Good day, and thank you for standing by. Welcome to the Hexagon Second Quarter Report 2024 conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. 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, CEO. Please go ahead.
Good morning. Thank you all for joining our Q2 2024 earnings call. Despite headwinds in our core markets, we have delivered a solid quarter of incremental operational and strategic improvements. In this Q2, we recorded sales of EUR 1,353 million impacted by weakness in the construction sector and slowing investments in automotive, affecting sales of our sensing and robotic systems. Growth in recurring revenues remains strong nevertheless, up 8 percentage points to EUR 560 million, driven by subscriptions and SaaS revenue momentum. In Q2, we also have hit a new all-time high of 67.3 percentage points of gross margin, very importantly making incremental improvements across all of the five divisions. This gain is a result of investments in innovation to constantly optimize the cost structure of our portfolio, came through diligent pricing to counter inflation, favorable mix, and operational improvements.
Moreover, the Manufacturing Intelligence and SIG divisions benefited from the divestment of non-strategic business units in prior quarters. Strong operating margin followed this gross margin expansion, landing at 29.5 percentage points versus prior year at 28.9%, also supported by gains from the rationalization program. Cash management was strong, with conversion at 85%, which is in line with the annual guidance, and operational cash flow before NRIs has grown by 17 percentage points year-over-year. Looking into Q3, we expect demand to remain challenged, but we also expect these operational improvements to continue, as well as the momentum in recurring revenue. Very importantly, Q3 will also be particularly active for us in terms of new products introduction across divisions to position us strongly to capture market shares as demand improves.
If we move to slide four, in terms of geographic trends, we see Americas, the Middle East, and India as the areas in which we experience more sustained broad-based commercial momentum. In the U.S., manufacturing, data centers, public safety, and defense demand remain strong, despite a large comparative deal booked in Q2 2023 skewing our revenue growth this year. In Western Europe, despite uncertainty in the automotive supply chain, in machine shops, and the construction sector, we managed to grow by 4 percentage points with particularly strong momentum in the Middle East across industries. Aerospace and process industries remain positive in Europe, driving demand for software and for more automation. In China, we saw a revenue decline of 4 percentage points, although against an 11 percentage points of growth comparative last year, with order intake softening on the back of several consecutive years of good growth.
As you know, we have a very strong team in place in China, and our team is always making the most out of its market environment, so we stay positive for the future of our operations and growth in that region. India confirms the positive trend for sure, with good underlying growth. We have a strong commercial team in place. We're localizing the business in India wherever necessary to continue to build up our operations and leverage that growth opportunity into the future. Looking at the divisional performance in slide five, Manufacturing Intelligence was flat against an 11 percentage points of growth in Q2 2023. ALI grew at 9%. Geosystems contracted by 5 percentage points. AS declined by two against a very strong quarter last year. SIG grew by 6 percentage points.
As you can see, Geosystems managed to maintain a strong 32 percentage points of operating margin despite the top-line decline, and all of the other divisions delivered on strong year-over-year margin improvements. If we now look at each of the divisions one by one, but first of all, looking at their quarterly development over the last year or so, without going into too many details, you see in Q3 last year we recorded robust growth, particularly in Manufacturing Intelligence, ALI, and AS, and then softer comparatives will come our way moving into Q4. Manufacturing Intelligence in slide seven. We have delivered revenues of EUR 484 million at an operating margin of 26.7%, a good improvement year-over-year. We've seen positive progress with our laser trackers and precision robotics growing strongly, particularly in the commercial aerospace sector.
Good growth in our software portfolio, simulation, and enterprise quality management solutions has pushed recurring revenue up in MI by 4 percentage points year-on-year. The margin progression of 70 basis points was achieved through the divestment of PMI and the continuous efforts on rationalization and operational excellence. The asset life cycle intelligence division in slide eight recorded sales of EUR 203 million, up 9 percentage points year-on-year. SaaS revenues grew by 20% in the quarter, with recurring revenue up 10 percentage points as we keep on building a strong foundation for the future. ALI keeps on delivering good incremental margin on this growth, and its cash generation remains strong. Also, it was great to see in the quarter our largest wins coming from asset management applications for data centers and design solutions positions into the pharmaceutical and medical sectors as a push to continually diversify the business.
In Q2, we have released more capabilities to guarantee digital continuity between design and engineering all the way to operations and maintenance, supporting our cross-sell activities, and we have acquired a very interesting SaaS solutions for asset performance management that will definitely strengthen our portfolio. Moving now to Geosystems in slide nine. We have recorded sales of EUR 405 million in the quarter, down 5 percentage points. As mentioned, demand for surveying equipment and construction tools is impacted by interest rates and low confidence, but we are convinced that our innovation pipeline is strong and will stimulate demand into the future. In the Geosystems software portfolio, we have seen 12 percentage points of growth in recurring revenues, driven by very good adoption for HXDR, our digital reality platform now hosting more than 60 TB of data and projects, and our software portfolio for design, project management, and field solutions.
Pricing, cost management, and rationalization helped support the growth and operating margins for Geosystems in Q2. If we look now at autonomous solutions in slide 10, the overall demand environment is broadly unchanged for the AS division, if not for a degradation of confidence in the agriculture sector that we serve through accurate positioning solutions. The flattening of our top line is more a function of tough comparatives and strong sustained growth in the prior period, but the adoption of monitoring and safety solutions in mining, in high-end positioning, and autonomy in transportation is still positive. AS recorded sales of EUR 141 million in Q2 at a strong operating margin of 37% versus prior year at 35 percentage points. Also, in this case, recurring revenues grew strongly at 22 percentage points year over year, driven by correction services contracts. Safety, infrastructure, and geospatial in slide 11.
This division recorded sales of EUR 120 million, up 6 percentage points year-over-year at an operating margin of 20%. It was a good quarter for SIG, driven by the adoption of our public safety and security software solutions. In particular, the adoption of OnCall, our computer-aided dispatch platform, remains very good, both in terms of performance in field once deployed and pipeline development and overall market reception. We will now move to finance with David Mills.
Thank you, Paolo. In the following financial slides, I would like to take you through what was a resilient performance considering the challenging economic backdrop, which consequently impacted organic growth, with the business delivering incremental EBIT1 margin and continuing to generate cash flow securely in the target range. Moving on to the income statement, starting with Q2 2024, stepping through the sales bridge. Sales of EUR 1.3534 billion is a reported growth of -1%, negatively impacted by FX of -0.4% and equally a +0.4% net impact from structure, giving zero organic growth. Notably, gross margin improved significantly year-over-year to 67.3%. As we've previously discussed, this is an important component of our EBIT1 expansion and was delivered by a broad-based divisional improvement.
Operating earnings increased by 1% despite the flat growth to EUR 399.5 million, with a 60 basis point improvement in the margin to 29.5%, the details of which I will break out in the following profit bridges. The earnings before taxes were equivalent due to the increased interest expense of EUR 42 million versus the prior year of EUR 36 million, offsetting the increased EBIT. So in this quarter, we had interest expense equal to the prior quarter sequentially. Taxes being 80% in line with prior year bring us down to an EPS of EUR 10.80. For reference, the EBIT1, including PPA, includes EUR 28 million of amortization and so dilutes the percentage by 208 basis points to 27.4%. Moving on to the next slide, gross margin.
As already mentioned, the Q2 was an all-time high gross margin at 67.3, and this brings the rolling 12 months to 66.5, up from 65.9, so a 60 basis points improvement continuing the overall upward trend. The strong quarterly performance being from improved margin in all divisions and therefore with multiple drivers, including pricing discipline, the Rationalization Program, product innovation, enhanced by both a positive divisional and product mix, and further improved by the structural divestment. Moving on to slide 15. In the same way as we discussed the achievement of our long-term financial objective for EBIT1 margin development at the CMD, we can see this coming to fruition in the quarter, with one of the key components being gross profit improvement, as seen on the previous slide, adding an incremental 170 basis points.
Despite the flat organic progression, both sales and G&A costs are holding in absolute terms and as a percentage of revenue, with the Rationalization Program helping offset inflation and thus not diluting the EBIT1 margin. As anticipated, we have a negative -1 % impact on the net R&D, which is predominantly the increased amortization as new product releases are introduced, as we see the flattening of the gross R&D spend sequentially, excluding the incremental spend on the large automation project in AS, and the capitalization rate is consistent at 56%. The accumulation of this being the improvement on the year-over-year EBIT margin of 70 basis points. Moving to slide 16, the profit bridge. In Q2, profitability bridge currently has an accretive EBIT1 impact.
This is despite the negative currency translation on sales of EUR 5 million, having a corresponding EUR 2.5 million EBIT at a margin of 50%, as it's outweighed by the net year-over-year translation, which is a positive EUR 6.8 million, driven from the current year loss of EUR 4.5 million against the prior year loss of EUR 11.4 million. The translation movements are less material this quarter, driven mainly from continuing currency trends, with the further devaluation to the euro of the CNY by 2%, where sales exceed costs, and appreciation in the Swiss franc of 0.5%, which has the opposite characteristics, offset by a reversal in the 12-month trend on the US dollar, which appreciated by 1.2%. The structural element is accretive and reflects the net impact of acquisitions left disposable.
In the quarter, the disposal of the hand tool business in MI and the IT services in SIG exceed the incremental acquired sales, of which the material elements were Hard-Line in the AS division and in the period Voyansi and Xwatch in Geosystems. The marginally negative organic sales element has no dilution impact. So excluding the accretive impact of currency, we would have delivered a further 20 basis points improvement in EBIT one in Q2, which is in line with the Q1 performance. Moving to seasonality. From a modeling perspective, I would like to revisit the long-term seasonality for Hexagon, which we have previously presented. For Q3, historically, this has been moderately weaker from both a working capital and EBIT one margin perspective relative to the preceding Q2.
Post the COVID years, which have their own dynamics, the Q2, Q3 EBIT margin seasonality has been somewhat masked by the FX transaction impact and any relative geographical shift in the Asian market, which have their own phasing. That said, if the margins are adjusted for these one-time FX impacts, the seasonality is more evident. Moving on to the next slide, to the cash flow, which builds positively on the improvements from Q4 and Q1, and so continues the strong start to the year. The adjusted EBITDA demonstrates a stronger cash leverage at 4% than EBIT at 1%, as the D&A add-back continues to increase. Capital expenditure remaining at similar levels carries a 7% improvement to cash flow post-investments.
Net working capital was a EUR 3 million build versus the prior release of EUR 10 million, which generated an operating cash flow increase before tax and an interest of 3%, which is a cash conversion of 85% versus 84% prior year. Including cash taxes, which reduced, and interest payments, which increased, the improvement in cash flow before non-recurring is 17%. Non-recurring items cash flow of EUR 19.5 million brings an operating cash flow of EUR 229 million, up 12%. Moving to the next slide. Following on from the combined net working capital release in Q4 and Q1 of EUR 82 million, Q2 saw a moderate increase of EUR 3.1 million, though the ratio to rolling 12-month sales stayed at 7.3, which is 28 basis points below the prior Q2. The constituent elements of the movement being receivables and prepaids dropped EUR 14 million, despite increased sequential sales as collection focus continues with DSOs down to 80 days.
We are continuing to manage inventory, but with mixed changes, we had an increase of EUR 13 million, but DIIs are holding relatively flat at 118 days as the prior quarter. Though the total liabilities decreased normally over Q1, the trade DPOs are on a solid quarterly improvement trend up to 58 days. The decrease in deferred revenue is reflective of the billing cycle and was offset by a cyclical increase in accrued expenses. So in conclusion, the quarter again showed the resilience of the business with improvements in EBIT1 performance, supported by the rationalization program, and despite a more challenging macro environment, the cash focus has given a positive H1 delivery, building on the strong close of 2023. And with that, I would like to hand over to Ben.
Thank you, David, and good morning, everyone. If we go to slide 21, here we give an update on the rationalization program that we launched this time last year to improve our overall efficiency. As you can see, this is feeding into the margin improvement that we have delivered during the quarter. As Paolo said, we also see the benefit at the gross margin level of the disposals we made last year in Manufacturing Intelligence and SIG. And we continue to rationalize our facility footprint, closing a further 24 sites during the quarter. We're now around 70% of the way through that program, which overall aims to reduce our footprint by around 25%. If we move to slide 22, here you can see the overview of the product footprint by division that we presented last year at the Capital Markets Day.
What we've done here is highlight where in the portfolio this quarter's customer product launch and acquisition case studies come from to help your understanding of the new divisional structure. So if we go to slide 23, firstly, an example from manufacturing intelligence. A C Energy Solution Ltd are setting up Thailand's first electric vehicle battery factory, and they need high levels of precision in their assembly process to ensure the safe and reliable performance of the batteries. A C Energy have chosen to implement Hexagon's CMM machines and metrology software to underpin their overall quality control process. If we move to slide 24, we have an example from ALI. Ecopetrol, the largest oil and gas company in Colombia, is adopting ALI's product suite to digitize their entire operations, saving time, reducing waste, and generating pretty impressive cost savings.
This sale includes SDX, our asset lifecycle information management, our digital twin data platform, and EcoSys, our suite of project management tools. If we go to slide 25, we have another significant customer win for ALI in the enterprise asset management business, which, as you've seen, has had a strong quarter. One of the global hyperscalers has selected Hexagon's EAM platform to track the condition of their assets in their data center network, to both improve maintenance strategies, maximize the uptime of these facilities, and overall improve profitability. If we go to slide 26, we have an example from Geosystems' surveying hardware and software portfolio. Bluesky International, an aerial mapping company in the U.K., is using Hexagon's Leica CityMapper airborne sensors to capture the 3D data needed to make a digital twin of the city of Nottingham for use in urban planning and decision-making.
The capture data is also made available for resale via the Hexagon content program. On slide 27, we have a customer win from the SIG division. Here, we've won a follow-on order during the quarter from BMW for our OnCall dispatch, planning, and response solutions at four of their production facilities in Hungary. And this follows a successful implementation at their campus in Munich over the last 12 months. If we go to slide 28, we'd like to highlight an exciting product launch for ALI, the second generation of their successful SDX platform, which was launched a few weeks ago. The new version is a cloud-native multi-tenant SaaS version, which will make it easier to integrate project data as well as operational data to create a digital twin of a large industrial facility.
This can be used to transform the way industrial enterprises manage their assets throughout their lifecycle, leading to significant gains in efficiency, safety, and sustainability. Staying with ALI, if we go on to slide 29, we'd like to highlight the acquisition of Itus Digital, which closed during the quarter. Itus has developed a modern SaaS-based APM software platform, which can be used to manage a customer's asset strategy, predict the likelihood of failure of these assets, monitor asset performance, and allow you to take timely measures when risks start to increase across your business. This both improves uptime and reliability. And as Paolo said, we see strong synergies between Itus and our existing EAM platform. If we go on to slide 30, we highlight the acquisition of Xwatch, which Geosystems completed in April.
Xwatch is a provider of OEM-agnostic machine control and related software technologies, which allow operators to set limits on an excavator's operating height and reach in order to set a predictable working zone. This significantly increases the safety of those employees working around large machines like this. Finally, if we move to slide 31, another acquisition made by Geosystems during the quarter, Voyansi, which is a provider of BIM solutions and reality capture services. Voyansi's services are used to digitize all asset types, including industrial facilities, data centers, shopping centers, and so forth, and create a digital twin which can be used throughout the design, build, and operate phases of that asset lifecycle. Their solutions obviously complement Hexagon's existing leadership in reality capture technologies. So we welcome Itus, Xwatch, and Voyansi to the group. With that, I hand back to Paolo.
Thank you, David and Ben. So in conclusion, we will see how the market environment develops in the short and midterm, but I'm pleased with the level of execution that we have demonstrated in the quarter. We remain focused on targeting growth areas, focused on executing on innovation and building a more resilient business through recurring revenues, growth, and operating margin improvement, efficiency, and predictable cash generation. Therefore, I'm confident in our strategy and the business model for the future. Also, I'm very excited to meet with customers and analysts and investors at the upcoming trade shows later in Q3, where we will show great new solutions and innovation. And with this operator, we're now available to take questions. Thank you very much.
Thank you. As a reminder, to ask a question, you will need to press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. We will now take our first question. Please stand by. And the first question comes from the line of Daniel Djurberg from Handelsbanken. Please go ahead. Your line is now open.
Thank you, operator, and good morning, Paolo, David, and Ben. And congrats to the nice audience, at least. I will ask you on the R&D spend, roughly 16% of revenues, obviously in no-growth markets, that obviously impacts this negatively. But my question is, if you can comment a little bit on what you've seen from the launch product and platform, say, the last 12 months, how has these impacted the growth for the company? If you can give any range of how it's been supportive. Thanks.
Yeah, hi, good morning, Daniel. Just a couple of comments by division. So in terms of Manufacturing Intelligence, we have done a lot of effort in innovation and localization in specific markets. I mean, we have seen the results of that in the last couple of years in terms of China sustaining growth rates above competition, also because of this level of innovation that was focused on that specific market. The second aspect that is helping support in the business, supporting growth and supporting gross margin is all the innovation that went into robotics and tracking solutions. There's a big push in commercial aerospace to double down on volumes, and we have the best solutions in the market in terms of optical technologies as well as software that goes with it.
In terms of ALI, just to mention one, I mean, you've seen, you heard from Ben, a continuation of the investments in SDX. It's pretty simple what we're trying to achieve. We want to have the best data strategy for customers so to keep them in our own environment and connect the various applications as well as we possibly can, maintain continuity, and help with ourselves. Moving on to Geosystems, I would point out two aspects. Gross margin also comes as a result of investment in innovation. We stay focused on refining the construction of our sensors in the market by making more use of AI and analytics at the edge. That's important for customers, and that's important for our own gross margins. And secondly, the 12 percentage points of recurring revenue also comes as a result of investment in HXDR.
We have more than 33,000 customers by now, a ton of projects, very good growth, and so we're positive about it for the second half of the year and the future. In terms of autonomous solutions, I'm equally excited by what's been done and what's ahead of us in terms of innovation for autonomy and for mining. I pointed out 22 percentage points of growth in recurring revenue. Here again, correction services are unique and differentiated and very valuable for customers as a result of innovation. And then last but not least, it was great to see public safety grow in double-digit within the SIG division in Q2 as a result of having OnCall, which is at the moment the most state-of-the-art computer-aided dispatch platform in the market.
Perfect. Very good answer. May I also just have a follow-up on your ambition in the India market, your current position a bit, brand awareness, competition, and if it's possible to keep similar margins in India as you have elsewhere, for example, in China?
Yeah, it's a great question. We're building up our operations. The business is still relatively small, but growing at a good pace. We have seen good growth for everything that's related to the infrastructure built up, particularly last year. And at the moment, we have 20-30 percentage points of sustained growth in manufacturing to support sort of the local market. As you know, we roughly have 2,500 people in India supporting both with the development of local software solutions as well as helping commercially the local market. This is another market in which both on the hardware and the software side, we're trying to localize so that we can address not only the right requirements in terms of data, but also requirements in terms of cost structure.
Perfect. Good luck and have a great summer.
Thank you. You too.
Thank you. We will now take our next question. Please stand by. The next question comes from the line of Alexander Virgo from Bank of America. Please go ahead. Your line is now open.
Yeah, thanks very much. Morning, Paolo, David, Ben. Thanks for taking my questions. I have one on growth and one on margins, please. So you've sort of given a bit of an indication for the first time on what you think is going to happen in terms of Q3 by describing the market as remaining challenging and difficult. Consensus has got 4% growth in Q3 and 6% growth in Q4. I wondered if you could just give us a sense. Does difficult mean zero, as you've done in the quarter here? I appreciate you don't guide, but some sort of help would probably be good. And then I'll follow up with a question on margins, if I may.
Yeah, what I would say is that one of the reasons why we've posted flat business performance in the quarter is because we see that there's uncertainty in the market in terms of the closing time for these commercial projects, right? So we see deadlines moving. When it comes to Q3, we think we're going to be trading at similar levels. And then when it comes to the outlook beyond that, we will see, it is in the hands of a lot of different factors. For sure, we have innovation coming to sustain market adoption, and for sure, we start to meet with lower comparative figures from prior year.
Okay, thank you, Paolo. And then on margins, I guess the issue is that zero contribution from organic in the bridge at the group level masks a lot of what's going on underneath. So I wondered if you could just give us a sense or help us on the moving parts more quickly. If I've got my numbers correct, I think the increase from R&D is only about EUR 11 million year-on-year. You've had close to EUR 40 million in terms of savings year-on-year, again, if I've got that correct. So what's going on under the hood by division or some sort of sense as to how we can, again, get a sense of how the margin's going to progress through the rest of the year? Thank you.
Yeah, Alex, I mean, you rightly point out that there's a lot moving, and that's why I tried to put the OpEx bridge in there to give a little bit more flavor of what was moving across the different lines to give a bit more visibility. I think we've given pretty good transparency there that you can see that we're really holding flat the sales and G&A costs. That's clearly where a significant portion of the rationalization program is going in. That rationalization program is also fortunately going into the gross margin to support that. So you do see those elements coming through. We're supporting with no organic growth and improved gross margin and offsetting, obviously, a year-over-year significant inflation increase in cost base. So that's where the majority of the savings program is going and where everything's coming through.
Hopefully, that gives you a little bit more flavor of what's going on.
Okay, thanks.
Thank you. We will now take our next question. The next question comes from the line of Andre Kukhnin from UBS. Please go ahead. Your line is now open.
Good morning, gentlemen. Thanks very much for taking my questions. I'll go one at a time and maybe start with a follow-up on the margin. In terms of the savings program, what should we expect for the run rate for Q3 and Q4 compared to the EUR 38 million in Q2?
I mean, the EUR 38 million, as you see, we're starting to approach what the full expectation was for the Rationalization Program. We've moved at a pace. I think we've moved quicker than perhaps we initially envisaged giving a fourth quarter for the finish of the program. We're not going to give exact where we're heading in terms of the incremental value, but I think we've moved significantly through the program thus far. If you look at that as an annualized version, we're at, I think, EUR 163 million. So we're very close to what was the original EUR 175 million saving over the EUR 200 million restructuring provision.
Thank you. And a more broader question, thinking beyond 2024, is there an ongoing recurring kind of productivity effort at Hexagon and this program comes on top, like some companies have something like 3% annual productivity gains as a sort of standing target and then special programs on top? Or are these the programs that drive this annual savings, and hence we should think about maybe a further program for 2025, 2026?
Yeah, hi, Andre. So first, we don't have a further program in sight. I'll say two things. I mean, the Rationalization Program that we have launched last year captured a portion of these initiatives. And then, of course, there's an ongoing push for efficiency that doesn't require an outlay of capital that we wanted to single out to investors specifically, right? I mean, if you look at, when it comes to the much talked about generative AI, if you look at two areas, beyond everything that it's in beta testing, beyond everything that is at the moment, at least for us at the level of anecdotal sort of return on investment, there's two pockets of efficiency when it comes to the development effort through GitHub and the content creation within marketing.
There's two pockets of return on investment and productivity that are coming through very strongly, easily measurable, that didn't require a participation from the rationalization effort. In terms of cost structure into the second half of the year, there's other levers that we can pull based on trading conditions that don't require, again, an outlay of capital as part of the rationalization program.
That's very clear. Thank you. If I may, just a final very quick question. In terms of kind of monthly demand run rates in Manufacturing Intelligence and Geosystems, was there anything unusual during the quarter in terms of monthly run rates and in terms of how this quarter started? Is there anything to call out?
Hey, Andre. In terms of Geosystems, I don't think so. I think we see a steady trend, I guess, through Q2 and into Q3. For manufacturing, obviously, if you look at the slide that shows the sequence of quarters, it's been slowing down over the last 12 months or so. I think looking into Q3, we see it sequentially similar, maybe with a little bit of incremental slowdown in China in Q3, but nothing too dramatic as we went through Q2 and into July.
Great. Very helpful. Thank you very much, Silvia.
Thank you. We will now take our next question. Please stand by. The next question comes from the line of Erik Golrang from SEB. Please go ahead. Your line is now open.
Thank you. I have two questions. The first one is, I guess, trying to peg the Q3 here, following up on some prior questions, just the order intake development in manufacturing solutions or intelligence in the quarter. And then the second question on the various software platforms you have and sort of customer responses and behavior to it. You had good development in the quarter, but there's some concern that we're seeing a delay in certain software investments here as customers wait for more sort of AI-related updates to various platforms. Is that something you at all are experiencing? And then the third question on the total investment level, CapEx, it was a bit down in Q4 and Q1, slightly up in the second quarter. What's your expectations there for the second half of this year? Thank you.
Yeah, hi, Erik. If I take the MI order trend, if you look to North America and Western Europe, there wasn't a huge mismatch between orders and revenues. But in China, it was a little bit weaker in Q2. So orders were a little bit below revenues. And that's why I think for Q3, we think China could end up being slightly negative, nothing too dramatic. But beyond that, orders were in line with sales.
Yeah, hi, good morning, Erik. In terms of software, we're pleased with the performance in the quarter. I don't think the things are going to change dramatically going forward. A couple of patterns that we have observed. One is that services related to software activities seem to be a little bit more under pressure, right?
So there's partly a reluctance to do configuration of packages or invest into stronger connectivity of these enterprise solutions to the rest of the stack that customers have, and this tends to have an impact. Secondly, I would say that the speed at which customers make decisions is different between key accounts and customers that are deeper in the supply chain, smaller companies, smaller packages, smaller value application software. And this is not unusual, I think, when there is a slowdown and key accounts have sort of digitalization initiatives that are more long-term, while smaller customers tend to be, as you know, a little bit more reactive to sentiment and rates.
Yeah, to your investment question, I mean, we have talked about that our R&D is at a kind of peak level in the innovation cycle at this moment in time. I did mention that we see outside of the one specific example in the automation in the AS division, that the R&D is flattening or reducing. I mean, we have EUR 156 million capital expenditure, as you said, and I would expect that to be flat to slowly starting to decline is the overall general trend that we're looking for.
Very clear. Thank you.
Thank you. We will now take our next question. Please stand by. The next question comes from the line of Magnus Kruber from Nordea. Please go ahead. Your line is now open.
Hi, Paolo , David, Ben, Magnus from Nordea, a couple from me as well. Good momentum in the software business was good to see. Could you say if you benefited from any larger perpetual deals that we should think about or keep in mind as moving to the coming quarter, or should we see the +9 in ALI as a sort of a clean number?
Yeah, Magnus, hi, good morning. I don't think the perpetual moved in any unusual sort of way. I think it's just a good acceptance for subscriptions and SaaS where we have good momentum. And then a lot of the innovation in our software portfolio is coming up through subscription packages, right? And I would say those initiatives, all of the platforms that consume a lot of 3D data created by our scanners tend to be priced on a consumption basis, and that tends to funnel into recurring revenues.
Perfect. Thank you so much. That's clear. And then a second one, could you comment a bit on the weakness in the automotive market? Is this something that sort of decelerated sharply in the quarter or some more of a gradual weakness? Any flavor that you could add to regions or verticals would be very helpful.
Yeah, Magnus, I'd say two things that we noticed. There's a weakness in Central Europe in the supply chain. I think there's uncertainty in the way people spend specifically for capital goods. And then secondly, in China, I think there's been a big wave of investment in and around EV. And you can see that as a byproduct of a few things that are happening in the market, a bit of consolidation and aspects that have got to do with geopolitics. There's more reluctance in investing from that perspective. So what we're trying to do is to stay very focused on growth areas, right? I mean, you heard about pharma, about process, you heard about data centers, you heard about aerospace and energy. All of the divisions are focused on finding different growth areas in industries that are more malleable to investing in digital solutions right now.
Perfect. Thank you so much. And just one final one on the gross margins, 170 basis points up year-over-year. Could you unpack that a little bit between the different components of mix and savings and so on. That would be helpful?
Yeah, I mean, as I say, it's a very broad increase. So it's very difficult to move that into the constituent elements. I think we've been pretty transparent to say it's driven by all of those factors. I could perhaps do it a little bit by some of the divisions that saw some of the different impacts. So, for example, product mix, strong software, and obviously ALI and MI. In terms of the rationalization program, it would have been MI and GEO. In terms of the investments, it would have been SIG and MI. In terms of pricing discipline, it was pretty much across all of them.
Got it. Thank you so much.
Thank you. We will now take our next question. The next question comes from the line of Joachim Gunell from DNB Markets. Please go ahead. Your line is now open.
Thank you, and good morning. On the cost savings program here, which was announced a year ago, since I would assume that market conditions have deteriorated or worsened. Can you comment whether you think that there is a need to actually fully take down that program based on what you were predicting?
Hi, Joachim. Good morning. As I said earlier, we don't plan to do anything above and beyond what has been announced last year. We're still working through all those projects, and then we have other ways of building efficiency into the business.
Great. And just finally then, when it comes to Geosystems and kind of eventual green shoots, what part of the business would you first expect to see those, and what are you currently seeing?
Yeah. I mean, I think from a construction indicator perspective, you still see the PMIs and the billing indexes and so forth being relatively weak. So if we do get interest rate cuts, it will eventually start to feed into an improvement there. But that historically doesn't come back so quickly. I think what you're more likely to see is a general improvement in optimism around the economic outlook that will then feed into our channel partners starting to buy a bit more inventory ahead of a pickup. That's normally how a recovery in Geosystems would work.
Excellent. Thank you.
Thank you. We will now take our next question. Please stand by. The next question comes from the line of Sven Merkt from Barclays. Please go ahead. Your line is now open.
Great. Good morning. Thank you for taking my questions. I have three. Maybe we can go to them one by one. I mean, first, you have been very clear on the overall growth outlook for the business for Q3, but maybe you could give us a bit more details on the segments in which you have good visibility and where we could see an improvement or a softening in the second half?
Yeah. Hi, Sven. Good morning. I mean, I think we've talked already about manufacturing intelligence and the outlook. In terms of ALI, I mean, I would see a continuation of the good momentum. Then, of course, comparatives change and the mix of software can change, but I would say the outlook is very much unchanged, right? And again, when I see growth coming from a variety of industry sectors, that creates more opportunity, and I think the ALI is set for a good future there. In terms of Geosystems, as Ben said, we stay focused on what we can control, right? I mean, right after summer, we're going to have a global event like InterGeo. We're going to have the opportunity to showcase our radar and monitoring solutions at MINExpo in Vegas, which happens once every four years.
Every time that we come to market with solutions that really add to the financial productivity of our customers' businesses or add to the compliance and safety requirements of these companies, we give them great reasons for coming back to the market and supporting Hexagon. In terms of autonomous solutions, the numbers that you see in terms of top line are more a function of comparatives than a function of the underlying strength and momentum in the business. I also see that we're going to think that we're going to see an acceleration, if not in the second half of the year into next year, when it comes to more autonomy projects that allow us to reutilize components of technology that we already have in-house. I think the outlook for SIG probably will remain similar to the levels at which we have been seeing them grow into Q2.
So that makes for the group-wide outlook that we have already discussed earlier.
Perfect. Thank you for all the details. Another question just on the cash tax. As you noted, they have been much lower in the quarter last year. Can you just give us some details on what growth is, how sustainable this is, and how we should think about the cash taxes in a four-year context?
Yeah. As you know, I mean, variation in cash taxes, it's always timing shifts. And so I think you have to look at the cumulative. I don't suspect we will have a significantly lower overall cash tax in the year, but we had obviously lower cash tax in this quarter. But you can't legislate for timing differences in that element. So I think look at the whole year and think that it's probably likely to be similar.
Okay. Perfect. That's helpful. And then just finally, you mentioned geopolitics and the reluctance to invest in some regions. Can you just give us a bit more clarity what exactly happened? Did you see already an impact in the quarter or since then, and how material is it at the moment?
Thanks, Sven. No, I wouldn't call out specific products or areas of the business. I think geopolitical uncertainty feeds into uncertainty in people making purchasing decisions, and they might decide to wait and see. So I think it's more of a high-level top-down effect than something that's kind of micro and you can pin down to specific businesses.
Okay. That's very helpful. Thank you.
Thank you. We will now go to our next question. Please stand by. The next question comes from the line of Daria Sipos from JP Morgan. Please go ahead. Your line is now open.
Hi, and thank you for taking my question. I just wanted to double-click a little bit on the GenAI implementation you mentioned internally. So you mentioned development efforts to GitHub and content creation through marketing. Do you have any kind of early indication of what sort of OpEx savings could result from that implementation, and how advanced is the implementation internally at the moment? Is there more to kind of roll out and gain incremental efficiencies? Thank you.
Yeah. Hi, Daria. What I would say is when you look at GitHub, now we start to have a population of software engineers within Hexagon using those copilots that's substantial, right? So we start to have data points that are very interesting, and then we can also analyze in terms of the productivity impact defined by seniority, right, of the development population. So I think we're getting better at utilizing those tools. We do have ratios, of course, in terms of productivity improvements in development. And then it's all a question of what are you trying to achieve, right? I mean, do you want to get the functionalities before competition? Do you want to move delivery dates for product development, or do you need to bank on efficiency in terms of OpEx?
What I'm happy about is that there's been very early engagement throughout the organization and a big push to make these adoptions measurable. Then we will see, right, how to use these tools in the future so they have an impact also financially for us.
Thank you. That's very helpful.
Thank you. We will now take our next question. The next question comes from the line of Nay Soe Naing from Berenberg. Please go ahead. Your line is now open.
Hi. Good morning. Thank you for taking my questions. I've got two, if I may, and I'll go one by one if that's okay. The first one is a two-parter on the top-line growth. Starting with just a clarification question here. I think earlier you mentioned that for Q3, you're expecting at a similar level of growth outlook. Just want to clarify here, similar level to the Q2 or the Q1? And second part of the question is, if I were to assume about low single-digit organic growth for 2024, if I then take an average for the past three years, looking out to your midterm targets to hit the bottom of the 5%-7% organic average growth target, you'll have to do a minimum about 5% growth in 2025 and 2026. Could you share your confidence level on that growth trajectory, please?
Yeah. Hi, good morning. So yeah, first of all, we refer to similar growth level as experienced in Q2. And then secondly, when it comes to the financial plan from 2022 to 2026, as you know, with the conclusion of H1, we are at the midpoint. And I think so far, as of the end of Q2, we are exactly at the midpoint of the 5-7 percentage points of organic growth range that we have indicated and that had baked in from the get-go an expectation of softening and downturn within this period. So yeah, we stay confident on the achievability of that goal.
Okay. Thank you. And then the second question is on the margins. I've noticed specifically around your depreciation amortization cost. And of course, your amortization on the capitalized R&D has gone up in the quarter or sequentially going up as well, but the depreciation amortization rate has remained pretty flat both in Q1 and Q2. Could you maybe help me understand where the savings are coming from despite the amortization cost going up quarter on quarter, please?
Yeah. I mean, the depreciation cost is up EUR 8 million year-over-year. So you do see the return of that, and the differential between cap and amortization is smaller in this quarter than it was in the prior year. So it's definitely moving. We've said we're at the peak of our innovation, and as Paolo's alluded to, we have significant future releases also, which will accelerate that rate, but you definitely do see the rate increasing.
Right. Okay. And if I may squeeze in one last question, quick question here. On your R&D cycle, you mentioned that we should expect the intangibles CapEx level to stay consistent at Q1, Q2 level, but then should also expect that to wind down in the outer years . Can you give us a timeframe as to when the decline will, when we should start to see a decline?
No. I mean, obviously, we've talked about being at a peak of an innovation cycle in a relatively short term. I wouldn't want to try and predict where growth and everything else was going over that long term to say where that spend match would go to.
All right. Okay. Thanks.
Thank you.
Thank you. We will now take our next question. Please stand by. The next question comes from the line of Mikael Laséen from Carnegie Investment Bank. Please go ahead. Your line is now open.
Thank you. I have a question about the Geosystems and the growth and the margin dynamics. If you can elaborate on the demand situation for different sensors and the main product areas and how mix shifts within those are affecting the margin for that segment?
Yeah. Hey, Mikael. I mean, I would say if you look at it over the last 12 months, I would say that we probably had 12 months of weakness within Geosystems on the surveying tools. Machine control a little bit softer. But if you look back three or four quarters, reality capture was stronger following the release of the second-generation BLK. What you've seen over the last couple of quarters is as the reality capture has hit tougher comps, that has slowed down as well. So that's kind of put downward pressure on Geosystems' overall growth rate. But from a margin mix perspective, I wouldn't call out any big differences between those products. The margin decline in this quarter is more the fact that you've got lower volumes offset by savings that we've had from the cost-saving program.
Okay. Got it. Can you also mention something about the software platforms that you have launched and how they are developing? Nexus, for example, and HXDR seems to be developing well. Can you also mention something about Reality Cloud Studio, for example?
Yeah. Sure. Hi, Mikael. Good morning. Reality Cloud Studio is one of the applications within HXDR that is deployed for content and is deployed for hosting and sharing scanning data that comes from our portfolio. In terms of Nexus, I think it's in a different stage of maturity. At the moment, it's used to drive cross-selling within the portfolio of solution at MI. So we're pleased with progress on both, and we stay very positive about the future on both.
Okay. Thanks.
Thank you. Due to time constraints, we will not be taking any further questions, and I will hand back to Paolo Guglielmini for any closing remarks.
Yeah. Thank you. Well, I just want to thank you all for listening in in this last hour. Despite the headwinds, we are pleased with the way we executed in the quarter. We stay focused on capturing the growth areas that we see out there by industry and regions. And I'm pleased with what the teams have done in terms of building a more resilient business. We have a lot of innovation to look forward to. So yeah, we'll be excited to share more of these updates with you in three months from now. Thank you.
This concludes today's conference call. Thank you for participating. You may now disconnect.