MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the financial condition and results of operations ofColfax Corporation ("Colfax," "the Company," "we," "our," and "us") should be read in conjunction with the Condensed Consolidated Financial Statements and related footnotes included in Part I. Item 1. "Financial Statements" of this Quarterly Report on Form 10-Q for the quarterly period endedApril 3, 2020 (this "Form 10-Q") and the Consolidated Financial Statements and related footnotes included in Part II. Item 8. "Financial Statements and Supplementary Data" of our Annual Report on Form 10-K for the year endedDecember 31, 2019 (the "2019 Form 10-K") filed with theSecurities and Exchange Commission (the "SEC") onFebruary 21, 2020 .
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements contained in this Form 10-Q that are not historical facts are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 21E of the Exchange Act. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date this Form 10-Q is filed with theSEC . All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including statements regarding: the impact of the COVID-19 global pandemic, including the actions by governments, businesses and individuals in response to the situation, on the global and regional economies, financial markets, and overall demand for our products, projections of revenue, profit margins, expenses, tax provisions and tax rates, earnings or losses from operations, impact of foreign exchange rates, cash flows, pension and benefit obligations and funding requirements, synergies or other financial items; plans, strategies and objectives of management for future operations including statements relating to potential acquisitions, compensation plans or purchase commitments; developments, performance or industry or market rankings relating to products or services; future economic conditions or performance; the outcome of outstanding claims or legal proceedings including asbestos-related liabilities and insurance coverage litigation; potential gains and recoveries of costs; assumptions underlying any of the foregoing; and any other statements that address activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future. Forward-looking statements may be characterized by terminology such as "believe," "anticipate," "should," "would," "intend," "plan," "will," "expect," "estimate," "project," "positioned," "strategy," "targets," "aims," "seeks," "sees," and similar expressions. These statements are based on assumptions and assessments made by our management as of the filing date of this Form 10-Q in light of their experience and perception of historical trends, current conditions, expected future developments and other factors we believe to be appropriate. These forward-looking statements are subject to a number of risks and uncertainties and actual results could differ materially due to numerous factors, including but not limited to the following:
• risks related to the impact of the COVID-19 global pandemic, including
actions by governments, businesses and individuals in response to the
situation, such as the scope and duration of the outbreak, the nature and
effectiveness of government actions and restrictive measures implemented
in response, material delays and cancellations of medical procedures,
supply chain disruptions, the impact on creditworthiness and financial
viability of customers, and other impacts on the Company's business and ability to execute business continuity plans; • changes in the general economy, as well as the cyclical nature of the markets we serve;
• the significant turmoil in the commodity markets and decline in certain
commodity prices, including oil, due to economic disruptions from the COVID-19 pandemic and various geopolitical events;
• our ability to identify, finance, acquire and successfully integrate
attractive acquisition targets;
• our exposure to unanticipated liabilities resulting from acquisitions;
• our ability and the ability of our customers to access required capital at
a reasonable cost;
• our ability to accurately estimate the cost of or realize savings from our
restructuring programs;
• the amount of and our ability to estimate our asbestos-related liabilities;
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• the solvency of our insurers and the likelihood of their payment for asbestos-related costs;
• material disruptions at any of our manufacturing facilities;
• noncompliance with various laws and regulations associated with our
international operations, including anti-bribery laws, export control
regulations and sanctions and embargoes;
• risks associated with our international operations, including risks from
trade protection measures and other changes in trade relations;
• risks associated with the representation of our employees by trade unions
and work councils;
• our exposure to product liability claims;
• potential costs and liabilities associated with environmental, health and
safety laws and regulations;
• failure to maintain, protect and defend our intellectual property rights;
• the loss of key members of our leadership team;
• restrictions in our principal credit facility that may limit our flexibility in operating our business;
• impairment in the value of intangible assets;
• the funding requirements or obligations of our defined benefit pension
plans and other postretirement benefit plans;
• significant movements in foreign currency exchange rates;
• availability and cost of raw materials, parts and components used in our
products;
• new regulations and customer preferences reflecting an increased focus on
environmental, social and governance issues, including new regulations
related to the use of conflict minerals;
• service interruptions, data corruption, cyber-based attacks or network
security breaches affecting our information technology infrastructure;
• risks arising from changes in technology;
• the competitive environment in our industry;
• changes in our tax rates or exposure to additional income tax liabilities,
including the effects of the COVID-19 global pandemic and the
Cuts and Jobs Act and the Coronavirus Aid, Relief, and Economic Security
Act (the "CARES Act");
• our ability to manage and grow our business and execution of our business
and growth strategies;
• the level of capital investment and expenditures by our customers in our
strategic markets;
• our financial performance;
• difficulties and delays in integrating the DJO acquisition or fully
realizing projected cost savings and benefits of the DJO acquisition; and
• other risks and factors, listed in Item 1A. "Risk Factors" in Part I of our 2019 Form 10-K and in this Form 10-Q. 29
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The effects of the COVID-19 pandemic, including actions by governments, businesses and individuals in response to it, may give rise to or amplify the risks associated with many of these factors.
Any such forward-looking statements are not guarantees of future performance and actual results, developments and business decisions may differ materially from those envisaged by such forward-looking statements. These forward-looking statements speak only as of the date this Form 10-Q is filed with theSEC . We do not assume any obligation and do not intend to update any forward-looking statement except as required by law. See Part I. Item 1A. "Risk Factors" in our 2019 Form 10-K and Part II. Item 1A. "Risk Factors" in this Form 10-Q for a further discussion regarding some of the reasons that actual results may be materially different from those that we anticipate. 30 --------------------------------------------------------------------------------
Overview
In
OnSeptember 30, 2019 , we completed the sale of our Air and Gas Handling business for an aggregate purchase price of$1.8 billion , including$1.67 billion cash paid at closing, subject to certain adjustments pursuant to the purchase agreement, and the assumption of certain liabilities and minority interests. Accordingly, the results of operations for the Air and Gas Handling segment have been excluded from the discussion of our results of operations for all periods presented. Refer to Note 3, "Discontinued Operations" in the accompanying Notes to Condensed Consolidated Financial Statements for more information.
Based on the above, we now conduct our continuing operations through two segments: Fabrication Technology and Medical Technology, which also represent our reportable segments.
• Fabrication Technology - a global supplier of consumable products and
equipment for use in the cutting, joining, and automated welding of steel, aluminum, and other metals and metal alloys.
• Medical Technology - a leading provider of orthopedic solutions,
providing orthopedic devices, software and services spanning the full
continuum of patient care, from injury prevention to joint replacement
to rehabilitation.
Certain amounts not allocated to the two reportable segments and intersegment eliminations are reported under the heading "Corporate and other."
We have sales, engineering, administrative and production facilities throughout the world. Through our reportable segments, we serve a global customer base across multiple markets through a combination of direct sales and third-party distribution channels. Our customer base is highly diversified in the medical and industrial end markets. Integral to our operations is Colfax Business System (CBS).CBS is our business management system, combining a comprehensive set of tools and repeatable, teachable processes that we use to create superior value for our customers, shareholders and associates. Rooted in our core values, it is our culture. We believe our management team's access to, and experience in, the application ofCBS is one of our primary competitive strengths. 31 --------------------------------------------------------------------------------
Results of Operations
The following discussion of Results of Operations addresses the comparison of the periods presented. Our management evaluates the operating results of each of its reportable segments based upon Net sales, Segment operating income, which represents Operating income before Restructuring and other related charges, and Adjusted EBITA as defined in the "Non-GAAP Measures" section.
Items Affecting Comparability of Reported Results
Our results from continuing operations for the three months endedApril 3, 2020 include the impact of six additional days as compared to the three months endedMarch 29, 2019 due to our accounting close schedule andleap year . The second and third quarters will have the same number of days compared to 2019. The fourth quarter of 2020 will have 5 fewer days compared to 2019 due to our accounting close schedule. The comparability of our operating results for the three months endedApril 3, 2020 and three months endedMarch 29, 2019 is affected by the following additional significant items:
Recent Events
InDecember 2019 , a novel coronavirus disease ("COVID-19") was first reported inChina . OnMarch 11, 2020 , due to worldwide spread of the virus, theWorld Health Organization characterized COVID-19 as a pandemic. The COVID-19 global pandemic has resulted in a widespread health crisis, and the resulting impact on governments, businesses and individuals and actions taken by them in response to the situation have resulted in widespread economic disruptions, significantly affecting broader economies, financial markets, and overall demand for our products. As reflected in the discussions that follow, the impact of the pandemic and actions taken in response to it have had a variety of impacts on our results of operations for the first quarter of 2020, primarily in the last month of the quarter. Through the date of this Form 10-Q, these impacts have continued and grown more significant. We expect these effects to continue until the pandemic subsides or government and businesses are able to return to more normal operations. The full impacts of the global emergence of COVID-19 on our business are currently unknown and cannot be predicted. In an effort to protect the health and safety of our employees, we have taken actions to adopt social distancing policies at our locations around the world, including working from home, reducing the number of people in our sites at any one time, and suspending employee travel. In an effort to contain COVID-19 or slow its spread, governments around the world have also enacted various measures, including orders to close all businesses not deemed "essential," isolate residents to their homes or places of residence, and practice social distancing when engaging in essential activities. We generally began seeing the effects of COVID-19 on our businesses in mid-March. Our Medical Technology business sales have declined because of decreases in elective surgical procedures, organized sporting events and general population activity levels. We cannot predict how long this impact will continue or project future results; however, we expect the growing backlog of elective procedures to convert to revenue as healthcare access expands and elective procedures resume in affected regions, the timing and extent of which remains highly uncertain and cannot be predicted. In addition, while we expect government policy decisions that will allow for the resumption of organized sports and activity levels, we cannot predict the timing of such decisions or the extent to which such activities will resume. Within our Fabrication Technology segment, customer demand has significantly declined, principally in theAmericas andEurope . Certain local governments have also ordered closures of certain of our production facilities late in the quarter and all but one have re-opened in April, with the last expected to re-open in May. We expect our sales to improve as facilities are re-opened and customer demand recovers, in-line generally with industrial GDP improvements and steel consumption; however, we cannot predict the timing and extent of these improvements. The Company has implemented a broad range of actions to mitigate the effects of lower sales levels. These actions are intended to be temporary and include reducing salaries, furloughing and laying-off employees, significantly curtailing discretionary expenses, re-phasing of capital expenditures, reducing supplier purchase levels and / or prices, adjusting working capital practices and other measures. In total, these actions are expected to reduce cash outlays by at least$100.0 million in Q2 2020. We continue to monitor the rapidly evolving situation and guidance from international and domestic authorities, including national and local public health authorities and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to further adjust our operating plan. As such, given the dynamic nature 32 -------------------------------------------------------------------------------- of this situation, the Company cannot reasonably estimate the full impacts of COVID-19 on our financial condition, results of operations or cash flows in the future.
Please see Part II. Items 1A. "Risk Factors" in this Form 10-Q for further discussion of the Company's risks relating to the COVID-19 pandemic.
Strategic Acquisitions
We complement our organic growth plans with strategic acquisitions. Acquisitions can significantly affect our reported results, and we report the change in our Net sales between periods both from existing and acquired businesses. The change in Net sales due to acquisitions for the periods presented in this filing represents the incremental sales as a result of acquisitions. OnFebruary 22, 2019 , we completed the acquisition of DJO, creating a new growth platform in the high-margin orthopedic solutions market.
Foreign Currency Fluctuations
A significant portion of our Net sales, approximately 58% for the three months endedApril 3, 2020 , were derived from operations outside theU.S. , with the majority of those sales denominated in currencies other than theU.S. dollar. Because much of our manufacturing and employee costs are outside theU.S. , a significant portion of our costs are also denominated in currencies other than theU.S. dollar. Changes in foreign exchange rates can impact our results of operations and are quantified when significant. For the first quarter of 2020 compared to the first quarter of 2019, fluctuations in foreign currencies had unfavorable impacts on the change in Net sales and Income taxes from continuing operations of approximately 3% and 12%, respectively. The changes in foreign exchange rates sinceDecember 31, 2019 also decreased net assets by approximately 4% as ofApril 3, 2020 . In 2018,Argentina became a highly inflationary economy, resulting in the remeasurement of our Argentinian operations into Brazilian real, the functional currency of the Argentinian entity's direct parent. Gains and losses from the remeasurement are reflected in earnings. Future impacts to earnings of applying highly inflationary accounting forArgentina on our Consolidated Financial Statements will be dependent upon movements in the applicable exchange rates. As of and for the three months endedApril 3, 2020 , theArgentina operation represented less than 1% of our Total assets and Net sales, and was restricted solely to our Fabrication Technology segment. The devaluation of the Argentinian peso in the first quarter of 2019 resulted in a loss of$0.8 million . However, in the first quarter of 2020, the Argentinian peso appreciated in value versus the Brazilian real, resulting in a gain of$1.3 million .
Seasonality
Our European operations typically experience a slowdown during the July, August and December vacation seasons. Sales in our Medical Technology segment typically peak in the fourth quarter. However, we expect that the business impact caused by the COVID-19 pandemic will distort the effects of historical seasonality patterns. 33 --------------------------------------------------------------------------------
Non-GAAP Measures
Adjusted EBITA
Adjusted EBITA, a non-GAAP performance measure, is included in this report because it is a key metric used by management to assess our operating performance. Adjusted EBITA excludes from Net income (loss) from continuing operations the effect of restructuring and other related charges, acquisition-related intangible asset amortization and other non-cash charges, and strategic transaction costs, as well as income tax expense (benefit), interest expense, net and pension settlement loss. We also present Adjusted EBITA margin, which is subject to the same adjustments as Adjusted EBITA. Further, we present Adjusted EBITA (and Adjusted EBITA margin) on a segment basis, where we exclude the impact of restructuring, strategic transaction costs, and acquisition-related amortization and other non-cash charges from segment operating income. Adjusted EBITA assists Colfax management in comparing its operating performance over time because certain items may obscure underlying business trends and make comparisons of long-term performance difficult, as they are of a nature and/or size that occur with inconsistent frequency or relate to discrete restructuring plans that are fundamentally different from the ongoing productivity improvements of the Company. Colfax management also believes that presenting these measures allows investors to view its performance using the same measure that the Company uses in evaluating its financial and business performance and trends. Non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information calculated in accordance with GAAP. Investors are encouraged to review the reconciliation of these non-GAAP measures to their most directly comparable GAAP financial measures. The following tables set forth a reconciliation of Net income (loss) from continuing operations, the most directly comparable GAAP financial measure, to Adjusted EBITA. Three Months Ended April 3, 2020 March 29, 2019 (Dollars in millions) Net income (loss) from continuing operations (GAAP) $ 8.9$ (21.5 ) Income tax expense 13.2 2.0 Interest expense, net(1) 24.8 21.8 Restructuring and other related charges(2) 11.9
10.8
Strategic transaction costs(3) 0.9
53.3
Acquisition-related amortization and other non-cash charges(4)
35.8
23.7
Adjusted EBITA (non-GAAP) $ 95.5$ 90.2 Net income margin from continuing operations (GAAP) 1.1 % (3.1 )% Adjusted EBITA margin (non-GAAP) 11.7 %
13.2 %
(1) The three months endedMarch 29, 2019 includes$0.8 million of debt extinguishment charges. (2) Restructuring and other related charges includes$1.8 million of expense classified as Cost of sales on the Company's Condensed Consolidated Statements of Operations for the three months endedApril 3, 2020 . (3) Includes costs incurred for the acquisition of DJO. (4) Includes amortization of acquired intangibles and fair value charges on acquired inventory. 34
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The following tables set forth a reconciliation of operating income (loss), the
most directly comparable financial statement measure, to Adjusted EBITA by
segment for the three months ended
Three
Months Ended
Corporate and Fabrication Technology Medical Technology other Total (Dollars in millions) Operating income (loss) (GAAP) $ 66.2 $ (5.3 )$ (14.1 ) $ 46.8 Restructuring and other related charges(1) 2.8 9.1 - 11.9 Segment operating income (loss) (non-GAAP) 69.0 3.8 (14.1 ) 58.8 Strategic transaction costs - - 0.9 0.9 Acquisition-related amortization and other non-cash charges 8.9 26.9 - 35.8 Adjusted EBITA (non-GAAP) $ 77.9 $ 30.7$ (13.2 ) $ 95.5 Segment operating income (loss) margin (non-GAAP) 13.1 % 1.3 % - % 7.2 % Adjusted EBITA margin (non-GAAP) 14.8 % 10.6 % - % 11.7 % (1) Restructuring and other related charges in the Medical Technology segment includes$1.8 million of expense classified as Cost of sales on the Company's Condensed Consolidated Statements of Operations. Three
Months Ended
Corporate and Fabrication Technology Medical Technology(1) other Total (Dollars in millions) Operating income (loss) (GAAP) $ 66.3 $ 4.1$ (68.1 ) $ 2.3 Restructuring and other related charges 4.3 6.5 - 10.8 Segment operating income (loss) (non-GAAP) 70.6 10.7 (68.1 ) 13.2 Strategic transaction costs - - 53.3 53.3 Acquisition-related amortization and other non-cash charges 8.7 15.0 - 23.7 Adjusted EBITA (non-GAAP) $ 79.3 $ 25.7$ (14.8 ) $ 90.2 Segment operating income (loss) margin (non-GAAP) 12.6 % 8.6 % - % 1.9 % Adjusted EBITA margin (non-GAAP) 14.1 % 20.8 % - % 13.2 %
(1) The Medical Technology segment includes results from the acquisition date of
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Total Company Sales
Net sales for the three months ended
Net Sales (1) % (Dollars in millions)
For the three months ended
(43.3 ) (6.3 )% Acquisitions(3) 199.5 29.2 % Foreign Currency Translation(4) (23.7 ) (3.5 )% 132.5 19.4 %
For the three months ended
(1) The three months endedMarch 29, 2019 reflects 35 days of sales from our Medical Technology segment, as the DJO acquisition was completed onFebruary 22, 2019 . The increase inNet Sales for the year-to-date period throughFebruary 22, 2020 is reflected in the Acquisitions line below. (2) Excludes the impact of foreign exchange rate fluctuations and acquisitions, thus providing a measure of growth due to factors such as price, product mix and volume. (3) Represents the incremental sales as a result of our acquisitions discussed previously. (4) Represents the difference between prior year sales valued at the actual prior year foreign exchange rates and prior year sales valued at current year foreign exchange rates. The increase in Net sales during the first quarter of 2020 compared to the first quarter of 2019 is primarily attributed to Net sales from acquisitions. Net sales from acquisitions represents the incremental sales as a result of the acquisition of DJO, our Medical Technology segment, completed onFebruary 22, 2019 . The decrease in Net sales from existing businesses is attributable to decreases of$30.8 million in our Medical Technology segment and$12.5 million in our Fabrication Technology segment reflecting the impact of the COVID-19 pandemic. Our Medical Technology segment delivered organic growth compared to the first quarter of 2019, including the period prior to acquisition, until the COVID-19 outbreak began impacting our sales due to deferrals of elective surgical procedures, and reductions in organized sports and general population activity levels in affected regions substantially offsetting the growth recognized through February. We cannot predict the timing, but we expect the growing backlog of elective procedures to convert to revenue as healthcare access expands and reverts to prior levels and as government policy decisions allow for the resumption of organized sports and activity levels. Our Fabrication Technology segment had a decrease from existing businesses of 2.2% as a result of softening sales volume caused by the COVID-19 impact due to certain local government ordered facility closures late in the quarter and significant decline in customer demand, principally in theAmericas ,Europe , andIndia , partially offset by new product initiatives and pricing improvements. Certain of these facilities have re-opened in April, with the rest currently expected to re-open in May. We expect our sales to recover as facilities are re-opened and customer demand recovers, in-line generally with industrial GDP improvements and steel consumption; however, we cannot predict the timing of these improvements. Fluctuation of foreign currency translation rates had a negative impact of$23.7 million during the quarter due largely to the strengthening of theU.S. dollar relative to other currencies. 36 --------------------------------------------------------------------------------
Operating Results
The following table summarizes our results of continuing operations for the comparable periods. Three Months Ended April 3, 2020 March 29, 2019 (Dollars in millions) Gross profit $ 348.2$ 261.0 Gross profit margin 42.7 % 38.2 % Selling, general and administrative expense $ 291.3$ 247.8 Operating income $ 46.8 $ 2.3 Operating income margin 5.7 % 0.3 % Net income (loss) from continuing operations $ 8.9$ (21.5 ) Net income (loss) margin from continuing operations 1.1 % (3.1 )% Adjusted EBITA (non-GAAP) $ 95.5 $ 90.2 Adjusted EBITA Margin (non-GAAP) 11.7 % 13.2 % Items excluded from Adjusted EBITA: Restructuring and other related charges(1) $ 11.9 $ 10.8 Strategic transaction costs $ 0.9 $ 53.3 Acquisition-related amortization and other non-cash charges $ 35.8 $ 23.7 Interest expense, net $ 24.8 $ 21.8 Income tax expense $ 13.2 $ 2.0 (1) Restructuring and other related charges includes$1.8 million of expense classified as Cost of sales on the Company's Condensed Consolidated Statements of Operations for the three months endedApril 3, 2020 .
First Quarter of 2020 Compared to First Quarter of 2019
The$87.2 million increase in Gross profit during the first quarter of 2020 in comparison to the first quarter of 2019 was primarily attributable to the inclusion of three months of activity of our Medical Technology segment in 2020 as compared with one month in the prior year. Gross profit in our Fabrication Technology segment decreased$5.1 million during the first quarter of 2020 in comparison to the first quarter of 2019 due to softening sales volume caused by COVID-19 impact and unfavorable foreign currency translation, partially offset by an improved product mix and new product initiatives. Improved Gross profit margin in the first quarter of 2020 compared to first quarter of 2019 was primarily attributed to higher gross margin from our Medical Technology segment. The$43.5 million increase in Selling, general and administrative expense in the first quarter of 2020 as compared to the first quarter of 2019 was mainly due to a full quarter of activity within a full quarter of activity within our Medical Technology segment, partially offset by a decrease of strategic transaction costs of$52.4 million . The$12.1 million increase in acquisition-related amortization and other non-cash charges in the first quarter of 2020 as compared to the first quarter of 2019 was due to the inclusion of a full quarter of amortization of intangibles for our Medical Technology segment, partially offset by a decrease in Medical Technology segment inventory step-up charges. Restructuring and other related charges increased during the first quarter of 2020 in comparison to the first quarter of 2019 mainly due to three months of activity of our Medical Technology segment in 2020 as compared with one month in the prior year. Interest expense, net for the first quarter of 2020 increased by$3.0 million compared to the first quarter of 2019, primarily attributable to increases in debt related to our acquisition of DJO. The effective tax rate for Income from continuing operations during the first quarter of 2020 was 59.8%, which was higher than the 2020 U.S. federal statutory tax rate of 21% mainly due to the impact of additionalU.S. tax on international operations and taxable foreign exchange gains offset in part by a discrete tax benefit associated with the enactment of a tax law change in 37 --------------------------------------------------------------------------------India . The effective tax rate for the first quarter of 2019 was (10.5)%, which was lower than the 2019 U.S. federal statutory tax rate of 21% mainly due to non-deductible deal costs and an aggregate discreteU.S. tax expense due to a change in valuation allowance associated with our acquisition of DJO. Net income (loss) from continuing operations increased in the first quarter of 2020 as compared to the first quarter of 2019 largely due to a decrease of strategic transaction costs partially offset by the increase in Acquisition-related amortization and other non-cash charges. Net income margin from continuing operations increased by 420 basis points during the first quarter of 2020 in comparison to the first quarter of 2019 for the same reasons as Net income (loss) from continuing operations. The higher Adjusted EBITA in the first quarter of 2020 as compared to the first quarter of 2019 was primarily driven by the contribution from our Medical Technology segment. Adjusted EBITA margin decreased by 150 basis points during the first quarter of 2020 in comparison to the first quarter of 2019, mainly attributable to decreases in our Medical Technology segment Adjusted EBITA margin partially offset by margin growth in our Fabrication Technology segment.
Business Segments
As discussed further above, we report results in two reportable segments: Fabrication Technology and Medical Technology.
Fabrication Technology
We formulate, develop, manufacture and supply consumable products and equipment for use in the cutting, joining and automated welding of steel, aluminum and other metals and metal alloys. Our fabrication technology products are marketed under several brand names, most notably ESAB, which we believe is well known in the global cutting and welding industry. ESAB's comprehensive range of welding consumables includes electrodes, cored and solid wires and fluxes using a wide range of specialty and other materials, and cutting consumables including electrodes, nozzles, shields and tips. ESAB's fabrication technology equipment ranges from portable welding machines to large customized automated cutting and welding systems. Products are sold into a wide range of end markets, including infrastructure, wind power, marine, pipelines, mobile/off-highway equipment, oil, gas, and mining. The following table summarizes selected financial data for our Fabrication Technology segment: Three Months Ended April 3, 2020 March 29, 2019 (Dollars in millions) Net sales$ 525.5 $ 560.4 Gross profit$ 188.8 $ 193.9 Gross profit margin 35.9 % 34.6 % Selling, general and administrative expense$ 119.8 $ 123.3 Segment operating income $ 69.0$ 70.6 Segment operating income margin 13.1 % 12.6 % Adjusted EBITA (Non-GAAP) $ 77.9$ 79.3 Adjusted EBITA Margin (Non-GAAP) 14.8 % 14.1 % Items excluded from Adjusted EBITA: Restructuring and other related charges $ 2.8 $ 4.3 Acquisition-related amortization and other non-cash charges $ 8.9
$ 8.7
Net sales decreased$34.9 million in the first quarter of 2020 compared to the first quarter of 2019. The decrease was primarily due to unfavorable foreign currency translation impact of$22.4 million as well as lower sales volumes. The decrease from existing businesses of 2.2% is a result of softening sales volume caused by the COVID-19 impact due to certain local government ordered facility closures late in the quarter and significant decline in customer demand, principally in theAmericas ,Europe , andIndia , partially offset by new product initiatives and pricing improvements. Gross profit decreased in the first quarter of 2020 as compared to the first quarter of 2019 mainly driven by the lower sales volume, offset slightly by improved product mix. Gross profit margin 38 -------------------------------------------------------------------------------- increased by 130 basis points when compared to the same period in 2019, mainly due to favorable product mix and pricing improvements. Selling, general and administrative expense decreased in the first quarter of 2020 compared to the first quarter of 2019, mainly attributable to favorable foreign currency translation impact and minimizing discretionary spending to offset the COVID-19 impact. Segment operating income and Adjusted EBITA in the first quarter of 2020 compared to first quarter of 2019 were slightly lower resulting from lower Gross profit due to the decline in sales volume. Segment operating income margin and Adjusted EBITA margin both increased due to the improved Gross profit margin from a favorable product mix and lower selling, general and administrative expenses. Restructuring and other related charges decreased during the first quarter of 2020 in comparison to the first quarter of 2019, as a result of a different pace of our cost reduction programs.
Medical Technology
We develop, manufacture and distribute high-quality medical devices and services across the continuum of patient care from injury prevention to joint replacement to rehabilitation after surgery, injury or from degenerative disease, enabling people to regain or maintain their natural motion. Our products are used by orthopedic specialists, spine surgeons, primary care physicians, pain management specialists, physical therapists, podiatrists, chiropractors, athletic trainers and other healthcare professionals. Our products primarily include orthopedic braces, rehabilitation devices, footwear, surgical implants, and bone growth stimulators. The following table summarizes the selected financial data for our Medical Technology segment: Three Months Ended From February 22, 2019 to April 3, 2020 March 29, 2019 (Dollars in millions) Net sales $ 290.8 $ 123.5 Gross profit $ 161.2 $ 67.1 Gross profit margin 55.4 % 54.3 % Selling, general and administrative expense $ 157.4 $ 56.4 Segment operating income $ 3.8 $ 10.7 Segment operating income margin 1.3 % 8.6 % Adjusted EBITA (Non-GAAP) $ 30.7 $ 25.7 Adjusted EBITA Margin (Non-GAAP) 10.6 % 20.8 % Items excluded from Adjusted EBITA: Restructuring and other related charges(1) $ 9.1 $ 6.5 Acquisition-related amortization and other non-cash charges $ 26.9 $ 15.0 (1) Restructuring and other related charges includes$1.8 million of expense classified as Cost of sales on the Company's Condensed Consolidated Statements of Operations for the three months endedApril 3, 2020 . Net sales for our Medical Technology segment in the first quarter of 2020 compared to the first quarter of 2019 increased primarily due to the full quarter of activity in 2020. Our Medical Technology segment delivered organic growth compared to the first quarter of 2019, including the period prior to acquisition, until the COVID-19 outbreak began impacting our sales due to deferrals of elective surgical procedures, and reductions in organized sports and general population activity levels in affected regions substantially offsetting the growth recognized through February. Gross Profit increased due to the full quarter of activity in 2020 and lower inventory fair value charges of$5.3 million , partially offset by the impact of COVID-19. Profit margins in the first quarter of 2020 compared to first quarter of 2019 improved as a result of the decrease in inventory fair value charges. Acquisition-related amortization and other non-cash charges include inventory fair value charges of$1.4 million and$6.6 million in first quarter of 2020 and 2019, respectively. Selling, general and administrative expense increased in the first quarter of 2020 compared to the first quarter of 2019 due to the full quarter of activity in 2020. There were 94 days of activity in the first quarter of 2020 compared to 35 days in the first quarter of 2019. The increase in the Selling, general and administrative expenses was mainly due to the increase in the acquisition-related amortization and seasonal sales-related costs incurred during the first quarter of 2020, partially offset by cost control and reductions in discretionary spending implemented due to the COVID-19 outbreak. 39 -------------------------------------------------------------------------------- Segment operating income and margin in the first quarter of 2020 decreased compared to the first quarter of 2019 primarily due to the significant loss of revenue in the second half ofMarch 2020 due to COVID-19, inclusion of a full quarter of Acquisition-related amortization and other non-cash charges as compared with one month of these charges in the prior year quarter, and the timing of certain seasonal selling costs. Adjusted EBITA increased slightly due to including a full quarter of DJO results in 2020 versus one month in 2019. Adjusted EBITA margin declined due to including the seasonally-low margin months of January and February in 2020 results, and due to the significant loss of revenue in the second half ofMarch 2020 due to COVID-19. Restructuring and other related charges increased during the first quarter of 2020 in comparison to the first quarter of 2019, as a result of three months of activity in 2020 as compared with one month in the prior year. 40 --------------------------------------------------------------------------------
Liquidity and Capital Resources
Overview
We finance our capital and working capital requirements through a combination of cash flows from operating activities, various borrowings and the issuances of equity. We expect that our primary ongoing requirements for cash will be for working capital, funding of acquisitions, capital expenditures, restructuring, asbestos-related cash outflows, and debt service and required amortization of principal. We believe we could raise additional funds in the form of debt or equity if it was determined to be appropriate for strategic acquisitions or other corporate purposes. Based on our expected cash flows from operations, current cash positions, and contractually available borrowings under our credit facility, we expect to have sufficient liquidity to fund working capital needs and future growth over the next twelve months. We expect continued sales pressures in the second quarter of 2020, and possibly beyond, in both our Medical Technology and Fabrication Technology segments due to the COVID-19 pandemic, which will negatively impact our cash flow. We have implemented a broad set of measures to reduce spending and mitigate the effects of expected lower sales volumes. We also executed a temporary draw from our principal credit agreement that was used to partially repay other borrowings and contribute to the quarter-ending$365.6 million cash balance. At quarter-end, the Company has$917 million of capacity under its credit agreement and other facilities.
Term Loan and Revolving Credit Facility
Our credit agreement (the "Credit Facility") by and among the Company, as the borrower, certainU.S. subsidiaries of the Company, as guarantors, each of the lenders party thereto,JPMorgan Chase Bank, N.A ., as administrative agent,Citizens Bank, N.A. , as syndication agent, and the co-documentation agents named therein consists of a$975 million revolving credit facility (the "Revolver") and a Term A-1 loan in an aggregate principal amount of$825 million (the "Term Loan"), each with a maturity date ofDecember 6, 2024 . The Revolver contains a$50 million swing line loan sub-facility. As ofApril 3, 2020 , we are in compliance with the covenants under the Credit Facility. As ofApril 3, 2020 , the weighted-average interest rate of borrowings under the Credit Facility was 2.95%, excluding accretion of original issue discount and deferred financing fees, and there was$675 million available on the Revolver.
On
Other Indebtedness
In addition, we are party to various bilateral credit facilities with a
borrowing capacity of
We are also party to letter of credit facilities with an aggregate capacity of$412.1 million . Total letters of credit of$119.8 million were outstanding as ofApril 3, 2020 . Equity Capital In 2018, our Board of Directors authorized the repurchase of shares of our Common stock from time-to-time on the open market or in privately negotiated transactions. No repurchases of our Common stock have been made under this plan since the third quarter of 2018. As ofApril 3, 2020 , the remaining stock repurchase authorization provided by our Board of Directors was$100.0 million . The timing, amount, and method of shares repurchased is determined by management based on its evaluation of market conditions and other factors. There is no term associated with the remaining repurchase authorization. 41 --------------------------------------------------------------------------------
Cash Flows
As ofApril 3, 2020 , we had$365.6 million of Cash and cash equivalents, an increase of$256 million from$109.6 million as ofDecember 31, 2019 . The net$250 million drawdown on our available lines of credit is the primary reason for this increase. The following table summarizes the change in Cash and cash equivalents during the periods indicated: Three Months Ended April 3, 2020 March 29, 2019 (Dollars in millions) Net cash provided by (used in) operating activities $ 56.2 $ (72.3 ) Purchases of property, plant and equipment (31.1 ) (24.4 ) Proceeds from sale of property, plant and equipment 1.7
1.3
Acquisitions, net of cash received (7.8 ) (3,147.8 ) Net cash used in investing activities (37.3 ) (3,170.9 ) Proceeds from borrowings, net 244.3
2,954.6
Payment for noncontrolling interest share repurchase - (92.7 ) Proceeds from prepaid stock purchase contracts -
377.8
Other 0.9 (0.7 ) Net cash provided by financing activities 245.1
3,239.0
Effect of foreign exchange rates on Cash and cash equivalents (8.1 )
1.6
Increase (decrease) in Cash and cash equivalents $ 256.0 $
(2.6 )
Cash used in operating activities related to the discontinued operations of our divested Air and Gas Handling business for the three months endedApril 3, 2020 andMarch 29, 2019 was$2.1 million and$2.8 million , respectively. Cash used in investing activities related to the discontinued operations our divested Air and Gas Handling business for the three months endedMarch 29, 2019 was$10.3 million .
Cash flows from operating activities can fluctuate significantly from period-to-period due to changes in working capital and the timing of payments for items such as pension funding and asbestos-related costs. Changes in significant operating cash flow items, inclusive of activities for our discontinued operations, are discussed below.
• Net cash received or paid for asbestos-related costs, net of insurance
proceeds, including the disposition of claims, defense costs and legal
expenses related to litigation against our insurers, creates variability
in our operating cash flows. During the three months ended
we had net asbestos cash inflows of
ended
• Funding requirements of our defined benefit plans, including pension plans
and other post-retirement benefit plans, can vary significantly from
period-to-period due to changes in the fair value of plan assets and
actuarial assumptions. For the three months ended
million and
• During the three months ended
payments of
our restructuring initiatives.
• Changes in net working capital also affected the operating cash flows for
the periods presented. We define working capital as Trade receivables, net
and Inventories, net reduced by Accounts payable and Customer advances and
billings in excess of costs incurred. During the three months ended April
3, 2020, net working capital provided cash of
impact of foreign exchange, due to a decrease in receivables and increase
in accounts payable, partially offset by an increase in inventory. The
improved working capital metrics compared to 2019 reflects the discipline
we have implemented to improve collections and manage inventory levels and
payables to conserve cash. During the three months ended
net working capital consumed cash of
of foreign exchange, primarily due to increases in inventory and accounts
payable. This use of cash included the initial one-time effort to bring
DJO suppliers into payment terms consistent with our normal practices, as
well as to eliminate a DJO accounts receivable factoring program. 42
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• Working capital for the three months ended
2019 reflects seasonal changes, which may be impacted by the COVID-19.
Cash flows used in investing activities during the three months endedApril 3, 2020 mostly consists of purchases of property, plant and equipment. During the three months endedMarch 29, 2019 , cash flows used in investing activities included the DJO acquisition. Cash flows provided by financing activities for the three months endedApril 3, 2020 included a net increase in borrowings from our Revolver for working capital, general corporate or other purposes. Cash flows provided by financing activities for three months endedMarch 29, 2019 were impacted by proceeds from borrowings on newly acquired debt and issuance of common stock in conjunction with the DJO Acquisition, partially offset by the repurchases of a vast majority of the noncontrolling interest shares of a former Air and Gas Handling subsidiary inSouth Africa . Our Cash and cash equivalents as ofApril 3, 2020 include$89.1 million held in jurisdictions outside theU.S. We are currently exploring opportunities to reduce these levels to$75 million or less in the second quarter of 2020 through local usage and potential repatriation of funds. Cash repatriation may be subject to taxes, other local statutory restrictions and minority partner distributions.
Critical Accounting Policies
The methods, estimates and judgments that we use in applying our critical accounting policies have a significant impact on our results of operations and financial position. We evaluate our estimates and judgments on an ongoing basis. Our estimates are based upon our historical experience, our evaluation of business and macroeconomic trends and information from other outside sources, as appropriate. Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may vary from what our management anticipates, and different assumptions or estimates about the future could have a material impact on our results of operations and financial position. There have been no other significant additions to the methods, estimates and judgments included in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies" in our 2019 Form 10-K.
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