HEXAGON PRIMARY BUSINESSES
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Hexagon’s risk management activities are designed to identify, control and reduce risks associated with its business. The majority of these activities are managed within each subsidiary of Hexagon. However, certain legal, strategic and financial risks are managed at the Group level.
Market risk concerns risks such as economic trends, competition and risks related to acquisitions and integration. Market risks are primarily managed within each subsidiary of Hexagon.
Risk: An important part of Hexagon’s strategy is to work actively with acquisitions of companies and businesses. Strategic acquisitions will continue to be part of Hexagon’s growth strategy going forward. It cannot be guaranteed, however, that Hexagon will be able to find suitable acquisition targets, nor can it be guaranteed that the necessary financing for future acquisition targets can be obtained on terms acceptable to Hexagon. This may lead to a decreasing growth rate for Hexagon.
Acquisitions entail risk. The acquired entities’ relations with customers, suppliers and key personnel may be negatively affected. There is also a risk that integration processes may prove more costly or more time consuming than estimated and that anticipated synergies in whole or in part fail to materialise.
Risk Management: Hexagon monitors a large number of companies to find acquisitions that can strengthen the Group’s product portfolio or improve its distribution network. Potential targets are regularly evaluated on financial, technology and commercial grounds. Every acquisition candidate’s potential place in the Group is determined on the basis of synergy simulations and implementation strategies. Thorough due diligence is performed to evaluate potential risks.
From 2000 to 2015, Hexagon made some 100 acquisitions, including the key strategic acquisitions of Brown & Sharpe (2001), Leica Geosystems (2005), NovAtel (2007) and Intergraph (2010). Based on extensive experience of acquisitions and integration and clear strategies and goals, Hexagon is strongly positioned to successfully integrate acquired companies into the Group.
Risk: Hexagon engages in worldwide operations that are dependent on general economic trends and conditions that are unique for certain countries or regions. As in virtually all businesses, general market conditions affect the inclination and the capabilities of Hexagon’s existing and potential customers to invest in design, measurement and visualisation technologies. A weak economic trend in the whole or part of the world may therefore result in lower market growth that falls below expectations.
Risk Management: Hexagon’s business is widely spread geographically, with a broad customer base within numerous market segments. Potential negative effects of a downturn in the developed world may for example be partially off-set by growth in emerging markets and vice versa.
Risk: Parts of Hexagon’s operation are carried out in sectors which are subject to price pressure and rapid technological change. Hexagon’s ability to compete in the market environment by introducing new and successful products with enhanced functionality while simultaneously cutting costs on new and existing products is of the utmost importance in order to avoid erosion of market share. Research and development efforts are costly and new product development always entails a risk of unsuccessful product launches or commercialisation, which could have material consequences.
Risk Management: Hexagon invests annually approximately 10-12 per cent of net sales in research and development. A total of about 3,400 employees are engaged in research and development at Hexagon. The objective for Hexagon’s R&D division is to transform customer needs into products and services and to detect market and technology opportunities early on.
Operational risks concern risks related to reception of new products and services, dependence on suppliers and risks related to human capital. Since the majority of operational risks are attributable to Hexagon’s customer and supplier relations, ongoing risk analysis of customers and suppliers are conducted to assess business risks. Operational risks are primarily managed within each subsidiary of Hexagon.
Risk: Hexagon’s business activities are conducted in a large number of markets with multiple customer categories. In 2015, Surveying was the single largest customer category and accounted for 22 per cent of net sales. For Hexagon, this customer category may involve certain risks as a downturn or weak development in the surveying sector can have a negative impact on Hexagon’s business. Surveying is followed by customer categories Power and Energy with 20 per cent, Electronics and Manufacturing with 13 per cent and Infrastructure and Construction with 11 per cent.
Risk Management: Hexagon has a favourable risk diversification in products and geographical areas and dependence of a single customer or customer category is not decisive for the Group’s performance. The largest customer represents approximately 2 per cent of the Group’s total net sales. Credit risk in customer receivables account for the majority of Hexagon’s counterparty risk. Hexagon believes there is no significant concentration of counterparty risk.
Risk: Hexagon’s products consist of components from several different suppliers. To be in a position to sell and deliver solutions to customers, Hexagon is dependent upon deliveries from third parties in accordance with agreed requirements relating to, for example, quantity, quality and delivery times. Erroneous or default deliveries by suppliers can cause delay or default in Hexagon’s deliveries, which can result in reduced sales.
Risk Management: Hexagon has a favourable risk diversification and dependence of a single supplier is not decisive for the Group’s performance. The largest supplier accounted for approximately 1 per cent of Hexagon’s total net sales in 2015. To minimise the risk of shortages in the supply or of excessive price variations among suppliers, Hexagon works actively to coordinate sourcing within the Group and to identify alternative suppliers for strategic components. Supplier risk surveys are performed (by Hexagon’s external partner) in order to identify and mitigate risks associated with the suppliers’ operations.
Risk: The resignation of key employees or Hexagon’s failure to attract skilled personnel may have an adverse impact on the Group’s operations.
Risk Management: Since future success is largely dependent on the capacity to retain, recruit and develop skilled staff, being an attractive employer is an important success factor for Hexagon. Group and business area management jointly handle risks associated with human capital.
Risk: Hexagon’s production units and distribution centers are exposed to risks (fire, explosion, natural hazards, machinery damages, etc.) that could lead to property damages and business interruption.
Risk Management: Risk grading surveys are performed (by Hexagon’s external partner) in order to identify and mitigate risks as well as support local management in their loss prevention work. Surveys are conducted in line with a long term planning together with each subsidiary.
Financial risks are managed at Group level. The Group Treasury Policy, which is updated and approved annually by the Board of Directors, stipulates the rules and limitations for the management of financial risks throughout the Group.
Risk: Hexagon’s operations are mainly conducted internationally. During 2015, total operating earnings, excluding non-recurring items, from operations in currencies other than EUR amounted to an equivalent of 570.5 MEUR. Of these currencies, USD, CHF and CNY have the biggest impact on Hexagon’s earnings and net assets. Currency risk is the risk that currency exchange rate fluctuations will have an adverse effect on income statement, balance sheet or cash flow.
Sales and purchases of goods and services in currencies other than the subsidiary’s functional currency, give rise to transaction exposure.
Translation exposure arises when the income statement and balance sheets are translated into EUR. The balance sheet translation exposure might substantially affect other comprehensive income negatively. Furthermore, the comparability of Hexagon’s earnings between periods is affected by changes in currency exchange rates. The income statement translation exposure is described in the table below for the currencies having the largest impact on Hexagon’s earnings and net assets including the effect on Hexagon’s operating earnings in 2015.
Risk Management: Hexagon’s reporting currency is EUR, which has a stabilising effect on certain key ratios that are of importance to Hexagon’s cost of capital.
As far as possible, transaction exposure is concentrated to the countries where the manufacturing entities are located. This is achieved by invoicing the sales entities in their respective functional currency from the manufacturing entities. According to the Group’s financial policy, transaction exposure should not be hedged. The rationale for the change is that the vast majority of transactions concern a short period of time from order to payment. Moreover, a transaction hedge of a flow only postpones the effect of a change in currency rates.
The translation exposure can be hedged by denominating borrowings in the same currency as the corresponding net assets. But in order to have the volatility in net debt at an acceptable level, currently, the majority of the borrowings is denominated in EUR.
Risk: The interest rate risk is the risk that changes in market interest rates will adversely affect the Group’s net interest expense and/or cash flow. Interest rate exposure arises primarily from outstanding loans. The impact on the Group’s net interest expense depends, among other things, on the average interest fixing period for borrowings.
Risk Management: In accordance with the Group Treasury Policy, the average interest rate duration of the external debt is to be between 6 months and 3 years. During 2015 interest rate derivatives were used to manage the interest rate risk.
Hexagon’s internal bank coordinates the management of financial risks and is also responsible for the Group’s external borrowing and its internal financing. Centralisation generates substantial economies of scale, lower financing costs, as well as better control and management of the Group’s financial risks.
Risk: Credit risk, i.e., the risk that customers may be unable to fulfill their payment obligations, account for the majority of Hexagon’s counterparty risk.
Financial credit risk is the exposure to default of counterparties with which Hexagon has invested cash or with which it has entered into forward exchange contracts or other financial instruments.
Risk Management: Through a combination of geographical and industry diversification of customers the risk for significant credit losses is reduced.
To reduce Hexagon’s financial credit risk, surplus cash is only invested with a limited number of approved banks and derivative transactions are only conducted with counterparties where an ISDA (International Swaps and Derivatives Association) netting agreement has been established. As Hexagon is a net borrower, excess liquidity is primarily used to repay external debt and therefore the average surplus cash invested with banks is kept as low as possible.
Risk: Liquidity risk is the risk of not being able to meet payment obligations in full as they become due or only being able to do so at materially disadvantageous terms due to lack of cash resources.
Risk Management: The Group Treasury Policy states that the total liquidity reserve shall at all times be at least 10 per cent of forecasted annual net sales. At year-end 2015, cash and unutilised credit limits totalled 1,242.5 MEUR (1,006.8).
Risk: Refinancing risk refers to the risk that Hexagon does not have sufficient financing available when needed to refinance maturing debt, because existing lenders decline extending or difficulties arise in procuring new lines of credit at a given point in time. Hexagon’s ability to satisfy future capital needs is to a large degree dependent on successful sales of the company’s products and services. There is no guarantee that Hexagon will be able to raise the necessary capital. In this regard, the general development on the capital and credit markets is also of major importance. Hexagon, moreover, requires sufficient financing in order to refinance maturing debt. Securing these requirements demands a strong financial position in the Group, combined with active measures to ensure access to credit. There is no guarantee that Hexagon will be able to raise the sufficient funds in order to refinance maturing debt.
Risk Management: In order to ensure that appropriate financing is in place and to decrease the refinancing risk, no more than 20 per cent of the Group’s gross debt, including committed credit facilities, is allowed to mature within the succeeding 12 months, unless replacement facilities have been entered into.
Hexagon’s main sources of financing consist of:
Risk: Hexagon’s operations, assets and staff are to a certain degree exposed to various risk of damages, losses and injuries which could tentatively threaten the Group’s business continuity, earnings, financial assets and personnel.
Risk Management: To ensure a well-balanced insurance coverage and financial economies of scale, Hexagon’s insurance programme includes among other things group-wide property and liability insurance, travel insurance, errors and omissions insurance and transport insurance combined with local insurance coverage wherever needed. The insurance programme is periodically amended so that own risk and insured risk are optimally balanced.
Legal risks are primarily managed within each subsidiary of Hexagon. The Group legal function supports the subsidiaries and manages certain legal risks at Group level.
Risk: Hexagon’s main markets are subject to extensive regulation. Hexagon’s operations may be affected by regulatory changes, changes to customs duties and other trading obstacles, pricing and currency controls, as well as other government legislation and restrictions in the countries where Hexagon is active.
Risk Management: Hexagon closely monitors legislation, regulations and applicable ordinances in each market and seeks to adapt the business to identified future changes in the area. To manage country-specific risks, Hexagon observes local legislation and monitors political development in the countries where the Group conducts operations. To this effect, Hexagon has adopted a worldwide compliance programme across the Group to ensure that its subsidiaries at all times comply with all applicable legislation, rules and ordinances.
Risk: Patent infringement and plagiarism are risks to which Hexagon is exposed. There is no guarantee that Hexagon will be able to protect obtained patents, trademarks and other intellectual property rights or that submitted applications for registration will be granted. Furthermore, there is a risk that new technologies and products are developed which circumvent or replace Hexagon’s intellectual property rights. Infringement disputes can, like disputes in general, be costly and time consuming and may therefore adversely affect Hexagon’s business.
Risk Management: Hexagon seeks to protect its technology innovations to safeguard the returns on the resources that Hexagon assigns to research and development. The Group strives to protect its technical innovations through patents and protects its intellectual property through legal proceedings when warranted.
Risk: Certain companies within Hexagon have operations that have environmental impact. Stricter regulation of environmental matters can result in increased costs or further investments for the companies within Hexagon which are subject to such regulation.
Risk Management: Hexagon complies with all applicable laws and obligations and obtains relevant approvals where needed. Hexagon continuously monitors anticipated and implemented changes in legislation in the countries in which it operates.
Risk: Hexagon operates through subsidiaries in a number of jurisdictions and all cross-border transactions are normally a tax risk because there are no global transfer pricing rules. Local tax authorities have their local transfer pricing rules to follow and authorities interpret transfer pricing guidelines differently.
Hexagon’s interpretation of prevailing tax law, tax treaties, OECD guidelines and agreements entered into with foreign tax authorities may be challenged by tax authorities in some countries. Rules and guidelines may also be subject to future changes which can have an effect on the Group’s tax position. Furthermore, a change of the business or part of the business can have an impact on agreements entered into with tax authorities in some tax jurisdictions.
The tax rate may increase if large acquisitions are made in high tax jurisdictions or if the corporate tax rates change in countries where Hexagon carries out substantial business.
Risk Management: Transactions between Group companies are carried out in accordance with Hexagon’s interpretation of prevailing tax laws, tax treaties, OECD’s guidelines and agreements entered into with foreign tax authorities and are normally at arm’s length.
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