Operational risks are primarily managed within each subsidiary of the Hexagon Group, while financial risks are managed at the Group level. The Group's Treasury Policy, which is updated and approved annually by the Board of Directors, stipulates the rules and limitations for the management of financial risk throughout the Group.
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
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 decreasing growth rates 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, 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.
During 2000 to 2010, Hexagon made some 70 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.
ACQUISITION AND INTEGRATION OF INTERGRAPH
Risk
Subsequent to Hexagon’s acquisition of Intergraph, senior management of Intergraph has in part been replaced. There is a risk that the new management’s impact on the business of Intergraph may not achieve their targets. A method for achieving cost synergies in relation to the acquisition of Intergraph may be reduction of overlapping resources, including reduction of staff, which may entail some financial risk.
Intergraph has ongoing business operations and contractual relationships with entities within the U.S. Government. There is a risk that this may limit Hexagon’s insight in such businesses activities and restrict Hexagon’s possibilities to exert influence in relation to the part of Intergraph’s business comprised by such contracts.
In connection with the acquisition of Intergraph, parts of the purchase price have been classified as goodwill. There is a risk that Hexagon may not be able to support the value of such goodwill in the future. In the event that future impairment tests display a sustainable decrease in the value of goodwill, this will lead to impairment charges, which will have a negative impact on Hexagon’s financial position and results.
Risk Management
Intergraph continues to operate under the Intergraph name and branding. The management of the two Intergraph divisions Process, Power & Marine (PP&M) and Security Government & Infrastructure (SG&I) remains unchanged. Hexagon’s President and CEO has taken on the role as President of Intergraph which should result in accelerated integration of Intergraph into the Hexagon Group. The integration of Intergraph is proceeding according to plan and expected synergies remain unchanged.
In order to comply with U.S. requirements relating to the mitigation of foreign ownership, control or influence (FOCI) over the affairs of a business having access to such information, Intergraph has transferred the contracts involving access to classified information and certain related business into a new subsidiary – Intergraph Government Solutions Corp (IGS). Hexagon has entered into a proxy agreement with the U.S. Defense Security Service relating to IGS pursuant to which IGS is being managed by a minimum of three proxy board directors who are completely independent of Hexagon and will be subject to a variety of procedures designed to mitigate FOCI. As a result, a substantial portion of the assets and business being acquired through the Intergraph transaction will be managed by a proxy board which will have the legal ability to exercise substantial control over the conduct of the business of IGS. In addition, the ability of IGS to continue to conduct operations that involve access to classified information will be dependent upon its ability to comply with the relevant FOCI mitigation requirements and to maintain the necessary security clearances.
IMPACT OF THE ECONOMY
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 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 on Hexagon’s performance are somewhat balanced by sales of growth technologies and sales to growth markets with differing economic cycles. Emerging markets accounted for about 30 per cent of net sales in 2010 and Hexagon is continuously focusing on increasing its local presence in regions where growth is expected to remain strong.
COMPETITION AND PRICE PRESSURES
Risk
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.
Risk Management
Hexagon invests annually approximately 10 per cent of net sales in research and development. A total of about 2 000 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.
CUSTOMERS
Risk
Hexagon’s business activities are conducted in a large number of markets with multiple customer categories. Including Intergraph pro forma 2010, surveying is the single largest customer category and accounted for 24 per cent of net sales in 2010. For Hexagon, this customer category may involve certain risks. 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 (18 per cent), aerospace and defence (13 per cent) and safety and security (11 per cent).
Risk Management
Hexagon has 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 about 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.
SUPPLIERS
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 accounts for approximately 2.8 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.
HUMAN CAPITAL
Risk
The future success of Hexagon is largely dependent on the capacity to retain, recruit and develop skilled employees. Accordingly, being an attractive employer is an important success factor for Hexagon. 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.
Financial Risk Management
Financial risks are managed at Group level. The Group’s Treasury Policy, which is updated and approved annually by the Board, stipulates the rules and limitations for the management of financial risks throughout the Group. Hexagon’s treasury operations run the Group’s internal bank, which is responsible for coordinating the financial risk management. The internal bank 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. Within Hexagon, there is no mandate to conduct independent trading in currency or interest rate instruments. All relevant exposures are monitored continuously and are reported to Group Management on a regular basis.
CURRENCY
Risk
Hexagon’s operations are mainly located outside Sweden. During 2010, total operating earnings, excluding non-recurring items, from operations in foreign currencies amounted to an equivalent of 2 604 MSEK. The foreign currencies that have the biggest impact on Hexagon’s earnings and net assets are USD, CHF, EUR and CNY. Currency risk is the risk that foreign currency exchange rate fluctuations will have an adverse effect on cash flow, income statement or balance sheet. Sales and purchase of goods and services in currencies, other than the subsidiary’s functional currency, give rise to transaction exposure. As far as possible, transaction exposure is concentrated in the countries where manufacturing entities are located. This is achieved by invoicing the sales entities in their respective functional currency.
Translation exposure arises when the profit and loss accounts and balance sheets are translated into SEK. Furthermore, the comparability of Hexagon’s result between periods is affected by changes in foreign currency exchange rates.
Risk Management
The General Meeting of Hexagon resolved on 24 November 2010 to replace SEK with EUR as the accounting currency effective as of 1 January 2011. In addition, Hexagon has decided to have EUR as the presentation currency for its consolidated financial statements starting 1 January 2011.
The reason for the change is that due to the accelerating globalisation of Hexagon’s operations, the Group’s sales, costs and net assets are primarily denominated in currencies other than SEK. A change of accounting currency from SEK to EUR should decrease the currency exposure in both the profit and loss statement as well as in comprehensive income. The move will also enable Hexagon to better match debt with net assets which will have a stabilising effect on certain key ratios that are of importance to Hexagon’s cost of capital.
Transaction exposure is hedged in accordance with Group Treasury Policy. Contracted transactions, i.e. accounts receivable and payable, and orders booked, are fully hedged. In addition, 40 to 100 per cent of a rolling six month exposure forecast is hedged. Hedging of transaction exposure is done by using foreign exchange forward contracts. Cash flow hedge accounting is applied and thereby market value is partly deferred in the hedge reserve in equity to offset the gains/losses on hedged future sales and purchases in foreign currencies. Translation exposure related to actual and forecasted earnings in foreign operations is not hedged.
INTEREST
Risk
The interest rate risk is the risk that changes in interest rates will adversely affect the Group’s net interest expense and/or the 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 all external debt has short interest rate duration, on average shorter than six months. The average interest fixing period as of the end of 2010 was less than two months. During 2010 no interest rate derivatives were used to manage the interest rate risk.
CREDIT
Risk
Credit risk, i.e. the risk that customers may be unable to fulfil their payment obligations, account for the majority of Hexagon’s counterparty risk. Credit risk also includes the risk that customers will not pay receivables that Hexagon has invoiced or intends to invoice.
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 are 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 the Hexagon Group 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. Through a combination of geographical and industry diversification of customers the risk for significant credit losses are reduced.
LIQUIDITY
Risk
Liquidity risk is the risk of not being able to meet payment obligations in full as they become due or being able to do so at materially disadvantageous terms due to lack of cash resources.
Risk Management
The Hexagon Group Treasury Policy is 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 4 556 MSEK (4 737).
REFINANCING
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.
The financing of the 2 125 MUSD acquisition of Intergraph, consists of three components: a bridge to equity loan of 850 MUSD with maturity on 6 July 2011, a bridge to bond loan of 375 MUSD with maturity on 6 July 2012 and a term loan of 900 MUSD with maturity on 6 July 2015. The proceeds from the rights issue offering and the subsequent bond issue was used and will be used to refinance the equity and bond loans. The term loan of 900 MUSD, together with the term and multicurrency revolving credit facilities of 1 000 MEUR, with maturity on 6 July 2015, forms the foundation of the Group’s financing. All the above financing agreements, with maturity 6 July 2015, include standard financial covenants.
INSURABLE RISK
Risk
Hexagon’ operations, assets and staff are to a certain degree exposed to various risk of damages, losses and injuries which could tentatively threaten the Hexagon 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 program 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. As Hexagon develops and damage-prevention programmes are completed, the insurance programme is periodically amended so that own risk and insured risk are optimally balanced.
Sensitivity Analysis
The Group’s earnings are affected by changes in certain key factors, as described below. The calculations proceed from the conditions prevailing in 2010 and the effects are expressed on an annualised basis. Earnings in foreign subsidiaries are converted into SEK based on average exchange rates for the period the earnings arise.
During the year there have been very significant changes to the exchange rates of the foreign currencies that have the biggest impact on Hexagon’s earnings and net assets, namely USD, CHF, EUR and CNY. The SEK has strengthened substantially against all these currencies. Since Hexagon has a majority of the operating earnings denominated in USD, EUR and CNY, this had a negative impact on operating earnings. But the weakening of the CHF had an adverse effect, since a significant part of the cost and a part of the external debt is denominated in CHF. An isolated change in the exchange rate for SEK by 1 per cent for all assets and liabilities denominated in all foreign currencies would have had an immaterial effect on net income but an effect on equity of 194 MSEK net after the impact of hedging.
During 2010, total operating earnings, excluding non-recurring items, from operations in foreign currencies amounted to an equivalent of 2 604 MSEK. An isolated change in the exchange rate for SEK by 1 per cent against all other foreign currencies would have an effect on operating earnings of approximately 24 MSEK.
Based on the average interest fixing period of less than 2 months in the Group’s total loan portfolio as of year-end 2010, a simultaneous 1 percentage point change in interest rates in all of Hexagon’s funding currencies would entail a pre-tax impact of about 149 MSEK in the coming 12 months earnings.
