Fortive Corporation — Q3 2020 Form 10-Q
Reporting period: Quarter ended September 25, 2020; financial statements are unaudited. Unless otherwise noted, amounts are in millions of dollars. Q3 and year-to-date (YTD) comparisons are against the comparable 2019 periods.
Business context
Fortive reported two segments: Professional Instrumentation and Industrial Technologies. The reported Q3 and YTD results include Industrial Technologies, which Fortive spun off as Vontier on October 9, 2020. Fortive distributed 80.1% of Vontier to shareholders and retained 19.9%, which it planned to divest within twelve months. Vontier will be reported as a discontinued operation beginning in Q4 2020.
Key financial results
| Metric | Q3 2020 | Q3 2019 | YTD 2020 | YTD 2019 |
|---|---|---|---|---|
| Sales | $1,902.3 | $1,860.0 | $5,187.0 | $5,317.6 |
| Gross profit | $983.4 | $927.7 | $2,673.5 | $2,644.4 |
| Operating profit | $310.4 | $242.1 | $621.1 | $708.9 |
| Net earnings from continuing operations | $225.8 | $207.3 | $398.4 | $546.6 |
| Diluted EPS from continuing operations | $0.61 | $0.56 | $1.02 | $1.46 |
- Margins: Gross margin was 51.7% in Q3 and 51.5% YTD, up 1.8 percentage points in each comparison. Operating margin was 16.3% in Q3, up 3.3 points, and 12.0% YTD, down 1.3 points.
- Cash flow: YTD operating cash flow was $1,151.9; capital expenditures were $86.2. Operating cash flow less capital expenditures was approximately $1,065.7. Cash and equivalents were $1,489.1 at quarter-end, versus $1,205.2 at year-end 2019.
- Debt and liquidity: Debt carrying value was $5,698.4, including $999.2 current and $4,699.2 long-term. The filing reported $2.7 billion of debt maturities within one year, while classifying certain term loans as long-term based on intended and available refinancing. The $2.0 billion revolving facility was undrawn; Fortive reported compliance with its financial covenants.
- Liquidity after quarter-end: Fortive received cash consideration from Vontier’s separation and said it intended to use it for debt repayment and regular quarterly dividends. It repaid $350 million of the 2021 term loan and approximately $131 million of yen-denominated debt in October, and gave notice to redeem approximately $750 million of 2.35% notes, with redemption scheduled for November 13.
Changes versus prior periods
- Q3 sales rose 2.3%; YTD sales fell 2.5%. Sales from existing businesses declined 0.1% in Q3 and 7.1% YTD, while acquisitions contributed 2.2% and 5.6%, respectively.
- Q3 operating profit increased despite modest sales growth, reflecting cost reductions, favorable mix and lower material costs, as well as less acquisition-related fair-value and transaction effects than in the prior-year quarter.
- YTD operating profit declined, including an $85.3 million non-cash goodwill impairment for the Telematics reporting unit, separation-related costs, and lower sales from existing businesses. The impairment followed a COVID-related deterioration in the unit’s outlook.
- YTD operating cash flow increased by $355.9 million from $796.0 million. Better working-capital cash contribution and timing of other payments helped; 2019 investing cash use was unusually high due to acquisitions, including ASP.
- Net interest expense was lower in Q3 ($43.9 million versus $47.0 million), but higher YTD ($130.7 million versus $116.7 million), primarily reflecting debt used to fund acquisitions.
Outlook, commentary and risks
- Management reported sequential demand improvement across businesses and geographies in Q3, while noting continuing COVID-19 uncertainty. All essential production facilities were open; the company had not experienced significant supply-chain or distribution constraints as of the filing.
- For the remaining portfolio after the Vontier separation, management expected Q4 2020 year-over-year global demand to range from relatively flat to growth of 3%. Recurring-revenue, healthcare and backlog-oriented businesses were viewed as more resilient; short-cycle industrial businesses remained more exposed.
- Management planned further cost actions and cash-flow focus in Q4, alongside approximately $30 million of additional strategic productivity-improvement spending. Expected 2020 capital spending for the post-separation portfolio was approximately $80 million, including about $20 million for ASP integration.
- COVID-19 remained a material risk to demand, operations, customer collections and supply chains. The filing also highlights risks that the Vontier separation could be found taxable and that separation-related indemnification obligations could adversely affect Fortive.
- Unusual items include $62 million of Vontier stand-up and separation costs YTD ($21 million in Q3), recorded in SG&A and expected to be reclassified to discontinued operations in future filings; and the $85.3 million Telematics goodwill impairment. Adoption of the expected-credit-loss standard increased the opening receivables allowance by $40.0 million, with a $31.3 million after-tax reduction to beginning retained earnings.
Important facts for investors to verify
- How post-separation results, segment reporting and the retained Vontier stake are presented in subsequent filings, including the timing and proceeds of any divestiture.
- Actual debt repayments, the cost of redeeming the 2.35% notes, and Fortive’s debt and liquidity position after applying separation proceeds.
- Whether Q4 demand and recovery trends met management’s stated flat-to-3% range for the post-separation portfolio.
- Whether COVID-19, customer credit deterioration or supply-chain disruption leads to further margin pressure, receivable provisions or goodwill impairment.
- The eventual tax and indemnification consequences of the Vontier separation, and the reclassification of separation costs to discontinued operations.