a machine that's maybe not calibrated correctly.

Perfect. Well, we're bumping up against time anyway. So I'm not -- the glitches in the system are probably telling us that it's maybe time to call an end to proceedings. Ben, I want to thank you very much for taking the time to join us. Really appreciate it. What an interesting discussion, and also like to thank the investors who have joined us on the session today. Thanks very much.

Thanks, Adam. Thanks, everyone.

Perfect. Bye-bye.