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 and Operational Risk Management
Market and operational risks are primarily managed within each subsidiary of Hexagon. 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.
ACQUISITIONS AND INTEGRATION
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.
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, technological 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 2012, Hexagon made some 80 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.
IMPACT OF THE ECONOMY
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.
Hexagon’s business is widely spread geographically, with a broad customer base within numerous market segments. Potentially negative effects of a downturn in the developed world may for example be partially off-set by growth in emerging markets and vice versa.
COMPETITION AND PRICE PRESSURE
Parts of Hexagon’s operations 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.
Hexagon invests annually approximately 11 per cent of net sales in research and development. A total of about 3,000 engineers 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 technological opportunities early on.
Hexagon’s business activities are conducted in a large number of markets with multiple customer categories. In 2012, surveying was the single largest customer category and accounted for 21 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 (20 per cent), aerospace and defence (11 per cent) and construction (11 per cent).
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 1.5 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.
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.
Hexagon has a favourable risk diversification and dependence of a single supplier is not decisive for the Group’s performance. The largest supplier accounts for approximately 1.8 per cent of Hexagon’s total net sales. 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.
The resignation of key employees or Hexagon’s failure to attract skilled personnel may have an adverse impact on the Group’s operations.
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.
Financial Risk Management
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. 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. All relevant exposures are monitored continuously and are reported to Group Management and the Board of Directors on a regular basis.
Hexagon’s operations are mainly conducted internationally. During 2012, total operating earnings, excluding non-recurring items, from operations in currencies other than EUR amounted to an equivalent of 416.1 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 result 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 2012.
|Movement1||Net of income and cost||Profit impact|
|1 Compared to EUR|
As of 1 January 2011, Hexagon has changed the presentation currency of the Group from Swedish kronor (SEK) to Euro (EUR). The change reduces the currency exposure in both the income statement and other comprehensive income. It also allows Hexagon to better match debt by currency to net assets, which has a stabilising effect on the 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. Transaction exposure was hedged until December 2012 at which point in time the Group Treasury Policy was changed. The Policy now states that 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 is partially hedged by denominating borrowings in the same currency as of the corresponding net assets. The reason for hedging net assets is to reduce the volatility in other comprehensive income. However, when hedging assets in other currencies than EUR, the volatility in net debt increases. The two kinds of volatilities are carefully monitored.
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.
In accordance with the Group Treasury Policy, all external debt has short interest rate duration, on average shorter than six months. The average interest fixing period as of the end of 2012 was less than three months. During 2012 no interest rate derivatives were used to manage the interest rate 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.
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.
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.
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, cash and unutilised credit limits totalled 450.8 MEUR (360.1).
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.
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 primary source of financing is a 900 MUSD and a 1,000 MEUR Term and Revolving Credit Facilities Agreement that expires in July 2015. In 2009 Hexagon issued a 2,000 MSEK five year bond and to further diversify the debt structure, Hexagon, in the first quarter of 2012, established a Swedish Commercial Paper Programme. The programme enables Hexagon to issue commercial paper up to a total amount of 8,000 MSEK. Commercial paper can be issued with tenor of up to 12 months under the programme.
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.
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.
The Group’s earnings are affected by changes in certain key factors, as described below. The calculations proceed from the conditions prevailing in 2012 and the effects are expressed on an annualised basis. Earnings in non-EUR subsidiaries are converted into EUR based on average exchange rates for the period when the earnings arise.
During the year there have been significant changes to the exchange rates of currencies that have the biggest impact on Hexagon’s earnings and net assets, namely USD, CHF and CNY. The EUR has weakened against USD, CHF and CNY. Since Hexagon has a majority of the operating earnings denominated in USD and CNY, this had a positive impact on operating earnings. The strengthening of the CHF had a negative impact since a considerable part of the costs are denominated in CHF. An isolated strengthening in the exchange rate for EUR by 1 per cent for all assets and liabilities denominated in non-EUR currencies would have had an immaterial effect on net income but a negative effect on equity of 39.6 MEUR (35.1) net, and vice versa, after the impact of hedging.
During 2012, total operating earnings, excluding non-recurring items, from operations in other currencies than EUR amounted to an equivalent of 416.1 MEUR (324.1). An isolated weakening of the exchange rate for EUR by 1 per cent against all other currencies would have a net effect on operating earnings of approximately 4.2 MEUR (3.2).
Based on the average interest fixing period of less than three months in the Group’s total loan portfolio as of year-end 2012, a simultaneous 1 percentage point change in interest rates in all of Hexagon’s funding currencies would entail a pre-tax impact of about 12.9 MEUR (15.7) in the coming 12 months earnings.