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

Good day, and thank you for standing by, and welcome to Hexagon's year-end 2022 report and conference call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to the CEO, Paolo Guglielmini. Please go ahead, sir.

Yes. Thank you for joining us this morning for this year-end report 2022. We're going to start the presentation from Slide 4 with an overview of our Q4 results. We have recorded sales increase by 15% as a result of strong organic growth of 8 percentage points with strong pent-up demand in the very last weeks of the quarter, particularly from Manufacturing Intelligence and Geosystems. We've had good momentum across all the regions with all regions and divisions participating to the organic growth, and we have supported the reported results through 2 percentage points of structure and 5 percentage points from currency up to EUR 1.4 billion. Manufacturing Intelligence has experienced 13% organic growth, and Autonomy & Positioning portfolio contributed to 15 percentage points of organic growth year-on-year. We have had a small impact from the supply of electronic components in the quarter. This is a problem that is on its way to being resolved. In terms of mix shipments, we probably experienced only 1 percentage point of impact back from the issue, and we have caught up with deliveries of missing components from previous quarters. The backlog contributed close to 2 percentage points to growth in the quarter. But of course, these shortages are still affecting us in terms of working capital as we're going to see in one of the following slides. In terms of financials, we have posted adjusted operating earnings of EUR 418 million, an increase of 12 percentage points year-on-year, driven by strong gross margin of 66.2% and an adjusted operating margin of 29.8% against 3.7% last year with a negative impact from currency. If we move on to Slide 5. This is a snapshot of our top and bottom line development over the last years. This is a seasonality path that has faded, I would say, more recently as a result of changes in demand through COVID, but also a growing recurring revenue base. If we move on to Slide 6. Another snapshot of our performance in Q4 2022. Adjusted operating margin of EUR 418 million, as said, represent 12 percentage points of growth. The margin percentage was down year-on-year, I would say, affected by negative effect transaction of roughly EUR 20 million. So of course, that's the net P&L impact of regarding balance sheet items for FX in the quarter. Without that effect, we would have seen incremental margin on prior year. If you move to Slide 7 with a summary of our performance for the full year, 2022. We have posted operating net sales of EUR 5.2 billion or 8% organic increase and 20% adjusted operating margin growth year-on-year, growth of 15 percentage points year-on-year in terms of EPS up to EUR 0.45. Moving on to Slide #8, our cash flow results. As a consequence of such a spike in demand in the last weeks, we have delivered cash conversion of 61%, which is slightly lower than our recent run rate and our target level is between 80% and 90%. And this was really primarily driven by the increasing working capital to fund and support the growth in the last part of the quarter, therefore, growth in receivables and inventories. I was alluding earlier to a resolution relative to the shortages in electronic components. We do carry abnormally high related inventory levels in the form of work in progress goods and safety stocks of these components. But we believe these impacts are very time-specific and will normalize over the course of the next months. And then, of course, in Slide 9, you see how this impact as well our working capital as a percentage of sales ratio as we move on to falling back into the trend line throughout H1. I will now introduce you to Ben Maslen, our Head of Investor Relations and Chief Strategy Officer, for an update about market and divisions.

Thank you, Paolo. Good morning, everybody. If we go to Slide 11, you can see the usual slide showing the geographical split of the business. Not too much to report here, the relative increase of North America, increased during the quarter compared to Q4 last year based on good growth and favorable currency. And against that, China was slightly smaller weighting this quarter due to a flatter growth development during the quarter. If we go to Slide 12. You can see the analysis of organic growth by region. Positive in Q4 that no region declined during the quarter, and the strongest regions in terms of organic growth were Western Europe, Asia, excluding China and South America. If we go to Slide 13. You can see the usual split between the geographic regions and the key demand segments. As usual, we won't go through this in detail because we'll discuss it on the following slides. That is for your reference only. On Slide 14, we have the EMEA market trends for the quarter. So a very good growth development in Western Europe, 13% organic growth. Good growth in the industries, automotive, aerospace and defense, but also very good demand for public safety and construction and infrastructure solutions. Outside Western Europe, we saw obviously a sharp decline in Russia as we have in previous quarters. reflecting the impact of the sanctions and the actions we took earlier in the year to freeze business operations. And then for EMEA ex Russia and Western Europe, the demand here remains very good, double-digit organic growth. If we go to Slide 15, you can see the demand trends in the Americas. North America recorded 6% organic growth. Again, a very good development in discrete markets, good growth in aerospace and automotive industries. Slightly slower development in infrastructure and construction, reflecting tougher comparatives from last year. And we did see some weakness in the defense segment, where we see some geospatial service contracts coming to an end and rolling off. In South America, very good growth, double digits, driven by strong development in both mining and power energy. If we go to Slide 16, we have the Asia market trends. As I said, China recorded 0% organic growth for the quarter. Still a very good development in automotive and aerospace but, on the other side, a weaker development in infrastructure and construction, reflecting softness in those underlying markets and also some disruption in those segments from COVID-19 related restrictions during the quarter. Elsewhere in Asia, strong growth in Japan and India, driven by both the surveying and the manufacturing solutions suite. In terms of the reporting segments, if we go to Slide 18. Geospatial Enterprise Solutions had organic growth of 5%. In terms of the subdivisions, Geosystems delivered 4% organic growth, where we saw good demand in mining and infrastructure and construction, but the weak development in China drove that growth figure down. In Safety, Infrastructure and Geospatial, we had 3% organic growth. So continued good momentum in the core public safety business but, as I said, hampered by weakness in some geospatial defense projects. And Autonomy & Positioning delivered a very strong 15% organic growth right across the board, good demand in aerospace and defense and also agriculture. In terms of the EBIT margins, we reported an operating margin of 31.5%. So that's slightly up from last year, positively impacted by volume growth and product mix, but as Paolo said, negatively impacted by FX transaction effects during the quarter. Slide 19 for Industrial Enterprise Solutions. Organic growth of 12%. Very impressive performance by MI, 13% organic growth, driven by strong development across all geographies at all regions and also the software portfolio. And then ALI delivered 8% organic growth driven by strong growth in both the core design segments and also the enterprise asset management software business. Here, the margin of 28.8% was down compared to last year when we reported 31.9%. This has also been impacted by the drag of currency transaction effects during the quarter, but also a step-up in some investments we're making in new products like the Nexus platform and then a normalization of sales and marketing costs seen from a very low level post-COVID, and we can come in to discuss that later. In terms of Slide 20, this shows the gross margin over long term trends. So that trend continues upwards, benefiting the quarter from the normal long-term drivers, so new product introductions, the incoming acquisitions that we've done; but also helped by last year's price increases, which are continuing to compensate for input cost inflation. And if we go to Slide 21, we can see the trend in the operating margin. As discussed by Paolo, the better gross margin didn't drop through to the operating margin, mainly due to the short-term currency transaction effects, but also some of the investments that we're doing in IES. So with that, Paolo, I'll hand back to you.

Thank you, Ben. If we move on to Slide 23 and we start to comment on some of the highlights in terms of business development activities and investments. We have announced a couple of weeks ago the acquisition of Qognify. Qognify is headquartered in New York City. This software has a little more than $50 million in revenues with a strong recurring revenue base and about the [indiscernible]. Qognify is the provider of physical security and enterprising incident management software, which basically means Qognify is a great stack to onboard video feeds, combine them with real-time analytics and really help organizations minimize the impact of securities, safety operational incidents. We've had a collaboration with Qognify through our SIG organization for the last several months with cross-selling that is already in motion, and we see this as a very interesting opportunity across industries. Moving over to Slide 24. We also acquired LocLab. LocLab is a software team based out of Darmstadt in Germany. The organization already now is commercially active with some of the largest transportation, construction, and design consulting companies. In particular, we think LocLab developed proprietary technologies, modeling processes that are supported by AI for object recognition, developed a great library of 3D digital content that we think is an exceptional fit for several of our own solutions across the industries, starting with HxDR. And LocLab will operate as part of the Geosystems Division. If we move on to Slide 25, we have announced a key partnership with the ZF Group out of Germany that will advance the integration of Hexagon's software position in engines and GNSS correction services into ZF mass production, ADAS and autonomous driving systems. So as we know, there's still a heavy investment when it comes to advanced driver assistance systems. ZF is a leader in this sector, and we are going to integrate TerraStar correction services from our Autonomy & Positioning division to improve accuracy and positioning reliability of the ZF system. And this, of course, is a very interesting commercial opportunity for us. In Slide 26, as you know, we have announced an investment in Divergent 3D. We're going to invest $100 million in the business. Divergent is a pioneer of green manufacturing technologies, a highly, highly innovative company. This is a minority investment that is, I would say, absolutely in line with our ambition towards our finance and sustainable manufacturing. Divergent has developed 3 technologies that are proprietary. They have created what they call the DAPS system, meaning the Divergent Adaptive Production System that is composed of 3 main components. They have developed an AI-optimized generative design software, so diesel software that is highly integrated that received in and output boundary conditions, geometries for specific components that we want to manufacture and create an optimized geometry that is ready to be 3D printed. Secondly, Divergent has proprietary additive manufacturing technologies that really take the accuracy and throughput level of commercially available components and step them up to improve the economies of scale of those components without compromising on quality. And thirdly, Divergent has created an automated assembly cell, absolutely lights out for the robotic assembly of these components. We think that this is a platform that can be applied across industries. Its first application is in automotive. Of course, we have a lot of potential across discrete manufacturing, and you can think what the benefits are in terms of reducing time to market, moving from standard tooling and casting type investment and delays on to creating immediately available 3D-printed geometry. Of course, this will also help OEMs drastically reduce material usage, scrap rates and reduce the weight of printed components, which is absolutely critical in terms of driving range for e-mobility, for energy consumption. And then OEMs in our market, as we know, are cursed with very high demand in terms of CapEx requirements. And we believe that Divergent has created a concept that is extremely asset-light in terms of assembling these components. What does this investment mean to us? This is a technology in an adoption phase. Automotive OEMs that we have been in contact with are approaching Divergent to test, implementing some of those components in their upcoming new vehicle programs, of course, starting with the premium automotive sector. We've been working with Divergent for the last couple of years. We've already embedded some of our technologies in our stack, and we need to see them grow as the company will develop. Of course, we have opportunities for technology development, and we're going to be able to introduce our own customers to the DAPS system going further. Before we move on to Slide #27, an update about the enterprise asset management business. From an integration perspective, we see things developing very positively. The carve-out has been executed. It's been completed. We see growing business not only on a standalone basis for EAM. That is, of course, a very competitive tool in that market. But also, we see a growing pipeline of joint opportunities with the rest of ALI and Hexagon. In this instance, we see EAM being adopted by a large cereal producer in the U.S. One of the opportunities that come from EAM is really to allow the business to diversify its industrial and vertical footprint further. As well as Ben pointed out, we are investing from an R&D perspective in EAM to be able to pull off the synergies that have been announced at the time of the acquisition and make this horizontal platform a good vertical tool throughout Hexagon. Within ALI, in Q4, we have had good business development progress across the industries. I mean, as you know, I would say core energy-related natural resources-related applications will account between 25% and 30% of the ALI group. But we see incrementally progress across other applications. The first example of J5 being adopted by a large U.S.-based group to realize their goal of manufacturing bigger battery cells is a testament to that as well as the adoption of our OT cyber sec called PAS from the global manufacturer of synthetic rubber, polymers, latex, and specialty chemical materials. The third commercial win referred to in this line is with a leading EPC. I would say, next positive in our diversification strategy is the trend from a lot of the EPCs to go and diversify themselves. And when they do, of course, they proliferate usage of our own tools. If we move from ALI to our Geosystems application. Slide 29, we refer to the BLK2FLY having been named one of Time Magazine's Best Inventions for 2022. BLK has been recognized for its productivity and innovative design and performance. This is the world's first fully integrated autonomous laser scanner. It's part of the BLK suite of autonomous reality capture centers. That is growing nicely, creating new opportunities for Geosystems. We think that there's incremental potential for these applications, and we are working with our partners to develop the right commercial distribution channel for it. Slide 30. We have had a significant win in Q4 from in China with BYD. We have a very strong collaboration with this customer as well as many of the other key accounts in China that probably represent roughly 50% of our Manufacturing Intelligence business in the region across areas of very active investments, whether that's mobility or green transition or electronics. BYD is based down in Guangdong. This is an area in which we are increasingly investing. I'm going to visit them as well as some of our key accounts past Chinese New Year, and we expect to see a good level of traction across the portfolio as the reopening takes place. Still within the portfolio of Manufacturing Intelligence, we see continued momentum from ETQ, the enterprise quality management system that we have acquired earlier in 2022. In particular, we see very strong SaaS growth from ETQ, north of 30% to 40%. Margin expansion that is working as per the original plan. I would say also from a cross-selling perspective, we're now commercially active in all regions while ETQ was predominantly a U.S.-based business, and we see good level of adoptions for the SaaS business model that ETQ is developing across the regions. I would say incrementally, we are investing from a development and partnership perspective to build a very effective consumption model in ETQ as well as in EAM and the other parts of the business in which we are increasingly focusing on developing SaaS models. In Slide 32. I would say, and on to the commercial traction of the OnCall, computer-aided dispatching system that we released a couple of years back that we consider best in class and is having good level of commercial success. In this case, we worked with the Portuguese Ministry of Internal Administration. One of the reasons why OnCall is performing well in the market is when we meet these types of customers that want to really go and execute on big data voice, text, video with millions of calls and events to be managed. On Slide 33. This is a strengthening of our partnership with NV5 Global, a provider of compliance, technology and engineering consulting solution. They have invested in our bathymetric and topographic LiDAR systems and technologies in the context of the Florida Seafloor Mapping Initiative for the purpose of supporting marine navigation safety, nautical challenges, and environmental monitoring. Similar applications to the ones that we have represented in Slide 34. This is something we already announced a couple of months back within Q4. R-evolution, as you know, is a sustainable innovation and green-tech investment subsidiary of Hexagon, will supply intelligent mapping services of The Bahamas seabed. These services will enable the island nation to protect and restore and activate the blue carbon ecosystems, to invest in climate resilience and biodiversity initiatives. Just for your information, why are we doing this, why this matters? Over 80% of the global carbon cycle is circulated through the oceans with new carbon that is really emerging as a key nature bank solution for climate change. Blue carbon ecosystems capture greenhouse gases approximately 35x faster than tropical range forests. They can store 10 to 15x as much carbon as their terrestrial counterparts. So how do we make ourselves kind of useful and unique in these applications, we combine our airborne bathymetric LiDAR technologies with ad hoc proprietary analytics that have been developed by our innovation hub to go and provide a very accurate, reliable, scalable solution to track year-on-year changes and really detect the [ health ] state of the sea-grass ecosystem. We think that this is not only going to represent a large multiyear contract for us with The Bahamas, we think there's going to be opportunities in other regions and other ecosystems, I would say, more in general, that ESG is a true area of focus for us. We strive to become increasingly innovative in terms of the solutions in our portfolio, the solution that we can go and develop with these third parties as well as focusing on our own footprint and ESG disclosures going forward. If we move on to Slide 36, an update on the dividend payment. The Board of Directors proposed a dividend of EUR 0.12 per share for fiscal year 2022, which means an increase of 9 percentage points. And of course, the dividend will be paid out to shareholders in both euros and Swedish krone. Just to conclude on our Q4 report, an update on Slide 38, concerning the isolated email event that we have disclosed yesterday. We chose to release the Q4 summary and change the release date of our ’s full year-end report as a prudent measure, after discovering unauthorized access to one email account containing information related to our financial performance. This was an isolated event caused by a human error by a current employee acting in good faith. No other accounts were compromised, and no specific files were targeted. We don't have operational or financial repercussions. We have had a quick and effective investigation that was carried out. We have taken immediate actions to mitigate the situation. And I would say the obligations and disclosures were in accordance with MAR. We are, of course, continuously reviewing and strengthening our cybersecurity measures, processes and [ jobs ] including training on variety of security topics. Thank you very much. We can move forward to the Q&A portion of the call.

[Operator Instructions] We are now taking the first question. The first question is from Daniel Djurberg from Handelsbank.

I would like to start in China, you had a flat quarter here, but with strength in auto and aerospace. My question is really with the BYD win in mind here, how should we look at China from your perspective back into 2023. We saw a decline in Surveying, Power, Energy, and Mining, I think, in the quarter, but that were growing in Q3, but not in Q4. So any comments on China in the '23 time frame would be great.

Yes. Thank you for your questions. I mean, I would say, as you know, in China, we have the majority of our activities within discrete manufacturing with an organization that has performed very well throughout 2022 despite the lockdowns. This is an organization that has, I would say, a lot of critical mass that is localized over the course of the last 20 business -- 20 years with a portfolio that is, I would say, tailored to the needs of the local market. And then we have our second largest fuel activity within infrastructure and construction in the moment in which that specific market is depressed in terms of sort of CapEx. What we expect going forward is that if there's going to be a sort of a pickup in demand in terms of manufacturing, we're going to participate, for sure, despite the fact that, that portion of the business was already performing on a good level in 2022. And in terms of infrastructure and construction, we would expect over time for that market to sort of stabilizing demand to improve, although I would say the extent and the timing of it is something that we don't control, but we'll be ready for.

Okay. May I also ask you on reshoring? That has been positive for you in, I guess, Vietnam and Philippines, et cetera. What's your view on this trend on reshoring? Should we expect an acceleration or stabilization? At least I saw here in your chart that, it was -- you're growing nicely in Asia outside China within the electronics and manufacturing space.

I would say, we -- those reshoring activities are, of course, dependent on the CapEx cycle and the type of investments that specifically those consumer electronic companies go through. I would say that we are well positioned, that I have not seen, I would say, a shared shift within those electronic component manufacturers in the move of some of those investments from China to outside China. Our organizations have worked together well to make sure that we support the local teams, and we are equally as commercially prevalent there. But I would say probably that also the part of the business that is toughest to forecast from our perspective.

Good luck here in the Q1.

Thank you.

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

I wondered if I could talk firstly to IES. I think your organic growth is accelerating but margins are declining, which is odd given it's the strongest quarter of the year, as you've referred to. So could you just talk a little bit about the moving parts in there? I'm thinking particularly about investment. Are we at a new level now, I guess, with respect to -- ALM -- sorry, ALI and ETQ? And then the second question was a little bit of a follow-on from now, which is the free cash conversion in the quarter you alluded to was lower than you would have expected. Working capital, clearly, a big part of that but also investments again as well. So I guess if you could talk to whether or not we're seeing a new level on investments there that we should be factoring into our forecast as we think about cash conversion for 2023 and beyond. And how quickly you would expect those working capital issues to dissipate and unwind?

Yes. Thank you, Alexander. A couple of comments concerning IES, and then Ben will help us out on the conversion. I would say that there's 2 phenomenons. We've talked about FX that is playing a role there. In terms of the investment, we have probably in that part of the business 2 specific areas of focus. The first one is we want to make sure that EAM is ready for the cross-selling activities across the industries. So clearly, we are developing to make sure that, that happens. EAM is extremely competitive. We want to make a big data already. We want to make sure that we can develop APM capabilities to go and be competitive in industries -- in green industries, just to mention one, and help ALI with its diversification sort of strategy. We have talked at the time of the acquisition of developing capabilities in manufacturing, developing capabilities in construction, making sure we have a good vertical application development for EAM. And that, of course, requires certain level of investment from our side, but we don't think that that's going to be anything outside and probably that company already is in the cost structure. The second element in that part of the business that might have an impact. I mean we have announced Nexus for Manufacturing Intelligence. Already it's gone live in 2022. 2023 is the year in which Nexus comes alive sort of commercially for manufacturing intelligence. And that's super important. That needs to become a platform for not only cross-selling across the software portfolio for discrete manufacturing but also needs to become the enabler for, let's say, the cloudification of the software offering there. From that perspective, I think the investment level in ETQ is already at a good level. I think predominantly in ETQ, we're going to see commercial investments with good market reach because we feel that we have -- we [ do ] something that is very unique and clearly best in class from that perspective.

Yes. And I think, Alex, on EAM, I mean, if you remember, when we bought this business, it was a carve-out, so we got the business without the usual back office that you would have, presale, service support, things like that. So we had to add costs over the year, withstand the business up to make it a self-contained entity effectively. So that's done. Now in Q4, I think, we're at the run rate we've done that investment. And as Paolo said, it's set up to grow. On the cash flow side, as we said, there was a very strong sales development, a hockey stick, if you like, into the end of the year, and that's normally the case. But it was probably stronger than normal this year. So we had a very strong last 2 weeks of the year. That then leads to a big pickup in receivables that we would expect to reverse and come back in during Q1 and some in Q2. So I think that's purely a timing difference. We have added some buffer stocks to make sure we're secure in terms of components. There are still some lingering products where we have component supply issues. So we have products sitting in with. But as we said, it's not something that's big enough to call out. And I think we're probably at a relatively normal level for that, too. In terms of the investments, tangible assets stepped up. There were a few smaller property transactions that we did during the quarter. On the intangible side, this goes hand-in-hand with the investments that Paolo has talked about. Some of these products under IFRS, we capitalize now ahead of that full release next year, and that will run back to the P&L. So yes, in line with the investments that Paolo mentioned.

Okay. So I guess we should be -- just to clarify then, so we should be thinking about margins progression through 2023 as relatively flattish before we see the benefit of the growth coming through towards the back end of the year, helping those -- helping the margins come back up towards the back end of the year. Is that a fair characterization of it? .

Yes. I think the investment is done, and we're at the run rate we need to be. I think if you look at MI and ALI from this point, you'd see the normal seasonality through the year. So slightly softer margins in Q1 and then it will ramp up through Q2 and Q4 being the strongest quarters. But there's no step-up investment that needs to be done from here as a percentage of sales. I think we're at the right run rate. It's revenues that will drive the costs from here.

And the next question from Adam Wood from Morgan Stanley.

Maybe just first of all, could I dig in on the comments around the spike in the fourth quarter. Could you maybe just give us a little bit more detail around where you saw that whether it was geographic or industry and what was unusual? And maybe specifically digging in on China, was there more of a spike there as well at the end of Q4 as we started to see the reopening? If you could help us a little bit with what you've seen through the end of Q4 and into January there? And if that's made already a difference to what you're seeing on the business in that side of things? And maybe secondly, new products have been important on the hardware side. It feels as if the phasing of that has been pretty mixed up between COVID and supply chain shortages. Could you maybe just help us with timings of expected launches this year and the benefit to help us model on that side?