Business Context and Reporting Period
The filing is Colfax Corporation’s unaudited Form 10-Q for the three months ended March 29, 2019, filed May 8, 2019. The supplied metadata identifies Enovis CORP, but the filing itself identifies the registrant as Colfax Corporation.
Colfax operated through Air and Gas Handling, Fabrication Technology, and, following the February 22, 2019 acquisition of DJO Global, Medical Technology. The company completed the DJO acquisition for approximately $3.15 billion and continued to classify its previously sold Fluid Handling business as discontinued operations.
Financial Performance and Position
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Net sales | $1,007.7 million | $880.9 million |
| Gross profit | $358.3 million | $270.6 million |
| Gross margin | 35.6% | 30.7% |
| Operating income | $24.8 million | $62.2 million |
| Operating margin | 2.5% | 7.1% |
| Net income attributable to Colfax | $(52.0) million | $24.5 million |
| EPS from continuing operations | $(0.36) | $0.22 |
| Adjusted EBITA | $126.7 million | $90.8 million |
| Adjusted EBITA margin | 12.6% | 10.3% |
Revenue increased 14%, primarily from the DJO acquisition and other acquisitions, partially offset by a $56.2 million foreign-currency translation headwind. Gross margin improved by 490 basis points, while operating income declined because of acquisition-related costs, strategic transaction expenses, restructuring charges, higher interest expense, and a $43.8 million pension settlement loss.
Q1 2019 included $55.8 million of strategic transaction costs, $30.8 million of acquisition-related amortization and other non-cash charges, $15.4 million of restructuring charges, and the $43.8 million pension settlement loss. The company reported a $3.6 million income-tax benefit and a 7.4% effective tax rate, compared with a 15.8% rate in Q1 2018.
Cash Flow and Liquidity
- Cash used in operating activities was $72.3 million, compared with $2.7 million used in Q1 2018.
- Cash used in investing activities was $3.17 billion, including $3.15 billion for the DJO acquisition.
- Cash provided by financing activities was $3.24 billion, primarily from new borrowings and the tangible equity unit issuance.
- Cash and cash equivalents were $242.4 million at March 29, 2019, including $215.3 million held outside the United States.
- Total debt was $4.17 billion, compared with $1.20 billion at December 31, 2018. Debt fair value was approximately $4.2 billion.
- The company had $465.0 million available under its revolving credit facility and stated that liquidity was adequate for the next twelve months.
- Letters of credit outstanding totaled $355.9 million against total facility capacity of $757.2 million.
Material Changes Versus the Prior Comparable Period
- DJO contributed $123.5 million of Medical Technology revenue from the acquisition date through March 29, 2019, with a 54.3% gross margin and a 20.8% Adjusted EBITA margin.
- Air and Gas Handling revenue decreased to $323.7 million from $347.7 million, but segment operating income increased to $29.4 million from $23.4 million.
- Fabrication Technology revenue increased to $560.4 million from $533.3 million, and segment operating income increased to $70.6 million from $64.1 million.
- Corporate and other operating costs increased substantially, reflecting $55.8 million of strategic transaction costs, principally related to DJO and the review of strategic options for Air and Gas Handling.
- Interest expense increased to $29.1 million from $9.6 million as a result of acquisition-related borrowings.
- Operating cash flow deteriorated primarily because of $55.2 million of strategic transaction costs, $72.8 million of working-capital cash consumption, and restructuring and asbestos-related payments.
- The company adopted lease accounting guidance on January 1, 2019, recognizing $197.6 million of right-of-use assets and corresponding lease liabilities.
Guidance, Outlook, Commentary, Risks, and Unusual Items
The filing does not provide specific full-year revenue, earnings, or cash-flow guidance. Management stated that the DJO acquisition is intended to create a higher-margin, faster-growth, less-cyclical platform and expects potential synergies from applying the Colfax Business System.
Colfax was exploring strategic options for Air and Gas Handling, including a potential divestiture, but stated that the outcome could not be predicted. A May 7, 2019 employment amendment provided Howden’s chief executive with a potential retention bonus of $2.0 million, potentially increasing to $3.0 million, in connection with a potential transaction.
- The new credit facility includes leverage and interest-coverage covenants. The company was in compliance at March 29, 2019. The initial maximum total leverage ratio was 6.00:1.00, stepping down over time, and the minimum interest coverage ratio was 3.00:1.00.
- Management identified risks related to integrating DJO, realizing acquisition synergies, elevated leverage, refinancing, foreign-currency exposure, cyclical end markets, raw-material costs, and strategic actions involving Air and Gas Handling.
- Asbestos claims remained material: 16,762 unresolved claims at March 29, 2019, with $340.9 million of recorded asbestos-related liabilities and insurance assets or receivables totaling $343.0 million. Management cautioned that actual liabilities and recoveries could differ materially from estimates.
- A 10% depreciation in major currencies was estimated to reduce equity by approximately $314 million, net of Euro-denominated debt effects. A hypothetical 1% increase in interest rates would have increased quarterly interest expense by approximately $6.8 million.
- The company repurchased nearly all noncontrolling interests in a South African subsidiary for $92.7 million, financed with debt, and owned 99.8% of the subsidiary at quarter-end.
- Management stated that disclosure controls were effective, while integration of DJO’s internal controls and compliance processes was still in progress.
Most Important Facts for Investors to Verify
- Whether DJO integration delivers the projected margin expansion, growth, synergies, and cash-flow benefits.
- Debt reduction, covenant headroom, refinancing requirements, and the company’s ability to deleverage following the acquisition.
- The outcome and timing of the potential Air and Gas Handling divestiture or other strategic transaction.
- Whether operating cash flow improves after acquisition-related costs and working-capital investment normalize.
- The adequacy of asbestos insurance coverage and the ultimate cost of asbestos claims and related litigation.
- The preliminary allocation of the DJO purchase price, including goodwill and intangible assets, which remained subject to adjustment.
- Foreign-currency, interest-rate, cyclical-market, pension, product-liability, and integration risks described in the filing.