Fortive Corporation — Q3 2018 Form 10-Q
Reporting period: Third quarter and nine months ended September 28, 2018; comparisons are with the periods ended September 29, 2017. Fortive operates in Professional Instrumentation and Industrial Technologies.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Sales | $1,840.1 million | $1,685.3 million | $5,436.8 million | $4,849.3 million |
| Gross profit | $924.3 million | $839.4 million | $2,734.0 million | $2,388.5 million |
| Operating profit | $321.4 million | $356.7 million | $1,042.1 million | $1,001.4 million |
| Net earnings | $245.3 million | $267.8 million | $801.5 million | $707.6 million |
| Diluted EPS | $0.64 | $0.76 | $2.21 | $2.01 |
- Q3 sales increased 9.2%; growth from existing businesses was 3.2%, acquisitions contributed 7.2%, and currency reduced growth by 1.2%. Nine-month sales rose 12.1%.
- Q3 gross margin improved to 50.2% from 49.8%, while operating margin fell to 17.5% from 21.2%. Nine-month gross margin was 50.3% versus 49.3%; operating margin was 19.2% versus 20.7%.
- Q3 operating profit and net earnings declined despite higher sales. Acquisition/divestiture transaction costs reduced Q3 operating margin by an estimated 260 basis points; acquired businesses had a further 85-basis-point dilutive effect. Net earnings attributable to common stockholders were $227.9 million in Q3, including $17.4 million of preferred dividends.
- The effective tax rate declined to 17.2% for Q3 and 17.0% year to date, versus 23.1% and 25.2%, respectively, primarily reflecting U.S. tax-law changes and other tax benefits.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $899.6 million, compared with $713.0 million. Capital expenditures were $93.7 million; operating cash flow less capital expenditures was approximately $805.9 million, a calculated measure.
- Acquisition cash outflows were $2,825.2 million, contributing to net investing cash outflow of $2,914.8 million. Financing provided $2,234.5 million, including $1,337.4 million net proceeds from mandatory convertible preferred stock.
- Cash and equivalents were $1,145.1 million at quarter-end. Total debt carrying value was $5,002.5 million, including $1,824.5 million classified as current; debt less cash was approximately $3,857.4 million, calculated. Most cash was held outside the U.S.
- The $1.5 billion revolving credit facility had no borrowings; approximately $632 million was available after commercial-paper backstop usage. Fortive reported compliance with debt covenants. Management said liquidity should be sufficient for foreseeable needs.
Material developments, outlook and risks
- Fortive acquired Gordian for $778.2 million and Accruent for approximately $2.0 billion, both net of acquired cash. These acquisitions drove much of reported sales growth and increased goodwill and intangible assets. The company also acquired a minority interest in Tritium for less than $50 million.
- On October 1, 2018, after quarter-end, Fortive completed the A&S Business split-off, receiving total consideration of $2.7 billion, including cash proceeds, debt reduction and a share exchange with retirement of Fortive shares. The business is expected to be presented as discontinued operations beginning in Q4.
- The announced approximately $2.7 billion cash acquisition of Advanced Sterilization Products was expected to close in Q1 2019, subject to customary conditions, including regulatory approvals.
- Management expected existing-business sales to continue growing year over year during the rest of 2018 and forecast 2018 capital spending of approximately $115–$125 million, excluding A&S-related spending. Significant transaction costs were expected to continue in Q4.
- Headwinds included unfavorable sales mix, higher material costs and tariffs, growth investments, acquisition dilution and transaction expenses. Management highlighted uncertainty around trade policy, particularly U.S.–China relations, along with foreign-exchange exposure, market cyclicality, competition, acquisition integration, debt and potential impairment risks.
- Fortive issued 1.38 million shares of 5.0% mandatory convertible preferred stock, with a $1,000 liquidation preference per share and mandatory conversion scheduled for July 1, 2021. Its dividends reduced earnings available to common shareholders and conversion may dilute common shareholders.
Investor verification priorities
- Assess organic growth and the sustainability of margin pressure, separating acquired-business contributions and transaction costs from underlying performance.
- Review post-quarter A&S proceeds, debt repayments, discontinued-operations presentation and the funding and closing risks of the pending ASP acquisition.
- Track debt maturities, commercial-paper refinancing capacity, cash location and the impact of preferred-stock dividends and eventual conversion.
- Evaluate tariff, foreign-exchange and U.S.–China trade exposures, along with acquisition integration and goodwill/intangible-asset valuation.
- Confirm actual 2018 capital spending and sales growth against management’s stated expectations.