Ladies and gentlemen, welcome to the presentation of the Hexagon interim report Q3 2012. Today, I'm pleased to present Ola Rollén, President and CEO. For the first part of this call, all participants will be in a listen-only mode, afterwards there will be a question and answer session. Mr. Rollén, please begin.
Thank you very much, welcome to this earnings call for the third quarter for the Hexagon group. Of course, we're cheerful today. This is actually my 50th interim statement, so if I sound really happy, you understand why. I'd like to go to slide number four, which is headed Overview Third Quarter 2012. The recorded growth in the third quarter is 11%, and the organic growth, i.e., netted of currency impacts and acquisitions, is 5%. What we can see is that apart from Europe, all regions across the world display organic growth. We see an acceleration in Asia and South America. Emerging markets, strong double-digit growth, actually 17%, whilst mature markets have slight growth. Excluding Europe, Hexagon would have reported 9% organic growth, so the slowdown is very Euro-centric, as we can see.
Hexagon Geosystems reports growth, even though the division has the largest exposure of all our businesses to Europe. We've also noted in the quarter the Hexagon Metrology business reports growth despite tough comparison numbers in the third quarter and a weakening European automotive market. Intergraph SG&I turned around in the quarter, PP&M in Intergraph continue to outgrow its underlying market. We report a strong gross profit, 56% in the quarter, and an EBIT margin at 21% for the core business Measurement Technologies. Strong cash flow, which enable us to swiftly reduce our debt, that will continue into the fourth quarter. Slide five, seasonality in profit. Traditionally, the third quarter has been our weakest quarter. It's difficult with all the changes in the global economy to say what is a normal pattern in a year.
We've tried to highlight it by displaying previous quarters, you can now compare the third quarter to other third quarters in previous years. It's true to say that it's become less accentuated with the acquisition of Intergraph and other changes, primarily geographically. Slide six, key figures. Net sales amount to EUR 578.1 million, which is 11% recorded growth and 5% organic growth. We report an EBIT of EUR 115.7 million, which is 17% above the corresponding period last year. That equals to an EBIT margin of 20% for the group in the quarter. Without other operations, we would have reported 21% in the quarter. Earnings before taxes amount to EUR 104.3 million, which is a 24% growth, driven by the growth in operating earnings, also driven by the fact that we now have significantly lower interest costs.
Net earnings grew to EUR 84.5 million, which corresponds to an increase of 25%. The other parameter you have to add there is, of course, the tax rate, which is down one percentage point compared to the corresponding quarter last year. Thus, earnings per share grew by 26% to EUR 0.24 in the quarter. Now, if we turn to slide seven and look at the nine-month P&L statement, we report operating net sales of EUR 1.75 billion, which is 5% organic growth and 11% recorded growth for the first nine months. Operating earnings amount to EUR 354 million, which corresponds to an EBIT margin of 20.2%. Earnings before taxes amount to EUR 316.5 million, which is 16% above the corresponding period last year. Earnings per share have now grown by 18%, if we back out non-recurring items from EUR 0.61 to EUR 0.72 for the nine-month period. Cash flow.
Cash flow from operations before changes in working capital amount to EUR 142.9 million. Paid tax in the quarter was significantly higher than the corresponding quarter last year. Amounts to almost EUR 16 million versus slightly lower than EUR four million for the third quarter last year. If you look at the tax paid in the cash flow statement for the nine-month period, you can see that we've been able to reduce the tax rate over the corresponding period last year by almost EUR 10 million. You can make a similar assessment if we look at the financial net paid, which is different from what we booked in the P&L statement, obviously. It's now reduced from EUR 42 million for the nine-month period to EUR 38 million, reflecting the amortization of debt that we are undertaking. Cash flow from operations in the quarter, EUR 116 million. Changes in working capital, a positive EUR 13.8 million.
This is the natural seasonality of our working capital changes that we should see a positive trend in the second half of the year. Thus cash flow from operations amount to EUR 129.8 million. Ordinary investment activities amount to EUR 45.2 million, and the increase is driven primarily by two factors. We are currently investing in new facilities around the world, and I'm going to come back to that. Plus, we've increased our R&D activity from 9% gross spending to sales to 11% gross spending to sales. This reflects our effort to bring new products that can continue to grow Hexagon's top line going into 2013. Thus, the operating cash flow amounts to EUR 84.6 million for the quarter and EUR 208.6 million for the nine-month period. Currency effects, slide nine.
If we look at the quarter, we had a negative trend for the Swiss franc against the euro, which actually gives us a positive profit impact since we have a negative exposure in Swiss francs. The U.S. dollar and the Chinese renminbi, two other important currencies, were also having a positive profit impact in the quarter. Thus we report an EBIT impact of +EUR 9 million against the corresponding period last year, and a sales impact of 6% or EUR 31.3 million for the quarter. For the fourth quarter, if currencies stay roughly the same as they are right now, we expect the currency impact to be roughly 2%-4%, with a normal margin and profitability on the EBIT line, and the 2%-4% is obviously the sales impact. Market development in the quarter. If we go to slide 11, we see significant shifts in very rigid numbers.
Western Europe is now down four percentage points in Hexagon's total sales mix. North America has increased its share of total sales from 28% to 29%, and South America has increased by another percentage point, reflecting the very strong demand we see in South America at the moment. EMEA, excluding Western Europe, stays put at 7%, and China is increasing its share from 14% to 16%, reflecting the strong demand we see in China in the quarter. Asia Pacific remains at 13%. 21% of sales now stems from markets outside Western Europe and North America. If we look at slide 12, where we try to capture business trends in the quarter and compare that to the previous quarter, i.e., the second quarter of 2012.
Starting with Western Europe, we can now see that the yellow arrow reflecting 0% to 8% growth has now been replaced by a red arrow, reflecting the negative growth for the group and the zero growth for the core business Measurement Technologies. Middle East, not much changes. NAFTA, not much changes on the top line. South America continues to grow strongly. We've replaced yellow arrows in the regions Asia Pacific and China with blue arrows reflecting the very strong growth we report in Asia in the quarter. Turning to segments, we can see that we do note a slowdown for the construction industry in Western Europe and a slowdown for the automotive industry in Western Europe, coupled with a slowdown in general manufacturing in Western Europe.
If you want a quick summary, you could say it's really Western Europe that has changed significantly in the quarter compared to previous quarters of 2013. When it comes to the slowdown of the automotive industry, it's primarily automotive countries such as France and Italy, where we see most of the slowdown. Looking at other markets, we do see an increased activity for power and energy in China, an increased activity for the construction segment in China. We also see a decreased activity for surveying in Asia Pacific, that is the slowdown that we all noted for the mining industry in Australia. Moving to some comments about the various sub-markets. EMEA.
The demand for Hexagon's products and services in EMEA was basically flat in the quarter, minus one for the group, zero for the core business, reflecting the very strong slowdown we see for other operations, i.e., manufacturing in Scandinavia. Decreased activity levels in Western Europe primarily stems from automotive, general manufacturing, and infrastructure activities. Demand remains strong, though, however, for our CAD software and also for some subsets of Geosystems and Metrology in other regions. Regions like Africa, Eastern Europe, Middle East continue to grow at double-digit growth rates. Moving to slide 14, Americas. Market trends, automotive, aerospace, and general engineering, as well as infrastructure projects generate growth in NAFTA. We do see the continuous stabilization of the construction sector in the U.S. Defense and security products continue to remain a weak sector for us in North America.
We still see and detect high demand in the natural resources sector in Canada, and we report significant organic growth for all products and all end markets in South America. As a matter of fact, South America is our strongest growing region in the quarter with 37% organic growth. Asia market trends. All of Hexagon's divisions and application areas record growth in China in the quarter. The growth is primarily stemming from strong demand in local automotive manufacturing, local aerospace, local power and energy suppliers, and projects to increase power supply in the region. Infrastructure-related businesses also saw an increase in demand, but for mining in Australia. Hexagon Geosystems continue to recover in China as the new business initiatives start to contribute to growth, and that's something we're going to see continue into the new year.
Other areas of growth were India, Korea, and Japan that all reported strong double-digit growth in the quarter. As I've already commented, negative growth for Australia due to the slowdown in the mining sector. 11% organic growth, almost 30% of total sales. If we now turn to slide 16, we can start analyzing the various regions and what's happening. We've compared the third quarter of 2008, which was the previous peak. If you look at Hexagon's organic growth, it started to decline in the fourth quarter of 2008. The third quarter was the last strong quarter for the group, pre the financial crisis. Since that peak, Asia has continued to expand and is now almost 40% above the previous peak level of 2008.
We can also note that the very strong downturn in Europe and America, since that downturn, Americas has recovered and is now almost 20% above the previous peak. This is obviously growth stemming from South America, but the fact that we also see a recovery in primarily the engineering sector up till now. Now we also begin to see a recovery in the construction and infrastructure sectors in North America. Europe recovered well up till last year, and now we see a flattening development for the Western European markets. Within EMEA, you still have significant growth from the other regions, but Western Europe is 30% out of the 38% we see for EMEA. Segment information. If we move to slide 18, we can see that the core business, Measurement Technologies, is growing 6% organically for the nine-month period and 5% for the third quarter.
Measurement Technologies reports an all-time high EBIT margin for the third quarter, 21.3%, which corresponds to EUR 120.3 million, which is a 19% increase over the corresponding period last year. Actually an acceleration in earnings growth if you compare to the nine-month period. If we look at the various businesses within MT on slide 19, you can see an acceleration of growth within the technology area stemming from all three sub-businesses. PP&M growing at strong double-digit growth. SG&I returning to single digit, but growth. NovAtel reporting single digits, strong growth as well. Metrology, we do see a sequential slowdown in the organic growth in metrology from unsustainable levels of above 20%, 30% down to a more normalized level. Hexagon Geosystems is fighting the fact that 50% of the business is in Western Europe.
It's recently lost the high-speed rail business, but we do believe that we will see a gradual recovery to growth, single-digit growth in Geosystems. Slide 20, gross margin. Gross margin continued to improve in the quarter, and it's stemming from favorable product mix in the quarter. We had a lot of software content in a very rich mix in the quarter. Moving on to slide 21, we see the EBIT margin continue to improve towards our 2015 target of 25%. Orders and product releases. This month, we had a groundbreaking ceremony in Huntsville, Alabama, U.S., where we started the construction of a five-story, 250,000 sq ft facility for all our Huntsville, Alabama employees in Intergraph. This facility is expected to open, we expect to inaugurate it in the summer of 2014. The total investment is $58 million.
When you forecast our investments going forward, you need to be mindful about $58 million is roughly EUR 45 million over eight quarters, and that's roughly EUR 6 million per quarter. If we turn to slide 24, we signed an agreement. We formalized our partnership with WorleyParsons, an Australia-based EPC. Slide 25. Quite interesting and fascinating project, ITER, which is a consortium that is going to design the next-generation nuclear fusion reactors. It's a conglomerate of countries and regions that's come together in this global organization represented by European Union, China, Russia, Japan, India, South Korea, and the U.S. They're going to use Hexagon technology to design this new reactor. Slide 26, Projemar in Brazil will standardize on Hexagon software, designing the next-generation tanker ships, so-called FPSO hulls.
Slide 27, we had some significant wins in the quarter for our design software products as well with Daelim, TVA, and we also were ranked the number one overall engineering and design solution provider by the ARC Advisory Group in the quarter. Slide 28, Edmonton Fire Rescue Services standardized on Hexagon products and will complete its upgrade of the Intergraph I/CAD suite of software products for its fire rescue services. Slide 29, Vale, the large Brazilian miner, is not only using our design, our CAD design software to design their mining refinement factories, but they're also using Intergraph SG&I products now to maintain and keep control of what's going on in the open mine pits. Slide 30, SwissFEL is an institute that is developing ultra-fast chemical processes that you've never before been able to for record and capture.
They choose Hexagon Metrology as their supplier, since we were the only one that really could cope with the extremely high accuracy and level of precision necessary to be able to cope and capture these processes. Slide 31, BMW or MINI Cooper Oxford purchased and chose Hexagon Metrology to measure their body-in-white applications. Slide 32, several major orders were placed by GM, Timken, and the electric car manufacturer, Tesla, which you see on the picture. Slide 33, we received several major orders from the aerospace industry of North America as well, from engine manufacturers to aircraft manufacturers. Reflecting the increased activity that we do see and foresee going into next year from aerospace. Slide 34. This is the subway or underground network in large cities where we'd seen activity in the quarter.
We have not seen activity in high-speed rail. China Marine Surveillance also placed a significant order for lidar systems and airborne cameras in the quarter. Slide 35. KKC placed an order with us and made a frame agreement using Leica Geosystems in their activities. Slide 36. NGA, the National Geospatial-Intelligence Agency of North America or of the U.S., has also acquired a large number of Leica Geosystems precision robotic total stations, the so-called TS30 and TS15, with a built-in imaging solution. Slide 37. Our mojoMINI, which is an agricultural product will support the Brazilian agricultural equipment manufacturer, Jacto, and we've signed a three-year contract with Jacto. Monitoring services, slide 38. Lusail Light Rail transit system in Qatar will use our software, imos, to basically trace any deviations or any cracks or risks for cracks in its infrastructural underground tunnel activities. Slide 39.
We launch a new product called RCD30 Oblique, and it's an airborne camera, and the point with oblique is basically you take pictures with angles and thus can create 3D urban city modeling by using it. Slide 40. NovAtel is once again sponsoring the NASCAR fleet so that you can measure speed and basically post it on screen so that you can see how fast the cars are driving. That was some of the events and orders and activities that happened in the quarter. If we now go to slide 42 and try to summarize this quarter, we think it was a good quarter. We had another strong quarter sales growth, recorded 11% or organic 5% in spite of the slowdown in Western Europe. Gross margin at all-time high, 56% and 21% EBIT margin in our core business.
A 25% improvement in net earnings and a strong cash flow for the quarter. And by that, I've finished my presentation, and I'm now prepared to answer any questions there might be in the call. Thank you.
Ladies and gentlemen, if you have a question for the speakers, please press 01 on your telephone keypad and you enter a queue. That's 01 on your telephone keypad. And the first question comes from Mr. Lars Brorson from DNB. Please go ahead, sir.
Yes. Thank you very much. Good morning, all. I had three questions, if I could. First, with regards to the trends that you've seen on your page 12, can you give us a sense for how these trends developed as the quarter progressed, whether you had seen any specific discontinuities, particularly in September? In relation to that, specifically on Geosystems in Europe, are you seeing any material channel destocking there? That's my first question.
Well, the quick answer is no. We don't see a destocking simply because our distributors in Geosystems have been very careful restocking after the financial crisis in '08. In general, I'd say these trends that we display on slide 12, they continue into October.
That's useful. Thank you. The second question I had is on your gross margins, which are obviously expanding on a sequential basis despite a seasonally lower quarter, and I appreciate your comment on mix shift here. Can you give us a sense for what your underlying like-for-like gross margins are doing in Geosystems and also in Metrology? To Metrology, what are you seeing in terms of pricing on current deliveries?
If we start with Geosystems has improved its gross margin by one percentage point over the corresponding quarter last year. Metrology's gross margin is fairly flattish as a comparison to last year, but its EBIT margin has improved. We do not see any price pressure on Metrology.
Is that a general group comment or are you seeing regional differences? Specifically, what are you seeing pricing-wise in Europe?
Regarding metrology products?
Yes.
We don't see a price reduction, and you must remember that metrology is probably the most global business we got to the extent that we have key accounts that benchmark prices across the globe. For example, an auto manufacturer with operations in North, South America, Asia, and Europe would compare our quotes across the globe.
That's useful. Thank you. The third question I had is to your organic growth in PP&M. You say strong double-digit growth here, and the fact that you continue to outgrow the underlying market. Can you be a little more specific? Is it fair to assume that the 10% organic growth in technology equals close to 20% year-over-year for PP&M organically? Also to that, can you talk a little bit about the year-over-year comps that you've got in PP&M, both in this quarter and in the next couple of quarters?
Let's put it like this. We're happy with the growth.
You think it can accelerate from current levels?
I'm not going to comment on it. We're going to see as the year progresses.
Thank you.
Thanks.
The next question comes from Mr. Ben Maslen from Bank of America. Please go ahead, sir.
Yeah. Morning, Ola. A few questions, please. Firstly, I think you said that you expect Geosystems to get back to low single digit or mid-single digit growth. Can you just run through the drivers of that and by when you expect that? Is that for Q4 or later in 2013?
I believe it's going to be a sequential development where obviously it's going to continue into 2013. One has to understand that historically, Western Europe has been Geosystems' strongest market. What we're planning to do, without telling you too much, is to launch a set of new products in the new year. We have plans to strengthen our distribution capabilities in growth regions going into the new year, that we think will have a positive impact on Geosystems' organic growth.
Great, thanks. As a follow-up on that, we've seen some better news from high-speed rail budgets in China. There's a difference between headlines and I guess what happens on the ground, do you think that will be a help next year?
I do believe infrastructure could be a help for Hexagon Geosystems going into 2013, simply because you're not going to see any positive news coming out of China before the 8th of November.
On the 8th of November, they're changing guards in China, and the old regime or government will not take any long-term decisions pre the 8th of November. I do believe that when we see the new government or the new party representatives in place, we're going to see a much more, I don't know what we should call it, agile activity from China and specifically in the infrastructural areas.
Okay, great. Can I just ask a question on SG&I? I think you said you've hit a return to organic growth for this quarter. Is that sustainable going forward and what does the pipeline of new business look like or tender backlog heading into next year?
I think we're not too concerned about the pipeline, let's put it like that. I can't disclose what we have in the pipeline, obviously, but I believe that with a bit of luck, it could be a fairly good year for SG&I going into 2013.
Okay. I'll get back in the queue. Thank you.
Thank you.
We have a question from Mr. Erik Pettersson from ABG. Please go ahead, sir.
Yes. I have two questions. First one, incremental margins in your core business are improving quite a bit there, which to some extent I guess comes from positive mix. To get a better understanding of the different profitability levels today, what kind of drop through to EBIT would you have, assuming all growth comes from the technology business?
Why just the technology business?
Just for an understanding of the mix impact, does that grow faster?
The incremental margin for our best products is obviously very close to 90%, and for our worst products it might be 10%. We're currently seeing a favorable mix shift towards more high-margin products, and we expect and we hope that to continue.
Okay, thank you.
If I put it like this, by 2015, our group margin should be at 25%, so our incremental margin must be higher than 25% if we ever are going to reach our target.
Okay. Two more questions. The conditions in Europe, as you say, are quite weak, and you had some initiatives there on perhaps trying to accelerate growth. Do you see the need for any restructuring activities in your European footprint to compensate for the weaker demand?
We don't see a big cost-cutting program right now. We don't see the need for it right now, but one should never rule it out because it's a very unstable situation in the Western European markets. Let's put it like that.
Okay. Then one final question on your other operations, the work to divest that business, how is that progressing? Do you see it happening anytime soon?
Do you know a buyer? No, we are actively working with it. We're also looking at other ways to dispose of the activities. Let's put it like this, that one of our largest customers is the heavy vehicle industry in Scandinavia, and you've seen their report, so it doesn't help us disposing of these activities.
Thank you.
Thank you.
The next question comes from Mr. John King from Barclays. Please go ahead, sir.
Hi. Thanks for taking the question. Just a couple on PP&M, if I could. Ola, could you just characterize a little bit more for us where you're seeing the strongest growth for PP&M, whether it's Latin America or China or what have you? Connected to that, can you talk a bit more about the motivation behind establishing the Greater China unit for PP&M, and maybe how much of your PP&M revenues at the moment comes from Greater China? Thanks.
We don't disclose how much comes from Greater China, but we believe that we're probably one of the largest foreign suppliers in China at the moment, if not the largest. Growth comes from all regions, and I'd say the slowest growth for PP&M in the quarter is Western Europe. North, South America, Asia, Middle East, are all strong growth contributors in the quarter.
Great. Thank you.
The reason why we established a separate region is simply because that's the Hexagon model. We got more than 2,000 employees in China, so it would be foolish not to capitalize on our very strong presence in China.
Great, thank you.
Thank you.
The next question comes from Mr. Jon Hyltner from Handelsbanken. Please go ahead, sir.
Good morning. Can you hear me?
Yeah.
Great. I have some questions. I'll go by them one on one, please. You gave some good comments on what to expect for the assistance, you expect it to improve. I wonder if you could give some similar comments on Metrology, given that they have a much tougher comps there. Do you see it likely that you could accelerate growth in that segment as well?
That's a tough question because I think what one should expect going into next year is that we're going to see a very weak automotive market in Europe. On the other hand, I do believe that we might see an improvement for the automotive industry in Asia. How that pans out for the total demand from the automotive segment is yet to be determined. On top of that, we think aerospace might accelerate. At this moment, we still expect single-digit organic growth coming from Metrology. If it's strong or if it's weak, it's too early to say, but we do expect to see growth from the Metrology segment.
On a similar note, on your Measurement Technologies business, obviously, you will probably meet pretty tough comps in next year. How do you view that?
No, that's correct. Of course, if you grow at strong double-digit numbers, it's getting more and more difficult to sustain growth. Having said that, we do see a lot of activities in the energy sector in connection to nuclear build-out across the world, new oil and gas assets that are being detected and explored. We do see a continuous strong activity in the energy sector going forward.
Good. That was encouraging. One more question on cash flow and inventories. As you typically do, you have a strong cash flow in Q3. Still, if I look at your inventories, they've been going up now, I think it's for the past three quarters. Is this just due to you having fairly good sales, so they need to go up, or is there something that you are not happy with and might address in Q4 or next year?
I think that what we never disclose is our inventory really consists of two components, inventory has been going down, or working capital has dropped significantly against sales if you compare to last year. We're happy with the working capital as such. When it comes to inventory, the two components is inventory for sale, i.e., inventory that we keep to be able to ship to customers, we have a demo inventory. We're approaching the end of several generations of products where we still have demo inventory for those old products, we're now ramping up to replace those with new technologies. Thus, you have an artificially high demo inventory that we hopefully will be able to address in the fourth quarter. We talk about marginal.
That can't be that substantial, I guess.
No.
No. Okay. Thank you very much.
Thank you.
The next question comes from Mr. Mikael Laséen from Carnegie. Please go ahead, sir.
Yeah. Hi. Thank you. Could you talk about the synergies that you expect ahead? Talk a little bit more about that.
I'm not sure. That's a very broad question.
Yeah. How much that will impact sales already this year, and give us an update on your larger announced programs?
From the water management system, we expect to have our first commercial order and delivery in the fourth quarter. That will be not very significant numbers in the total scheme of things. We do expect an increase over the next coming few years, a significant increase for water management. All in all, we've said that we should see contributions from these projects, which basically are seven group projects that we run centrally, starting to contribute with meaningful numbers as of the second half next year. We've guesstimated that to between EUR 100 million to EUR 200 million in top line by 2015.
Okay. What about the virtual assembly project?
That's running as well.
Okay. Could you say something about the build-out pace for the hydrology projects that you see in China? Will that be mainly in the second half next year that that will contribute?
I think it's probably fair to say, if you start at zero in 2012, and you reach between EUR 100 million to EUR 200 million by 2015, you have a fairly good view on how this is going to pan out.
All right. Just a clarification, if it's possible, if you could say something about the SG&I growth rate this quarter, I maybe missed that.
It grew, and after three to four consecutive quarters of decline, we now record organic growth, and it's not double digits, but it's not 1%.
Roughly 4%-5% then.
Well, that's up to you.
Okay. Thank you.
Thank you.
The next question comes from Daniel Djurberg from SEB Enskilda. Please go ahead.
Yes, hello. Good morning. I just wanted to ask you something on the quite substantial growth that you've seen in South America during the quarter. I think you said it was up by 47%. Is the part of that reason the fact that you improved your market position through the acquisition of SISGRAPH? In that case, do you see similar acquisitions in other markets where you don't have the way you can improve your standing?
It was 37% organic growth-
Sorry
not 47, it's still significant, I wish all the regions could grow at that pace. Definitely, yes, we've seen a significant improvement in market penetration via our acquisition of SISGRAPH. Yes, we have some similar acquisitions in the pipeline that we're looking at, where we hope we would get similar effects.
Can you give us any sort of examples, or is there any sort of big markets where you are still quite low penetrated, such as India and so on, where you can make significant steps forward in acquiring distribution?
I think that if you look at regions like Eastern Europe, Russia, Central Asia, parts of Southeast Asia, East Asia, we definitely have white spots.
Thanks a lot.
Thanks.
We have a follow-up question from Mr. Ben Maslen from Bank of America. Please go ahead, sir.
Thanks. Ola, we've seen Trimble and AVEVA get together to kind of cooperate on, I think, scanning solutions, 3D scanning. Can you talk a bit about how you view this? Is this a kind of competitive threat? Is it a vindication of where the industry is going over the next few years? Maybe just what advantages you have to doing both parts of the equation in-house. Thank you.
Are you sure it's true? Isn't it FARO and AVEVA you're referring to?
I saw a headline on Trimble and AVEVA. No, I'm pretty sure it's Trimble.
All right. Well, what can one say? I guess we were right. People are reacting to our acquisition of Intergraph, and they see the benefits, and we're quite happy with that.
In terms of doing both parts of it in-house, is there an advantage to that or not, you think?
What do you expect me to answer?
What would the advantages be? Is it R&D? Is it bundled products?
No, it's everything really. It's more complicated, and it takes a bit longer time to answer than the time we actually have here at this earnings call, but we obviously believe that we have lots of benefits going forward by having both software and hardware and sensors in-house. I think that what we're going to create is something that you can't really create by striking alliances between independent companies.
Okay. Thank you.
Thank you.
Then, Patrik, on the gearing target, you're making progress towards the two and a half times. When you get there, what are your priorities for the balance sheet? Is it further debt reduction, or will you speed up M&A?
That's a very good question, and we will come back to that when we reach the target, which should be sometime in February.
Okay. I'll wait till then. Thank you.
Yep, thanks.
The next question comes from Mr. Prasad Borra from Goldman Sachs. Please go ahead.
Hi, Ola. A couple of questions from my end. Firstly, on Europe, was it a case of sales cycles lengthening, or did you actually see some of the deals slipping out of the pipeline? Secondly, on U.S., you have continued to see good growth in U.S., but are the fiscal cliff issues playing any role in the deal sizes decreasing or order entry weakening in the fourth quarter?
We start with Europe, we saw what the Germans call Mittelstand, i.e., the medium-sized, the small-sized companies that we deal with. They hesitated to invest in the third quarter. The very large companies in Europe, they continued their activities as planned, we didn't see a slowdown. It's really the smaller size, the medium-sized customers where we noted a slowdown. We didn't see a slippage, it was more of a hesitation to place the order. If we move across the Atlantic and discuss the fiscal cliff, we haven't seen any impact from that discussion as of October in our order books. I think that probably the attitude is we continue till Christmas, and then we see what happens in January. That's the feeling I get.
You must remember that some of our products are still benefiting from tax reductions and tax reduction programs in the fourth quarter in the United States.
Okay, just one more from my end. On China, you have been putting incremental investments in energy business and around dam monitoring projects. How is the pipeline shaping up? You mentioned that you have a project or a deal coming through in fourth quarter. Heading into 2013, do you actually have 10 times the number in terms of number of deals which you're going to see, or is it more like 2014 or 2015?
I think we will see a gradual increase over the next coming few years for water management systems in China. We are obviously optimistic about the potential that we do see, especially in connection to the new government in China. When it comes to energy, yes, that's correct. We have invested in our local organization in China to be able to capture more of the local market in China, I think it's fair to say that that's almost an untapped market between us and our competitors.
Okay. Thank you.
Thank you.
We have a last follow-up question from Mr. Jon Hyltner from Handelsbanken. Please go ahead.
Thank you. I get the last question. That's nice.
Yeah.
One question on mainly the auto segment. Last time around when we saw big stoppage weeks in the production units, did you see any of these car manufacturers taking the opportunity when production was down to look over production lines and maybe install some of your equipment as production was down?
That's a good question because we actually saw it in Asia, but we didn't see it in any other region. We saw Japanese car makers doing exactly what you suggest and some of the Chinese players, but we did not see that in Europe or North America in 2009.
Okay, good. Another question on the margin. You improved it by a percentage point in the quarter year-over-year, and it seems like most of it is mixed, but you are taking some measures on the costs before. Could you give us some magnitude of how much of the improvement is mixed and how much is cost savings and other factors?
I'd say in the nine months and this quarter, it's actually all mix because don't forget that we've increased our R&D spending from 9% of sales to 11% of sales, that corresponds to roughly EUR 60 million on an annualized basis that we've increased. We basically hired people, we've staffed up our R&D activities in primarily the technology segment and the Metrology segment.
You do have cost reductions in other areas, such as admin and sales, but you do have a significant increase in R&D.
Okay. That is very helpful. Thank you very much.
Thank you.
There are no further questions at this time. Mr. Rollén, please go ahead.
There isn't much left to go ahead with, so thank you for listening, and talk to you next quarter. Thank you, everyone.
This concludes the Hexagon interim report conference call. Thank you all for attending.