Hexagon AB

STO:HEXA B

Earnings Call Analysis

Hexagon's Resilient Q3 Performance Amid Market Challenges

In Q3 2024, Hexagon reported sales of EUR 1.3 billion, down 2% organically due to muted demand across sectors. Encouragingly, gross margins improved to 67.1%, reflecting effective cost management and strong performance in recurring revenues, which grew by 7% to EUR 565 million. Despite a 4% decline in operational earnings, the company maintains a robust operating margin of 29%. Looking ahead, management is optimistic about a demand recovery in 2025, with guidance for cash conversion expected to remain between 80% to 90% by year-end.

Resilient Performance Amidst Economic Challenges

In Q3 2024, Hexagon recorded sales of EUR 1.30 billion, representing a 4% decline year-on-year. This decrease was influenced by various factors including adverse foreign exchange impacts of 1% and a structural adjustment that accounted for a 0.4% decline, culminating in an organic growth reduction of 2%. Despite these challenges, the company showcased resilience through a consistent EBIT margin and improved cash flows, suggesting operational strength.

Gross Margin and Operational Earnings

The gross margin for the quarter was an impressive 67.1%, up from 65.5% the previous year, indicative of solid pricing strategies and operational efficiencies. Hexagon's operational earnings saw a 4% decline to EUR 37.6 million, consistent with the overall sales drop. However, the EBIT margin remained stable at 29%, aided by a successful rationalization program and improved organizational performance.

Cash Flow Generation and Targets

Hexagon demonstrated an effective cash flow generation strategy with a cash conversion rate of 70% for Q3, reflecting a significant improvement from 64% last year. For the year-to-date, cash conversion stands at 81%, above last year’s target of 80%. The company anticipates reaching the annual cash conversion range of 80% to 90%.

Guidance for Future Growth

Looking ahead, while Q4 is expected to face continued demand challenges, the management displayed optimism regarding 2025, anticipating a recovery in market dynamics. Noteworthy is the strong performance in recurring revenues across multiple divisions, with some seeing increases as high as 11%.

Divisional Highlights: Opportunities and Challenges

The Manufacturing Intelligence (MI) division recorded revenues of EUR 464 million at a 25.5% margin but experienced a decline largely due to weaknesses in the automotive sector, particularly in Europe. Meanwhile, the ALI division showed a strong growth trajectory of 6%, aided by a significant expansion in SaaS offerings and recurring revenues. The Geosystems division however faced a downturn with a 5% organic sales decline. Autonomous Solutions (AS) also reflected challenges, although its operating margin remained robust at 34%.

Innovation and Strategic Initiatives

Amidst the current market challenges, Hexagon continues to prioritize innovation with strategic product launches set for 2025. They recently introduced the ATS800 laser tracker, which is expected to gain market traction starting in Q1 of next year. This is indicative of Hexagon's commitment to maintaining competitive advantages through technological advancements.

Strategic Divestitures: Value Creation

The management disclosed plans to evaluate the potential spin-off of the Asset Life Cycle Intelligence division into a separate entity, referred to as NewCo. This initiative is aimed at creating two distinct companies with focused strategies impacting operational efficiency and financial performance. The expected separation is foreseen to enhance shareholder value and operational agility.

Market Position and Future Outlook

Despite recent difficulties, management expresses confidence in the company’s positioning within growing markets such as public sector and aerospace. They also highlighted the strength of relationships with key clients like BYD in China, suggesting robust demand potential within the electric vehicle market. The overall sentiment suggests optimism about future growth as macroeconomic conditions stabilize.

Earnings Call Transcript 2024-Q3

[Operator]

Good day, and thank you for standing by. Welcome to the Hexagon Report Third Quarter 2024 Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your first speaker today, Paolo Guglielmini. Please go ahead.

[Paolo Guglielmini, executive]

Thank you, everyone, for joining our Q3 2024 earnings call. Before discussing the group's performance in the last 3 months, I want to refer back to the press release that's been published earlier this morning in Slide 4.

The Board of Directors of Hexagon has authorized management to evaluate the potential separation of the Asset Life Cycle Intelligence division, ALI, into a NewCo. NewCo will also include businesses with strong customer, technology and operational synergies with ALI and namely ETQ, the enterprise quality management software platform that currently resides into manufacturing intelligence; Bricsys, a provider of CAD and BIM software currently in Geosystems; as well as utilities and infrastructure, a business currently in the SIG division providing network engineering software.

So what are we setting out to do with the strategy? Well, the ambition is to create two public companies at scale with distinctive strategies and financial profiles and to create additional value for all the stakeholders involved. So from Slide 5, we start looking at what these two global players would look like after a potential separation.

Hexagon will be a global market leader in building digital twins at any scale with an impressive span of innovation, customer footprint and installed base. Our core mission, which is one of deploying robotics, sensors, software and AI to capture and create insights from digital twins, will become simply more and more relevant in the future.

Regardless of the industries that we operate in, we see customers grappling with labor shortages, sustainability challenges, competitive demands on quality, safety of communities and operators, and to achieve all those goals, building a digital ground truth of reality to then improve that through workflows and insights is essential, and that's a massive opportunities of growth for Hexagon in the future, but it's also one that requires focus of intense and dedication of resources.

With revenues above EUR 4 billion, world-class margins and recurring revenues that are growing across all divisions, Hexagon would have a very strong and resilient financial profile where the focus and the resources to build an even stronger market leadership towards this mission.

And in Slide 6, this is what NewCo would look like. NewCo would be a pure software player with great scale, with EUR 1 billion in sales, market-leading margins and recurring revenues and a fantastic roster of blue-chip customers and, of course, great opportunities ahead.

NewCo's portfolio would be best-in-class when it comes to managing digital projects and assets and would have the technology, the innovation the financial and geographic scale to tackle massively important challenges.

Think about energy transition, think about grids, distribution, think about the modernization of infrastructure, aging workforces, the design of operations of data centers and their own cyber integrity.

Regarding transaction details in Slide 7, these will obviously emerge over time. The separation of NewCo would happen in a tax-efficient manner for shareholders. Shareholders will receive shares of NewCo in proportion to their existing holdings in Hexagon. Hexagon is evaluating listing options for NewCo in the U.S. and in Sweden.

The separation, spin-off and listing will be subject to the approval of the Board and the shareholders as well as being subject to other conditions and regulatory approvals. Obviously, there cannot be any assurances that a separation, a spin-off or a listing will occur. What the time line could look like in Slide 8.

Well, we expect this to be a 12- to 18-month process. The reason for the disclosure today is that we value transparent communication with the market, and we thought it was important to disclose the Board interest in this potential transaction, which could be, of course, significant if executed. And of course, we wanted to be proactive as well to prevent inaccurate market rumors and speculation.

During the course of these 12 to 18 months, we will be transparent with the market in a variety of ways and setups for quarterly calls with specific updates and potentially Capital Markets Day into next year. But for today, this is very much all the detail that we have to share with you on this project.

Now moving on to the performance update for Q3 2024 in Slide 10. As anticipated, Q3 has been challenging because of muted demand in several end markets, but also was a quarter in which we progressed very much in terms of business model, in terms of operational improvements and innovation.

In Q3, we have recorded sales of EUR 1.3 billion, down by 2 percentage points organically. Growth in recurring revenues remained very strong, 7 percentage points, up to EUR 565 million. Gross margins continue to be strong at 67% versus 65.5% in prior year as a result of innovation to drive pricing and cost structure of our products of favorable mix and operational improvements.

The operating margin was solid at 29%, despite FX supported by gross margin progression, but also by the rationalization program that has now come to conclusion, delivering savings at the top end of the initial expectations.

The cash conversion in Q3 typically is weaker, but came in at 70%. And so far, we are at 81% for the first 3 quarters of the year and will conclude 2024 well within the guidance range of 80% to 90%.

We're very happy with the reception that's being received at events like INTERGEO in Germany or MINExpo for the mining industry in Vegas as well as IMTS in Chicago. At those events, we have launched products as well, as earlier in the year, of course, we've got reviews by customers and specialists.

So even if in the short term, we expect demand to remain challenged in Q4, we're very confident that we are positioned well for growth into 2025 as the market environment improves.

Moving to Slide 11. A few comments by geography. We observed broad weakness that's persisting in the construction market across the globe, and in China, across multiple industries, although now more stable in terms of deal flow and possibly benefiting from the announced stimulus package over the course of 2025 and gradually.

Looking at areas that are driving positive demand, I would single out the manufacturing in the public sector in the U.S. for sure, the aerospace market globally as well as growth markets like Middle East and India.

Looking at Slide 12, this is where we showed divisional performance. On an organic basis, MI declined by 2 percentage points, ALI was up by 6, Geo down by 5, AS by 12, SIG was up by 2 percentage points. So as you can see, some divisions experienced strong growth in Q3 2023 with tough numbers to beat, notably MI, ALI and AS.

If you look at Slide 13, this is where, as ever, we show quarterly developments in sales and EBIT by division. We're going more into detail of the specific division, starting with Slide 14 for Manufacturing Intelligence.

We delivered revenues of EUR 464 million at an operating margin of 25.5%. We have seen a noticeable slowdown of activity in automotive, particularly in Europe. And certainly, the fact that our Chinese business stayed very strong throughout 2023 makes for a tough set of numbers to beat right now.

But we do see good traction in software with recurring revenues up 4% in MI and particularly in automation solutions that are driven by aerospace investments and large-scale applications. I think that these markets will remain cautious for the foreseeable future, but we see nothing that's pointing to a loss of market shares. Rather, the contrary. The team in MI keeps on doing well to deliver margin and cash in the meantime.

Looking at ALI now in Slide 15. We recorded revenues of EUR 208 million, up 6% year-on-year. We probably could have done more, but also in these industries, there is a tendency for projects approvals is late and be extended and for customers to be cautious in deploying capital.

In ALI, SaaS grew by 16% and overall recurring revenues by 6%. Very importantly, we are rolling out in ALI the new version of our platform that's called SDx to upgrade customers and capture share of wallet in their own design and operations software ecosystems.

The ALI margins slightly softened in Q4 as a result of the growth market investment that we are executing to capitalize on this innovation. But I think, here, we're going to have a very solid outlook for 2025 and beyond.

Looking at Geosystems now in Slide 16. In Geo, we have recorded sales of EUR 373 million in the quarter, down 5 percentage points. As you know, this market is globally impacted by interest rate, by no confidence, so customers are cautious before investing in new systems. But the portfolio and the innovation pipeline in Geosystems is strong. And in Q3, again, recurring revenues grew by 13%, also driven by HxDR, which is our digital reality platform.

On HxDR, we are embarking plenty of customers. We have users of our scanners, creators and consumers of geospatial content. And this is a great opportunity for us into the future as the platform scales to build a sizable SaaS business organically. I am expecting that the outlook for Geo gradually will improve from here. But in the meantime, margin performance, as you can see, has remained very healthy.

Now to Autonomous Solutions in Slide 17. AS recorded sales of EUR 135 million in Q3 at an operating margin of 34%. The drop in Q3 mostly is down to an exceptional performance last year with more than 30 percentage points of growth. Despite some delays, the demand for autonomy in mining and in defense will remain solid for the foreseeable future and offset the weakness in the agriculture market.

For those of you who attended MINExpo, it's clear that the electrification, autonomy and long-term demand for commodities will create stable demand for our positioning and safety portfolio in the future. Also in AS, recurring revenues grew by 11%, driven by our positioning correction services.

Looking at the SIG division now in Slide 18. SIG recorded sales of EUR 120 million, up 2 percentage points year-on-year with an operating margin of 21%. Within SIG, our business of services for the U.S. federal agencies declined materially, but we are pleased to see continued growth in the public safety software portfolio as we roll out the new dispatch platform OnCall. And now it's live at multiple sites, is very well appreciated by customers, is building very strong references and is supported by a great pipeline into the future. Public safety grew in double digits within SIG.

Slide 19. As discussed in several occasions, we are in the middle of a multiyear innovation push to position Hexagon optimally for growth into the future. And in this view in Slide 19, we have tried to single out a few of these releases starting with 2023 on the left.

The launch of the new lineup of precision automation cells in MI called PRESTO has as created in 2024 opportunities and has helped mitigate weakness in other areas of the portfolio already. MI maintains good momentum this year, also thanks to the work that's been done on EAM on its design portfolio and now rolling out this data backbone called SDx to connect these various solutions

We, of course, have already talked about the good growth on OnCall. And as you know, HxDR is behind their strong recurring revenue momentum in Geosystems. In Q3 recently, we have just released the new ATS800 laser tracker for MI and a brand-new motorized 3D measurement and layout tool called AICON for Geosystems. And both of these products will pay back their investment within 2 years of launch.

2025 will be another strong year for product launches, and these investments will put us in a position of real strength, particularly as the macro environment improves.

David, can you now take us through the finance section?

[David Mills, executive]

Certainly. Thank you, Paolo. On the following Q3 financial slides, I'd like to take you through what was a continually resilient performance, considering the ongoing challenging economic conditions of the quarter that consequently impacted organic growth, with the business delivering consistent EBIT1 margin and improved cash flow is seasonally weaker than the preceding quarters.

On to Slide 21. Starting with the Q3 2024 income statement, stepping through the sales growth. Sales of EUR 1,299.8 billion is a reported growth of minus 4%, negatively impacted by FX of minus 1% and equally a minus 0.4% net impact from structure, giving minus 2% organic growth.

Notably, the year-over-year gross margin improvement seen in Q2 continued into Q3 at 67.1% and, again, was delivered by a broad-based divisional improvements.

Operational earnings decreased by 4%, in line with the reported negative growth rate to EUR 37.6 million with a 10 basis point decline in the margin to 29%, the elements of which I'll break out in the following profit bridge.

Interest expense and financial costs of EUR 44 million versus EUR 43 million gave a delta on earnings before tax of minus 5%. Tax as being 18%, in line with prior year, bring us down on EPS of EUR 10.1. And for reference, the EBIT1, including PPA, includes EUR 28 million of amortization and dilutes the EBIT1 percentage by 212 basis points to 26.9%.

Moving to Slide 22. Q3 delivered a further strong gross margin of 67.1%, and this brings the rolling 12 months to 66.9% from 65.9%, up by 90 basis points, continuing the important upward trends that we've discussed in previous calls.

The strong quarterly performance gained from improved margins in the majority of this business and, therefore, with multiple drivers, as mentioned last quarter, including pricing discipline, the rationalization program, product innovation and by -- enhanced by both the positive divisional and product mix and further improved by the structural divestments taken during various quarters.

Into Slide 23, we have the profit bridge. In Q3, profitability bridge currency has a minus 1 diluted EBIT1 impact. This is due to the combination of the negative currency translation on sales of EUR 13.6 million, having a corresponding minus EUR 5.6 million EBIT at a margin of 41%. Combined with the net year-over-year transaction impact, which is a negative of EUR 10.7 million from a current year loss of EUR 7.7 million against the prior year gain of EUR 2.9 million.

Negative translation movements this quarter were driven mainly from a return to the trend of the depreciation of the U.S. dollar by 0.9%, with sales exceed costs and continued depreciation of the Swiss franc by 1.1%, which has the opposite characteristics. Whereas, the CNY this quarter was relatively neutral at an appreciation of just 0.2%.

The structural element was marginally accretive and reflects the net impact of acquisitions less disposals. And in the quarter, the disposals of the hand tool business in MI and 2 months of the IDS business in SIG exceed the incremental acquired sales for which the material elements were Voyansi and XWatch in Geosystems.

The organic sales evolution being negative this quarter due to the challenging macro backdrop, but with no negative EBIT impact due to the gross margin improvement in connection with the cost mitigation through the rationalization program, which was therefore accretive by 0.7%. So excluding the dilutive impact of currency, we would have delivered an incremental 85 basis points improvement in EBIT1 in Q3.

Moving to Slide 24, the cash flow. Moving on to Q3 cash flow, which shows improvement in the cash generation conversion over the prior year Q3 that is seasonally weaker than delivered in Q2. The adjusted EBITDA demonstrates a similar cash generation to the prior year, despite the minus 4% decline in EBIT as the depreciation and amortization add-back continues to increase.

Capital expenditure is sequentially down EUR 4 million, but increased over the prior year, which was a lower quarter due to 2 assets disposals in '23. Net working capital low at EUR 56 million build was significantly lower versus the prior year build of EUR 98 million, which generated an operating cash flow of EUR 264 million, an increase of 5%, which is a cash conversion of 70% versus 64% prior year.

Including cash taxes and interest payments, which both marginally reduced, the improvement in cash flow before nonrecurring items is 13%. Nonrecurring items of EUR 22.7 million brings an operational cash flow of EUR 143 million, up 10%.

Moving on to Slide 25. The Q3 net working capital, as I mentioned, was a build of EUR 56 million due to the cycle, as mentioned in the Q2 call. This increased the proportion of rolling 12-month sales to 8.3%, that's still 120 basis points below the Q3 prior year. The constituent elements of the movements being receivables and prepaid increased by EUR 9 million, with the resulting DSO at 84 days, which is in the normal range. Inventory increased by EUR 13 million and will be a continued focus during Q4, which is seasonally the strongest selling quarter for the group.

Liabilities decreased by EUR 14 million with the trade DPOs at a level of 55 and a good improvement over the prior year. A decrease in deferred revenue of EUR 35 million, which is reflective of the billing cycle and in line with the prior year Q3 change. Accrued expenses are increasing as expected, but at a tempered rate based on performance.

So in conclusion, despite the continuation of the challenging macro environment and consequential negative organic growth, the EBIT1 performance has remained resilient due to the continued improvement in gross margin, coupled with the cost management through the rationalization program, which has now achieved its expected return.

Cash conversion, though seasonally weaker in Q3 than earlier quarters, improved over the prior year and on a year-to-date basis remains in the target range.

And with that, I'd like to hand over to Ben.

[Benjamin Maslen, executive]

Thank you, David. Good morning.

If we go to Slide 27, firstly, on sustainability, we had the good news during the quarter that our greenhouse gas emission reduction targets, which are described here, have been approved by the Science Based Targets initiative.

To achieve these ambitious targets, we have many ongoing programs, facility upgrades, employee and supplier training, expanding renewable energy use and setting stringent criteria for product development and logistics. So we have good momentum right across the group, and we'll update our progress towards these targets in our coming annual sustainability report.

If we go to Slide 28. Here, we have a very important customer win to SIG during the quarter. The Malaysian Emergency Response Services have selected the OnCall suite of products to upgrade Malaysia's 999 emergency services communications. This large project will enhance collaboration and data sharing among Malaysia's 5 key public safety agencies, improving their efficiency and response times.

If we go to Slide 29, a large project win for ALI. During the quarter, a leading European EPC has selected SDx2 to manage their engineering project documentation, which will boost efficiency and productivity. As we described last quarter, when it was formally launched, SDx2 is a cloud-native multitalent SaaS solution that will make it easier to integrate project and operational data, create a digital twin of a large industrial facility to use throughout the asset's life.

If we go to Slide 30, we have a large follow-on order with one of our key accounts in China, BYD, the global leader in electric vehicles and renewable energy solutions. To support that cost reduction, efficiency and quality goals, we provide a large number of CMMs, measurement arms and laser trackers, plus the associated software during the quarter.

If we go to Slide 31, we have a customer example from Geosystems. If you've ever wondered at a major athletic event how they get the precise measurements you need in events like the javelin, shotput, distance and long jump, then here is your answer. Swiss Timing chose Hexagon's total stations at the Paris Olympic Games this summer to ensure fairness and accuracy in all high-stakes events.

If we go to Slide 32. As Paolo mentioned earlier, we had a very important product release in MI during the quarter, the ATS800 absolute tracker. We see this as a very important launch, which integrates the laser scan and a laser track into one solution, which is unique in the market. This will allow for more detailed feature extraction from large objects, which are measured at a distance, faster scanning and data processing, and you do not need to be an expert operator to get good results. The shipments of the ATS800 will start next year.

Slide 33. We wanted to highlight a white paper or industry report that Hexagon published this week on the topic of digital twins based on a survey we did 660 companies across 11 different verticals. The report looks at how and why organizations are using digital twins, the potential return on investment from using those and the pace of adoption of these technologies. As we highlighted at last year's Capital Markets Day, we see this as an important long-term driver for demand for Hexagon's technology, which will be relevant for both Hexagon and in a spin scenario, NewCo.

Hexagon customers use our suite of reality capture centers to digitize the real world and build digital twins of assets and then add layers of analytics on top. In NewCo, the digital twin starts with data centric design and engineering tools, which is taken through construction and into operations, providing customers real-time access to contextual data flowing through the asset life cycle. So please use the link on the slide to learn more about this important growth driver for Hexagon.

And with that, I will hand back to Paolo.

[Paolo Guglielmini, executive]

Thank you, David and Ben.

In conclusion in Slide 35, we will see how the market environment will develop in the short term, but we'll stay focused on execution, on innovation, customer engagement, financial delivery. And as announced earlier, we constantly look at ways to drive more focus and more value creation.

And with that, operator, we are available to take questions. Thank you.

[Operator]

[Operator Instructions] And the first question comes from the line of Joachim Gunell from DNB Markets.

[Joachim Gunell, analyst]

So two questions from my side. On ALI, you consider yourself here #1 or 2 player in the CAD and the EAM. So can you discuss a bit on how good business that is really in relation to the competitors and comment a bit on what other players you actually meet yourself?

[Paolo Guglielmini, executive]

Yes, sure. Joachim, we do believe that when you look at the entirety of NewCo, we have solutions that are truly market leading. And on top of that, we now, with SDx, have the right strategy to link the data and build a digital backbone, which is essential because customers want to buy into an integrated ecosystem, have access to data that's integrated.

And the very lion share of that work in terms of innovation has been done. This is why we all think that NewCo has a very powerful and appealing kind of growth profile. We also think that this business would operate into very interesting areas of growth into the future.

[Joachim Gunell, analyst]

And does this mean the news today that you are back at the drawing board here looking over strategic options for other parts of the business as well?

[Paolo Guglielmini, executive]

I would say that this -- the definition of this perimeter comes as a result of having looked at strategic options. We've done a lot of work with the leadership team and with the Board to review the strategy. And we saw that there were these two missions that were emerging from the business, the core mission of Hexagon that lives in the construction side and in the shop floors with the operator, where you're actually building reality, where physical construction takes place; and then a second mission that needs to be serving with digital products, designer and information technology experts in a way that's integrated.

And so this is why we feel very good about the opportunity that we have outlined. But of course, this morning, we have announced an investigation, and this is the starting point of the journey of evaluation, really.

[Joachim Gunell, analyst]

Okay. Perfect. Just on the combined entity then, since you now split out software and services on a quarterly basis, it's very helpful. But I would have thought that the growth rates here in the software and services business would have been higher than what we have seen year-to-date, say, at 3% or up to 5% if we strip out the FX effects.

Just unpack this trajectory. And then in your organic growth targets through the cycle, what's the assumption to, call it, the underlying software business versus sensor and robotics?

[Paolo Guglielmini, executive]

Yes. Great question. Look, I think the clearest KPI that I can point you towards is the recurring revenue that we have tried to talk about very transparently by division starting at Capital Markets Day. At the end of the day, we are in a low point of the cycle, which is why there's cautiousness from customers in investing in new CapEx, but you do see recurring revenue uptick at a good pace, which is on par or above with the software peers, and that's across divisions.

It's also one of the reasons why we feel very good about the way we've defined these perimeters because we see gross margin trajectory and recurring revenue trajectory on both.

[Operator]

And the next question comes from the line of Mikael Laséen from Carnegie Investment Bank.

[Mikael Laséen, analyst]

What prompted Hexagon to evaluate the potential spin-off of ALI at this time?

[Paolo Guglielmini, executive]

I think the timing is more driven by work that's been done internally. On the one hand, we have worked very collaboratively in the last years, which has allowed us to see more clearly, I think, through the synergies between the various elements.

We've always had good synergies between the BricsCAD team and ALI. We've recently built, 18 months ago, a sales team within ALI dedicated to the ETQ portfolio. We see good opportunities for EAM in terms of selling to the infrastructure customers of the utilities and intrabusiness that we're moving into that perimeter.

So I think having experienced firsthand those synergies coming together has been important. And then the Board has been very close to us and very supportive, and we have come together in the definition of this perimeter.

[Mikael Laséen, analyst]

Okay. And a follow-up on this. Could you say something and elaborate on how ALI is collaborating and integrating with Hexagon's other 4 segments? So specifically, what software that are shared in the group that originates from ALI and how this integration creates value within Hexagon?

[Paolo Guglielmini, executive]

Yes. We certainly have touch points in terms of capabilities between technology that we sell through the ALI channels and the rest of the organization. I've talked about HxDR a couple of times in the call today. Part of the deals that we have closed with HxDR also come from the ALI side.

But the way in which we have defined the perimeter comes from the confidence that those elements of collaboration will stay into the future. And they don't necessarily require for those technologies to be under the same management structure.

[Mikael Laséen, analyst]

All right. Got it. And then one finally, if I may. Can you just provide the insights into other order intake developed for the MI segment this quarter?

[David Mills, executive]

Yes. Mikael, the order intake was pretty similar to the revenue or shipment growth figure. So there wasn't a big difference between the two in Q3.

[Operator]

And the next question comes from the line of Erik Golrang from SEB.

[Erik Golrang, analyst]

Two questions -- or sorry, three questions. First one on NewCo, how much extra costs do you think you would have to add to that business to make it standalone?

And then second question, just a combination here, ALI, ETQ, Bricsys and the SIG part, what's the -- I guess, ALI and ETQ, I understand, if you could just help up with the rationale there with also bringing Bricsys and the other asset into this.

And then thirdly, I assume you're open to potentially also divesting NewCo, if there were bidders at the right price. Or is that the path that you've already explored?

[Paolo Guglielmini, executive]

Yes. Thank you, Erik. So first, when it comes to the cost that's associated with stepping up the entity, I think these are some of those details that we'll come back to in the foreseeable future.

In terms of BricsCAD, we see opportunities for selling into the ALI customer base BricsCAD, and that's something that's been already in the works in the last couple of years. We see a chance to intensify that if ever in terms of providing very good quality CAD and BIM technologies to owner-operators and EPCs.

Your third question, Erik?

[Erik Golrang, analyst]

Divesting NewCo rather than a spin-off. Or is that something you have looked at already?

[Paolo Guglielmini, executive]

Now, look, we've come together with the Board to the conclusion that the strategy that we have outlined and we are investigating is the best course of action. So this is where we are.

[Erik Golrang, analyst]

Okay. And then if I could just throw in one more on the business in the quarter. It's a follow-up to the MI book-to-bill there. If you look -- I assume the main drop on hardware in the quarter is in Geosystems.

Could you just sort of help us sort that out a bit? What are the main variables in that? And what trends are you seeing there into the fourth quarter?

[Benjamin Maslen, executive]

Yes, Erik. No, I would say that the drop in sensors was probably was spread across Geosystems. So Geosystems was similar to last quarter. For Manufacturing Intelligence, we saw a drop in China. As we flagged last quarter, we expected Q3 to be weaker than Q2 in China. So I'd say on the sensor side, it was fairly evenly split across the two businesses.

If you look into Q4, I think, on the Geosystems side, the demand environment looks fairly similar. Comparatives are probably slightly easier, reflecting the comp from Q4 last year. If you look at Manufacturing Intelligence, I think there's probably still slight negative momentum in North America and Western Europe, but I think that's offset by a probably slightly better development in China.

[Erik Golrang, analyst]

And is it fair to summarize that heading into the third quarter, you sort of indicated a bit weaker growth rates, but you're thinking about a more stable development into the second -- into the fourth quarter?

[Benjamin Maslen, executive]

Yes. Based on what we know now, it looks like a similar market environment, yes.

[Operator]

And the next question comes from the line of Sven Merkt from Barclays.

[Sven Merkt, analyst]

So maybe just one question on the various assets that you plan to include in the new scope of ALI. Could you just remind us of the growth profile of ETQ, Bricsys and this utility infrastructure business?

[Paolo Guglielmini, executive]

Broadly, I would say ETQ is growing 10 to 15 percentage points in total revenue and faster than that when it comes to SaaS. I think BricsCAD is going through, as we speak, a transition towards subscription, but it probably grew around the 10 to 15 percentage points also in Q3 and has good momentum. There's dynamics in that market that make the outlook we think very positive.

When it comes to utilities and infrastructure, which probably is one of the least known part of our portfolio, but we think has a lot of potential when it comes to selling EAM on to telecommunication providers and utilities providers, that business is growing in between single and high -- mid- and high single digits.

So these businesses have different levels of maturity and growth profile, but we feel very strongly about those synergies that, of course, we have tested over the course of the last quarters.

And this is also why, as of today, not only we externally announced this investigation to the market. But also internally, we announced movements of these teams under the same management structure because we want to pursue immediately that commercial potential.

[Sven Merkt, analyst]

Okay. Perfect. And as you said, this utilities and infrastructure business is not so well known. So could you just give us a rough indication how large it is from a revenue perspective?

[Benjamin Maslen, executive]

It's Ben. We'll come back on that. Not obviously that we don't know, but it is a carve-out from one business to another. So it depends a little bit on the perimeter of customers that you transfer. We've given you the overall scope of NewCo. You can probably back it out to some degree.

[Sven Merkt, analyst]

Okay. Perfect. And then just when you look at the R&D capitalization, how will they roughly be split between the new and the remaining business?

[Paolo Guglielmini, executive]

Yes. I think this is one of those elements that we will come back to. It's part of a further definition of the financial elements of the transaction.

[Sven Merkt, analyst]

Okay. And then just a final question on the spinout. From a revenue mix, when you look at it from a cloud on-premise subscription life maintenance part, how does it -- how will it roughly split between these different types?

[Paolo Guglielmini, executive]

Yes. Look, we've given a broad perimeter of the transaction. I think you know enough about the size and the pace of growth in both EAM and ETQ to kind of work out the SaaS -- the pure SaaS multi-tenant element of the perimeter.

What's important for the NewCo is that it has vast amounts of recurring revenue, there's growth that's happening across the board, and that's growth that's happening across customer profiles and the industries, which is why we think this is a very high potential move.

[Operator]

We will now take our next question, and the next question comes from the line of Hemal Bhundia from UBS.

[Hemal Bhundia, analyst]

Hemal Bhundia from UBS. I wanted to ask about your view on the construction end markets going into 2025. When in 2025, would you expect this to pick up? And secondly, could you give us some color on your expectations for China in 2025, please? I'll follow up with my second question after.

[Benjamin Maslen, executive]

Yes. I think the construction markets when you look at it by region, I think Europe has been weak now for a few quarters. It varies a lot by different countries. I'd say, in aggregate, we don't really see it sequentially getting much worse. And as I said earlier, we will start to get some easier comparatives as we go into 2025. We don't see the benefits of lower interest rates yet starting to feed into improved activity.

U.S., the market has been stronger. We saw a little bit of a softening in some of our businesses, machine control and geomatics during Q3. Whether that's the market deteriorating or that's uncertainty over the election, we'll have to see. But I'd say the U.S. generally remains better than the European market.

And then if you look at China, China, the construction market there has been weak for almost a couple of years now. We've seen the government announce stimulus measures through Q3. And I think they are more geared toward construction than maybe the sweet manufacturing part of our business. When we speak to our teams on the ground, they think it will take some time to feed into further activity. It's more of a 2025 tailwind and something that we'll see in Q4.

[Hemal Bhundia, analyst]

And my second question, I appreciate it's still a review process, but could you tell us what the spin-off can mean for your capital allocation strategy should the spin-off be pursued? Or is it still relatively early?

[Paolo Guglielmini, executive]

So if by capital allocation. You're implying M&A, we -- I think we have opportunities that are very important in both perimeters should we decide to go in this direction. I find also that our M&A activities probably would become more focused and targeted and successful because you are carving out two communities and user groups that need to be addressed with business models that are different and with portfolios that are targeted, right?

So for simplicity, really look at it from the outside in, right? We're talking about the community of designers, the community of information technology experts versus the community of makers, right? And these require digital tools that are deployed in a very different fashion.

So M&A is important for the group that I think it's going to be important for both AB in this potential future and for NewCo, but possibly in an even more targeted way.

[Operator]

We will now take our next question, and the next question comes from the line of Balajee Tirupati from Citi.

[Balajee Tirupati, analyst]

Balajee from Citi. Two questions from my side, if I may. Firstly, on the spin-off plan, you mentioned creation of structure under which collaboration between proposed new company and Hexagon would continue in future. If you could elaborate on that. And also if you could share color on the voting right distribution in the new company.

And second question, if you could share view on what you saw in the mining segment during the quarter. And did the decline come as a surprise and what you view is on demand here in coming quarters?

[Paolo Guglielmini, executive]

So in terms of collaboration, I think there's going to be two elements, right? One is the utilization in an optimal way of technology components that are important also for ALI that are coming from the rest of the group at the moment, and that's going to be, of course, no issue at all.

And then the second one is what could we do from a Hexagon portfolio to be in terms of selling on to the ALI customers and industrial sectors of reference. And that, too, should we go down this road will be a very fruitful partnership. Can you please repeat your second question?

[Balajee Tirupati, analyst]

Second part of this question was if you can also share the voting right distribution in new company. Will it be similar, A share and B share with current Hexagon business has?

[Paolo Guglielmini, executive]

Yes. As I said earlier, the detail that we have shared in Slide 7 is pretty much what we can talk about for today. So we'll come back to you on those aspects.

And then your third question when it comes to mining, I think mid- to long-term, nothing changes in terms of demand. I was stunned by the speed of progress on electrification in autonomy that I saw at the mining show in Vegas. It's a good thing that they organize it once every 4 years because the amount of technology and capital and assets that you see is incredible. The scale of transformation is incredible.

And so we're very convinced that we have the right portfolio, and we're going to invest further in mining. It's a brilliant use case for deploying robotics and AI to make an industry more productive.

I think in the specifics of Q3, a, we had very tough numbers to beat; b, there's a little bit of cautiousness in that market. You've also seen it in the way commodities are priced in the short term. And then third, I'd say, some of the deals that we expected in Q3 slipped, but we still have a very strong position there.

[Operator]

We will now take next question, and the next question comes from the line of Viktor Trollsten from Danske.

[Viktor Trollsten, analyst]

And perhaps my first question is, I guess, on the industrial logic, if you could expand a bit. It obviously seems to make sense putting all these entities together in the NewCo.

But could you remind us a bit on the interconnection between NewCo and, call it, RemainCo? I think we have spoken about synergies with other parts of Hexagon as well. But could you remind us on that, please?

[Paolo Guglielmini, executive]

Yes, sure. As I said earlier, the most crisp way to look at this is through the lenses of the personas that you want to serve, right, the users that you want to serve. And I think that's the best way to identify why the perimeter has been crafted in the way it has.

For Hexagon into the future, we're going to have data creation that, of course, takes place where physical realities take place. So our sensors and our robotic technologies will be capturing data, 3D data for anything that's real. And our recurrent revenue primarily will come from consuming that 3D data. So that will be software and platforms and AI that's very much tied to where data creation takes place.

So the best way to look in simple terms of the logic is really through those two lenses. This is not about software and hardware. This is about the integration of software and hardware, on the one hand, and software tools that serve designers and IT specialists on the other.

[Viktor Trollsten, analyst]

Okay. Yes, I understood. I guess, it aligns with what I think Ben has been speaking about quite some time going from technology-centric to customer-centric.

And then perhaps on your financial targets, which I guess could turn the review within the entity. But as Hexagon stands today, you have spoken about that you incorporate the downturn in your forecast for organic growth. Let's say, just philosophically, I do say that it's a difficult answer. But the downturn that we are currently in is that sort of the downturn that you have thought about.

Is it worse than you have thought about? Just any color on that. I guess the context is that what we know for 2024 now, we're looking since 2022. We have had organic growth of, let's say, 4%, 5% in the low end of your target. Just any color on that would be helpful.

[Paolo Guglielmini, executive]

Yes. I think as you say, this is the type of downturn that I think all I had in mind a couple of years back. I think the group has grown well in the first part of the planning process. And I'm sure we're going to come back to good growth rates into the future, but the environment is what it is.

And then when it comes to targets,in relation to the potential separation, as we said, this is a 12- to 18-month process. So we know what we need to do and deliver altogether into next year. And then if there's going to be a separation, we're going to have more than enough time in 2025 to talk about numbers and targets.

[Operator]

We will now go to our next question, and the next question comes from the line of Johannes Schaller from Deutsche Bank.

[Johannes Schaller, analyst]

I just wanted to go back, firstly, just on the decision between a spin-off and maybe an IPO or a sale of the NewCo. You said that M&A for both businesses is still going to be part of the strategy going forward. So I guess, you could have raised maybe some cash through a sale or an IPO. Just why did you decide for the spin-off instead?

And just a technical question. How much of the voting right approval do you need for this from your shareholders to proceed? And then I have another question on the business after.

[Paolo Guglielmini, executive]

Okay. On the logic, we've looked at various developments and options with the Board, and we're still going to be very much open-minded about it. But we think that this on the table now is the best solution. And then when it comes to all the rest and the time line and the path and the approval processes, we will come back in due course.

[Johannes Schaller, analyst]

Understood. And then maybe could you just zoom in a little bit on your automotive business? Obviously, you made comments around European weak. I guess that's not surprising. China, maybe it's a bit mixed. You had a strong deal with BYD.

Just how do you look at these two regions for your auto business maybe as we go into next year as well directionally?

[Paolo Guglielmini, executive]

Yes. I think at the moment, we have good traction in the U.S., also in the supply chain of the automotive sector. We feel we have a good competitive position in incumbents and entrants, right? So we feel that we are in good shape across the board.

Europe is difficult to call, as you know. There's something that's more structural that's going on. And the outlook, we think it's more uncertain.

What we feel very good about is that we have a position of strength in China, for sure. But we also are very well positioned in places like Eastern Europe or Turkey, where places in which potentially there could be set up of manufacturing facilities in the scheme of how these OEMs will share volumes into the future.

[Johannes Schaller, analyst]

Just a clarification on China. You had China quite weak on a group level, but automotive was not weak in this quarter.

[Paolo Guglielmini, executive]

Yes. I think automotive specifically was not a standout weakness. We all see that the market, specifically the smaller customers tend to be very cautious in the way they buy in China. I think the downturn in construction was already happening last year.

I do think that MI was particularly strong last year compared to specifically the industrial peers. And that's also why in 2024 comparably, some of those growth rates are slow.

[Operator]

We will now take our next question, and the next question comes from the line of Alexander Virgo from Bank of America.

[Alexander Virgo, analyst]

I wondered if you could talk a little bit about the operational side of the business. Just in terms of gross margins, normally, we see a step-up in Q4, 67% already. So I wondered if you could just give us a little bit of a sense of what you're expecting into the end of the year and how that -- how we can think about that sustainably into 2025.

And in particular, I guess, dropping that through to the EBIT margins in Geo, which, despite the headwinds that you're facing there, are over 30 -- over 32%, I beg your pardon.

And then second question just around free cash flow conversion. Obviously, improved year-on-year, but weaker Q-on-Q. Thinking about how strong that ends up being in Q4 and, again, thinking about the trajectory into 2025, I guess, maybe a bit more for David.

[Paolo Guglielmini, executive]

Okay. Alex, so from a gross margin perspective, the good news for us is that we've seen gross margin pickups in pretty much all of the divisions. So for us, what's important is that this is not a byproduct of less hardware and more software. This needs to be a byproduct of all of the divisions working on their margin profile, using innovation, driving pricing and making sure the gross margin for new products are accretive, and that was the case. So we think [indiscernible] also when it comes to Q4 and then we'll see about next year.

David, do you have comments on cash?

[David Mills, executive]

Yes. The comments on cash, yes, I agree. Look, the position is good on -- we have the seasonal change in Q3, which we knew about. But year-to-date, the cash conversion being at 81% is materially above the 71% that we were at the same point in time last year.

We reached 80% last year, and we expect to be in the 80% to 90% target. We don't give, obviously, quarterly cash, but we expect to be well within the target range.

[Operator]

And the last question comes from the line of Daniel Djurberg from Handelsbanken.

[Daniel Djurberg, analyst]

First question is if this evaluation also is about to counteract potentially a political risk and also the fact that cybersecurity makes more of a 1-to-1 integrated solutions more vulnerable than you historically. That's the first question.

[Paolo Guglielmini, executive]

I don't think we had that specifically in mind, Daniel. I just think there's an incredible opportunity to build not 1 but 2 global leaders that are exceptionally focused on what they need to do.

[Daniel Djurberg, analyst]

Perfect. And if I may also, would it be fair to assume that you could do some kind of joint venture to create or secure the common projects, customers in AI and other stuff that you have jointly?

[Paolo Guglielmini, executive]

Yes, for sure. We would have a very tight collaboration. That's already ongoing, and that certainly would be very fruitful.

[Daniel Djurberg, analyst]

And also on operations then on -- can you comment a bit on the ATS800 tracker? Can you just remind me about timing when you go to market and if you should expect some support that we have seen historically from new products also from these new products, i.e., the ATS and also the [ ICS2050 ]?

[Paolo Guglielmini, executive]

Yes. Thank you for asking. We're all excited about that project. And to be honest, I believe that development hasn't been started in MI by me, but my predecessor. That's how much technology there is that went into that development. It's basically a productivity tool, right, more than a measuring and positioning tool.

It's going to be, we think, accretive and noncannibalizing. We've got a lot of positive reception during the beta testing, but also IMTS. Q4 is the quarter for us to build the pipeline. Typically, these complex systems require a 6-month sales process, and we're going to start shipping into Q1. And we think the ATS800 will be commercially significant into 2025.

[Daniel Djurberg, analyst]

Perfect. And a super quick follow-up. You mentioned BYD as a customer win. Obviously, a follow-up order since a long time ago. But can you comment if this -- if you do follow BYD into the new fabs they build in Brazil and Turkey or if this is still within China?

[Paolo Guglielmini, executive]

Specifically, the opportunity that Ben has talked about was within China. But yes, we feel very good about the relationship with them and the partnership and the executive connectivity.

And actually, one of the positions of strength that we are is the fact that locally, wherever they will go, we're going to have teams to be able to support them, right? At the end, it's one of the key elements of differentiation rather than working with possibly local partners for them.

[Operator]

As we will no longer be taking any questions, I would like to hand back to Paolo Guglielmini for any closing remarks.

[Paolo Guglielmini, executive]

Yes. Thank you very much for attending this Q3 review. I'm sure we're going to be talking soon again. Have a good weekend.

[Operator]

This concludes the conference call. Thank you for participating. You may now disconnect.