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 endedOctober 2, 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 24, 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, 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 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;
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•the amount of and our ability to estimate our asbestos-related liabilities;
•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 industries;
•changes in our tax rates, realizability of deferred tax assets, or exposure to additional income tax liabilities, including the effects of the COVID-19 global pandemic and theU.S. Tax 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 this Form 10-Q.
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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 or contribute 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.
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 cutting, joining, and automated welding, as well as gas control equipment, providing a wide range of products with innovative technologies to solve challenges in a wide range of industries. •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 the 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. 29 --------------------------------------------------------------------------------
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 European Union Medical Devices Regulation ("MDR") costs, and Adjusted EBITA as defined in the "Non-GAAP Measures" section.
Items Affecting Comparability of Reported Results
The comparability of our operating results for the three and nine months ended
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. 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 or restricting employee travel. In an effort to contain COVID-19 or slow its spread, governments around the world have enacted measures in 2020, including periodically closing businesses not deemed "essential," isolating residents to their homes, limiting access to healthcare, curtailing activities including sporting events, and practicing social distancing. We implemented a broad range of temporary actions to mitigate the effects of lower sales levels including temporarily 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. As reflected in the discussions that follow, the pandemic and actions taken in response to it have had a variety of impacts on our results of operations during 2020. The most severe financial impact occurred in the second quarter, resulting in 31.8% lower sales than the second quarter of 2019. We began observing a recovery in the latter part of the second quarter, and it continued through the third quarter with sales improving to a 4.8% decrease from the third quarter of 2019. 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 that require us to further adjust our operations. As such, given the dynamic nature of this situation, we 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 higher-margin orthopedic solutions market. 30
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Foreign Currency Fluctuations
A significant portion of our Net sales, approximately 57% and 58% for the three and nine months endedOctober 2, 2020 respectively, 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 nine months endedOctober 2, 2020 compared to the nine months endedSeptember 27, 2019 , fluctuations in foreign currencies had an unfavorable impact on the change in Net sales from continuing operations of approximately 3% and affected Gross profit and Selling, general and administrative expenses by less than 2%. For the third quarter of 2020 compared to the third quarter of 2019, fluctuations in foreign currencies had an unfavorable impact on the change in Net sales of approximately 2% and affected Gross profit and Selling, general and administrative expenses by less than 1%. The changes in foreign exchange rates sinceDecember 31, 2019 also decreased net assets by less than 1% as ofOctober 2, 2020 .
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, the business impact caused by the COVID-19 pandemic may distort the effects of historical seasonality patterns. 31 --------------------------------------------------------------------------------
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 our management to assess our operating performance. Adjusted EBITA excludes from Net income (loss) from continuing operations the effect of restructuring and other related charges, MDR costs, 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 and other related charges, MDR costs, acquisition-related intangible asset amortization and other non-cash charges, and strategic transaction costs 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 and other initiatives that are fundamentally different from our ongoing productivity improvements. Colfax management also believes that presenting these measures allows investors to view its performance using the same measure that we use in evaluating our 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 Nine Months Ended September 27, September 27, October 2, 2020 2019 October 2, 2020 2019 (Dollars in millions) Net income (loss) from continuing operations (GAAP) $ 16.8 $
3.8 $ 22.6
19.5 (1.4) 2.6 6.8 Interest expense, net(1) 25.6 31.8 78.6 86.8 Pension settlement loss - 33.6 - 33.6 Restructuring and other related charges(2) 6.3 13.3 28.5 50.7 MDR and other(3) 2.6 - 4.5 - Strategic transaction costs(4) 0.6 0.9 3.2 56.7 Acquisition-related amortization and other non-cash charges(5) 36.2 43.7 108.1 124.1 Adjusted EBITA (non-GAAP)$ 107.7 $
125.8
2.1 % 0.4 % 1.0 % (0.6) % Adjusted EBITA margin (non-GAAP) 13.4 % 14.9 % 11.1 % 14.1 % (1) The nine months endedSeptember 27, 2019 includes$0.8 million of debt extinguishment charges in the first quarter of 2019. (2) Restructuring and other related charges includes$2.2 million and$4.9 million of expense classified as Cost of sales on our Condensed Consolidated Statements of Operations for the three and nine months endedOctober 2, 2020 , respectively, and$3.5 million of expense classified as Cost of sales on our Condensed Consolidated Statements of Operations for the three and nine months endedSeptember 27, 2019 . (3) Primarily related to costs specific to compliance with medical device reporting regulations and other requirements of the European Union Medical Device Regulation of 2017. (4) Includes costs incurred for the acquisition of DJO. (5) Includes amortization of acquired intangibles and fair value charges on acquired inventory. 32
-------------------------------------------------------------------------------- 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 and nine months endedOctober 2, 2020 andSeptember 27, 2019 . Three Months Ended October 2, 2020 Nine Months Ended October 2, 2020 Corporate and Fabrication Medical Corporate Fabrication Technology Medical Technology other Total Technology Technology and other Total (Dollars in millions) Operating income (loss) (GAAP) $ 60.5 $ 16.5$ (15.1) $ 61.9 $ 164.3$ (15.7) $ (44.7) $ 103.8 Restructuring and other related charges(1) 2.5 3.8 - 6.3 11.4 17.1 - 28.5 MDR and other - 2.6 - 2.6 - 4.5 - 4.5 Segment operating income (loss) (non-GAAP) 63.1 22.9 (15.1) 70.8 175.7 5.9 (44.7) 136.9 Strategic transaction costs - - 0.6 0.6 - - 3.2 3.2 Acquisition-related amortization and other non-cash charges 9.1 27.1 - 36.2 26.8 81.3 - 108.1 Adjusted EBITA (non-GAAP) $ 72.2 $ 50.0$ (14.5) $ 107.7 $ 202.5$ 87.2 $ (41.5) $ 248.2 Segment operating income margin (non-GAAP) 12.8 % 7.3 % - % 8.8 % 12.3 % 0.7 % - % 6.1 % Adjusted EBITA margin (non-GAAP) 14.7 % 15.9 % - % 13.4 % 14.1 % 10.7 % - % 11.1 % (1) For the three and nine months endedOctober 2, 2020 , Restructuring and other related charges in our Medical Technology segment includes$2.2 million and$4.9 million , respectively, of expense classified as Cost of sales on our Condensed Consolidated Statements of Operations. Three Months Ended September 27, 2019
Nine Months Ended
Fabrication Corporate and Fabrication Medical Corporate Technology Medical Technology other Total Technology Technology(1) and other Total (Dollars in millions) Operating income (loss) (GAAP) $ 68.4 $ 13.7$ (14.3) $ 67.9 $ 211.6 $ -$ (99.9) $ 111.7 Restructuring and other related charges(2) 4.6 8.7 - 13.3 13.0 37.8 - 50.7 Segment operating income (loss) (non-GAAP) 73.0 22.5 (14.3) 81.2 224.6 37.8 (99.9) 162.5 Strategic transaction costs - - 0.9 0.9 - - 56.7 56.7 Acquisition-related amortization and other non-cash charges 9.2 34.5 - 43.7 26.9 97.2 - 124.1 Adjusted EBITA (non-GAAP) $ 82.2 $ 56.9$ (13.4) $ 125.8 $ 251.4 $ 135.0 $ (43.2) $ 343.2 Segment operating income margin (non-GAAP) 13.5 % 7.3 % - % 9.6 % 13.3 % 5.1 % - % 6.7 % Adjusted EBITA margin (non-GAAP) 15.2 % 18.5 % - % 14.9 % 14.9 % 18.1 % - % 14.1 % (1) Our Medical Technology segment includes results from the acquisition date ofFebruary 22, 2019 . (2) Restructuring and other related charges includes$3.5 million of expense classified as Cost of sales on our Condensed Consolidated Statements of Operations for the three and nine months endedSeptember 27, 2019 . 33 --------------------------------------------------------------------------------
Sales
Net sales decreased for the three and nine months ended
Three Months Ended Nine Months Ended Net Sales % Net Sales(1) % (Dollars in millions) For the three and nine months ended September 27, 2019$ 846.5 $ 2,439.1 Components of Change: Existing Businesses(2) (27.4) (3.2) % (323.9) (13.3) % Acquisitions(3) - - % 199.5 8.2 % Foreign Currency Translation(4) (13.2) (1.6) % (72.1) (3.0) % (40.6) (4.8) % (196.5) (8.1) % For the three and nine months ended October 2, 2020$ 805.9 $ 2,242.6 (1) The nine months endedSeptember 27, 2019 reflects 217 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. (2) Excludes the impact of foreign exchange rate fluctuations and acquisitions, thus providing a measure of change 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. Net sales decreased in the third quarter of 2020 compared with the prior year period, primarily due to the COVID-19 pandemic. Our Fabrication Technology segment decreased$31.6 million , slightly offset by a$4.2 million increase in our Medical Technology segment, primarily due to the growth in our Reconstructive product group from the resumption of elective surgical procedures, as well as nonrecurring sales of personal protective equipment ("PPE") in our Prevention and Rehabilitation product group. The strengthening of theU.S. dollar relative to other currencies caused a$13.2 million currency translation negative impact. Net sales decreased in the nine months endedOctober 2, 2020 compared to the prior year period, primarily due to the COVID-19 pandemic. Our Fabrication Technology segment decreased$189.4 million and our Medical Technology segment decreased$134.5 million for existing businesses, partially offset by the$199.5 million increase from two additional months of acquisition sales in our Medical Technology segment, which represents the incremental reported sales compared to the corresponding prior year period as a result of the acquisition of DJO being completed onFebruary 22, 2019 . The strengthening of theU.S. dollar relative to other currencies caused a$72.1 million currency translation negative impact. 34 -------------------------------------------------------------------------------- Operating Results The following table summarizes our results of continuing operations for the comparable periods. Three Months Ended Nine Months Ended September 27, October 2, 2020 September 27, 2019 October 2, 2020 2019 (Dollars in millions) Gross profit$ 344.1 $ 368.1$ 933.4 $ 1,005.2 Gross profit margin 42.7 % 43.5 % 41.6 % 41.2 % Selling, general and administrative expense$ 278.1 $
290.5
$ 61.9 $
67.9
7.7 % 8.0 % 4.6 % 4.6 % Net income (loss) from continuing operations $ 16.8 $
3.8 $ 22.6
2.1 % 0.4 % 1.0 % (0.6) % Adjusted EBITA (non-GAAP)$ 107.7 $
125.8
13.4 % 14.9 % 11.1 % 14.1 % Items excluded from Adjusted EBITA: Restructuring and other related charges(1) $ 6.3 $
13.3 $ 28.5
$ 2.6 $
- $ 4.5 $ - Strategic transaction costs
$ 0.6 $ 0.9 $ 3.2$ 56.7 Acquisition-related amortization and other non-cash charges $ 36.2 $ 43.7$ 108.1 $ 124.1 Pension settlement loss $ - $ 33.6 $ -$ 33.6 Interest expense, net $ 25.6 $
31.8 $ 78.6
$ 19.5 $
(1.4) $ 2.6
(1) Restructuring and other related charges includes$2.2 million and$4.9 million of expense classified as Cost of sales on our Condensed Consolidated Statements of Operations for the three and nine months endedOctober 2, 2020 , respectively, and$3.5 million of expense classified as Cost of sales on our Condensed Consolidated Statements of Operations for the three and nine months endedSeptember 27, 2019 .
Third Quarter of 2020 Compared to Third Quarter of 2019
Gross profit decreased$24.0 million in the third quarter of 2020 compared with the prior year period due to a$20.1 million decrease in our Fabrication Technology segment and a$3.8 million decrease in our Medical Technology segment. The Gross profit decrease was attributable to lower sales volume, higher freight costs, and production inefficiencies related to the COVID-19 pandemic and unfavorable foreign currency translation, partially offset by new product initiatives and temporary cost reductions. Gross profit margin declined as a result of the lower sales and COVID-19 inefficiencies. Selling, general and administrative expense decreased$12.4 million due to a$7.5 million decrease in acquisition-related amortization and other non-cash charges due to finalization of the valuation of DJO definite-lived intangible assets in the fourth quarter of 2019, as well as temporary expense reductions. Restructuring and other related charges decreased due to completing certain Medical Technology segment restructuring programs.
Interest expense, net decreased
The effective tax rate for Net income (loss) from continuing operations during the third quarter of 2020 was 53.7%, which was higher than the 2020 U.S. federal statutory tax rate of 21%, mainly due to the net impact of additionalU.S. tax on international operations, withholding taxes, and certain non-deductible expenses. These unfavorable impacts were partially offset by the impact ofU.S. tax credits, a benefit fromU.S. state tax losses, and the realization of tax benefits associated with effective settlements on uncertain tax positions. The effective tax rate for the third quarter of 2019 was (56.0)%, which was 35 -------------------------------------------------------------------------------- lower than the 2019 U.S. federal statutory tax rate of 21% mainly due to a discrete tax benefit associated with the enactment of tax law changes in a European jurisdiction offset in part by losses in certain jurisdictions where a tax benefit was not expected to be recognized in 2019, and non-deductible deal costs. Net income (loss) from continuing operations increased in the third quarter of 2020 compared with the prior year period due to the pension settlement loss incurred in the third quarter of 2019 and a reduction of interest expense, offset by the impact of the COVID-19 pandemic. Net income (loss) margin from continuing operations increased by 170 basis points due to the aforementioned factors. Adjusted EBITA and related margins decreased primarily due to the impact of the COVID-19 pandemic, partially offset by structural and temporary reductions in Selling, general and administrative expense.
Nine Months Ended
Gross profit decreased$71.8 million in the nine months endedOctober 2, 2020 compared to the prior year period, due to a$91.6 million decrease in our Fabrication Technology segment, partially offset by a$19.8 million increase in our Medical Technology segment. Gross profit in our Fabrication Technology segment decreased due to lower sales volume and unfavorable foreign currency translation, partially offset by new product initiatives and temporary cost reductions. Gross profit in our Medical Technology segment increased primarily due to the inclusion of two additional months of activity, partially offset by decreased sales volume, higher freight costs, and production inefficiencies related to COVID-19. Gross profit margin improved slightly over the same period, primarily attributable to including two additional months of results of our Medical Technology segment in 2020 and temporary cost reductions, partially offset by the lower sales volume. Selling, general and administrative expense decreased$40.3 million mainly due to a$53.4 million decrease in strategic transaction costs and temporary cost reductions that peaked in the second quarter, all partially offset by two additional months of results of our Medical Technology segment. Restructuring and other related charges decreased by$22.2 million due to completing certain Medical Technology segment restructuring programs. Interest expense, net decreased by$8.2 million , primarily attributable to lower interest rates and theDecember 2019 credit facility capacity reduction. Additionally, interest expense decreased due to a lower average debt balance in 2020, as proceeds from the sale of the Air and Gas Handling business were used to pay down debt during the fourth quarter of 2019. The effective tax rate for Net income (loss) from continuing operations during the nine months endedOctober 2, 2020 was 10.5%, which was lower than the 2020U.S. federal statutory tax rate of 21% mainly due to the net impact ofU.S. tax credits, a benefit fromU.S. state tax losses, a discrete tax benefit associated with the filing of timely elected changes toU.S. Federal tax returns to credit rather than to deduct foreign taxes, the impact of an enacted law change inIndia , and the realization of tax benefits associated with effective settlements on uncertain tax positions. These favorable impacts were partially offset by the impact of additionalU.S. tax on international operations, withholding taxes, and certain non-deductible expenses. The effective tax rate for the nine months endedSeptember 27, 2019 was (78.5)%, which was lower than the 2019 U.S. federal statutory tax rate of 21% mainly due to losses in certain jurisdictions where a tax benefit was not expected to be recognized in 2019,$16.7 million of non-deductible deal costs, and an aggregate$9.2 million unfavorable discreteU.S. income tax expense due to a change in valuation allowance and state tax expense as a result of the DJO acquisition, offset in part by a discrete tax benefit associated with the enactment of tax law changes in a European jurisdiction. Net income (loss) from continuing operations increased in the nine months endedOctober 2, 2020 compared to the prior year period, largely due to the inclusion of two additional months of results of our Medical Technology segment in 2020, a decrease in strategic transaction costs, and the pension settlement loss incurred during the nine months endedSeptember 27, 2019 . These were offset by a decrease in Gross profit from COVID-19 impacts, mitigated by the reductions in Selling, general and administrative expense from our temporary cost reduction programs. Net income (loss) margin from continuing operations increased by 160 basis points for the same reasons that Net income from continuing operations increased. The lower Adjusted EBITA was driven by COVID-19 impacts, partially offset by the inclusion of two additional months of results of our Medical Technology segment in 2020 and the reductions in Selling, general and administrative expense from our temporary cost reduction programs. Adjusted EBITA margin decreased by 300 basis points due primarily to decreases in our Medical Technology segment Adjusted EBITA margin. 36 --------------------------------------------------------------------------------
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, including cutting, joining, and automated welding products, as well as gas control equipment. Our fabrication technology products are marketed under several brand names, most notably ESAB, providing a wide range of products with innovative technologies to solve challenges in virtually any 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 Nine Months Ended September 27, October 2, 2020 September 27, 2019 October 2, 2020 2019 (Dollars in millions) Net sales$ 491.5 $ 539.2$ 1,431.4 $ 1,692.3 Gross profit$ 174.0 $ 194.1 502.7$ 594.3 Gross profit margin 35.4 % 36.0 % 35.1 % 35.1 % Selling, general and administrative expense$ 110.9 $
121.1
$ 63.1 $
73.0
12.8 % 13.5 % 12.3 % 13.3 % Adjusted EBITA (non-GAAP) $ 72.2 $
82.2
14.7 % 15.2 % 14.1 % 14.9 % Items excluded from Adjusted EBITA: Restructuring and other related charges $ 2.5 $ 4.6 $ 11.4$ 13.0 Acquisition-related amortization and other non-cash charges $ 9.1 $ 9.2 $ 26.8$ 26.9 Pension settlement loss $ - $ 33.6 $ -$ 33.6
Third Quarter of 2020 Compared to Third Quarter of 2019
Net sales in our Fabrication technology segment decreased$47.7 million in the third quarter of 2020 compared with the prior year period due to a$16.1 million unfavorable foreign currency translation impact, as well as a 5.9% decrease due to a decline in customer demand driven by COVID-19, partially offset by new product initiative sales. The COVID-19 impact was most severe early in the second quarter, and we realized an approximate 19% sequential improvement in the third quarter. Sales improved across our regions, most strongly in the developing regions. Gross profit decreased, and Gross margin decreased 60 basis points, in the third quarter of 2020 due to lower sales volume caused by COVID-19, partially offset by new product initiatives and COVID-19-related cost reduction measures. Selling, general and administrative expense decreased due to lower discretionary spending and benefits from restructuring initiatives to reduce costs. In summary, Segment operating income, Adjusted EBITA, and related margins all declined due to lower sales levels related to COVID-19.
Nine Months Ended
Net sales decreased$260.9 million in the nine months endedOctober 2, 2020 compared with the prior year period, due to lower sales volumes related to COVID-19 and a$71.5 million unfavorable foreign currency translation impact. Despite the$91.6 million reduction in Gross profit due to lower sales resulting from COVID-19, Gross profit margin was maintained versus the prior year level due to temporary cost reductions and restructuring benefits. Selling, general and administrative expense 37 --------------------------------------------------------------------------------
decreased in the period due to benefits from restructuring initiatives and temporary cost reduction programs. Lower sales levels related to COVID-19 resulted in a decline in Segment operating income, Adjusted EBITA, and related margins over the same period.
Medical Technology We develop, manufacture and distribute high-quality medical devices and services across the continuum of patient care from injury prevention to joint replacement to rehabilitation after surgery, injury or from degenerative disease, enabling people to regain or maintain their natural motion. Our products are used by orthopedic specialists, spine surgeons, primary care physicians, pain management specialists, physical therapists, podiatrists, chiropractors, athletic trainers and other healthcare professionals. Our products primarily include orthopedic braces, rehabilitation devices, footwear, surgical implants, and bone growth stimulators. The following table summarizes the selected financial data for our Medical Technology segment: Three Months Ended Nine Months Ended September 27, From February 22, 2019 October 2, 2020 2019 October 2, 2020 to September 27, 2019 (Dollars in millions) Net sales$ 314.4 $ 307.3 $ 811.2 $ 746.7 Gross profit$ 170.2 $ 174.0 $ 430.7 $ 410.9 Gross profit margin 54.1 % 56.6 % 53.1 % 55.0 %
Selling, general and administrative expense
$ 22.9 $
22.5 $ 5.9 $ 37.8 Segment operating income margin
7.3 % 7.3 % 0.7 % 5.1 % Adjusted EBITA (non-GAAP) $ 50.0 $
56.9 $ 87.2 $ 135.0 Adjusted EBITA margin (non-GAAP)
15.9 % 18.5 % 10.7 % 18.1 %
Items excluded from Adjusted EBITA:
Restructuring and other related charges(1) $ 3.8
$ 2.6 $ - $ 4.5 $ - Acquisition-related amortization and other non-cash charges $ 27.1 $
34.5 $ 81.3 $ 97.2
(1) Restructuring and other related charges includes$2.2 million and$4.9 million of expense classified as Cost of sales on the Company's Condensed Consolidated Statements of Operations for the three and nine months endedOctober 2, 2020 , and$3.5 million of expense classified as Cost of sales on the Company's Condensed Consolidated Statements of Operations for the three and nine months endedSeptember 27, 2019 .
Third Quarter of 2020 Compared to Third Quarter of 2019
Net sales increased for our Medical Technology segment in the third quarter of 2020 compared with the prior year period due to greater organic growth including approximately$7 million for personal protective equipment that is not expected to recur. Our Medical Technology segment experienced a severe reduction in sales inApril 2020 due to a significant decline of elective surgical procedures, cancellations of organized sports, and an overall decrease in general population activity levels caused by certain government-ordered restrictions in response to COVID-19. Sales improved throughout the remainder of the second quarter and in the third quarter as elective surgical procedures resumed and the degree of sporting and general activity increased. Third quarter Reconstructive product line sales grew 9.3%, and Prevention & Rehabilitation sales declined 0.4%. Gross profit and Gross profit margin declined in the third quarter of 2020 compared to third quarter of 2019 due to freight and production inefficiencies related to COVID-19. Selling, general and administrative expense decreased due to lower acquisition-related amortization of intangible assets. Segment operating income increased primarily due to the growth in organic sales and reduction of acquisition-related amortization of intangible assets, partially offset by freight and production inefficiencies caused 38 -------------------------------------------------------------------------------- by COVID-19. Adjusted EBITA and related margins all declined for the reasons noted above. Restructuring and other related charges decreased by$4.9 million due to completing certain projects in earlier periods.
Nine Months Ended
Net sales increased for our Medical Technology segment in the nine months endedOctober 2, 2020 compared with the prior year period due to an additional two months of acquisition sales, partially offset by a decrease in sales volume related to COVID-19. Gross profit increased as a result of the aforementioned factors and a$17.0 million decrease of inventory fair value charges. Gross profit margin declined as a result of lower sales volume, higher freight, and production inefficiencies related to COVID-19. Selling, general and administrative expense also increased due to including two additional months of sales, partially offset by temporary expense reductions. Segment operating income, Adjusted EBITA, and related margins all declined as a result of the aforementioned factors. Restructuring and other related charges decreased by$20.7 million due to completing certain projects. 39 --------------------------------------------------------------------------------
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 occasional issuances of equity. We expect that our primary ongoing requirements for cash will be for working capital, acquisitions, capital expenditures, restructuring programs, 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 were 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. At quarter-end, the Company has a$66.4 million cash balance and$1.2 billion 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. OnMay 1, 2020 , the Company entered into an amendment to its Credit Facility (the "Amendment"). Refer to Note 10, "Debt" in the accompanying Notes to Condensed Consolidated Financial Statements for more information regarding the Amendment. As ofOctober 2, 2020 , we were in compliance with the covenants under the Credit Facility. As ofOctober 2, 2020 , the weighted-average interest rate of borrowings under the Credit Facility was 1.91%, excluding accretion of original issue discount and deferred financing fees, and there was$975 million of credit available on the Revolver. During the third quarter of 2020, the Company made a voluntary$40 million principal payment on the Term A-1 loan.
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$390.2 million . Total letters of credit of$84.3 million were outstanding as ofOctober 2, 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 ofOctober 2, 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. 40 --------------------------------------------------------------------------------
Cash Flows
As of
Nine Months Ended October 2, 2020 September 27, 2019 (Dollars in millions) Net cash provided by operating activities $ 173.1 $ 65.7 Purchases of property, plant and equipment (81.6) (100.4) Proceeds from sale of property, plant and equipment 4.9 7.5 Acquisitions, net of cash received (7.5) (3,136.8) Net cash used in investing activities (84.1) (3,229.7) Proceeds (repayments) from borrowings, net (116.1) 2,811.1 Payment for noncontrolling interest share repurchase - (93.1) Proceeds from prepaid stock purchase contracts - 377.8 Other (9.5) (4.9) Net cash provided by (used in) financing activities (125.6) 3,090.9 Effect of foreign exchange rates on Cash and cash equivalents (6.6) (5.2) Decrease in Cash and cash equivalents $ (43.2) $ (78.3) Cash used in operating activities related to the discontinued operations of our divested Air and Gas Handling business for the nine months endedOctober 2, 2020 was$7.2 million . Cash provided by operating activities related to the discontinued operations of our divested Air and Gas Handling business for the nine months endedSeptember 27, 2019 was$18.0 million . Cash used in investing activities related to the discontinued operations of the divested Air and Gas Handling business for the nine months endedSeptember 27, 2019 was$27.5 million . Cash flows from operating activities increased in the nine months endedOctober 2, 2020 versus the comparable 2019 period due to changes in working capital, lower restructuring outlays in 2020, and non-recurring strategic transaction costs in 2019. 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 restructuring and asbestos-related costs. Changes in significant operating cash flow items inclusive of activities for our discontinued operations, comparing the nine months endedOctober 2, 2020 with the comparable prior year period, are discussed below. •Year-to-date 2020 results include net asbestos outflows of$11.2 million versus outflows of$18.5 million in 2019, all of which related to our discontinued operations. These outflows represent disposition of claims, defense costs and legal expenses related to litigation against our insurers, net of insurance proceeds.
•Year-to-date payments for restructuring activities reduced from
•Year-to-date 2020 results include$44.6 million of inflows from working capital due to lower sales and operational improvements. Results in the comparable prior year period included a$91.0 million outflow, due to an increase inNet Sales , an estimated$40 million one-time effort to bring DJO suppliers into payment terms consistent with our normal practices, and the elimination of a DJO accounts receivable factoring program. We define working capital as Trade receivables, net and Inventories, net, both reduced by Accounts payable and customer advances and billings in excess of costs incurred. Cash flows used in investing activities during the nine months endedOctober 2, 2020 primarily consists of purchases of property, plant and equipment. During the nine months endedSeptember 27, 2019 , cash flows used in investing activities included the DJO acquisition. 41 -------------------------------------------------------------------------------- Cash flows used in financing activities for the nine months endedOctober 2, 2020 included a net increase in repayments on our Revolver and Term Loan. Cash flows provided by financing activities for nine months endedSeptember 27, 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 ofOctober 2, 2020 include$50.7 million held in jurisdictions outside theU.S. We reduced these levels by$12.1 million in the third quarter of 2020. Cash repatriation of non-U.S. cash into theU.S. may be subject to taxes, other local statutory restrictions and minority owner 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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