Jan 23, 2018
Executives
Corey Manchester - Director, Finance and IR Jeffrey Duchemin - President and CEO Robert Gagnon - CFO Kristen Knox - President and CEO, DSI
Analysts
Paul Knight - Janney Montgomery Matthew Campbell - Laridae Capital Will Settle - Woodmont Investment
Operator
Welcome to the Harvard Bioscience Incorporated Conference Call. My name is John and I will be your operator for today’s call.
At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.
[Operator Instructions]. Please note this conference is being recorded.
And I will now turn the call over to Corey Manchester.
Corey Manchester
Thanks, John. And good morning, everyone.
Thank you for joining us this morning. Leading the call today will be Jeffrey Duchemin, President and Chief Executive Officer; and Robert Gagnon, Chief Financial Officer of Harvard Bioscience.
Before I turn the call over to Jeff, I will read our Safe Harbor statement. In our discussion today, we may make statements that constitute forward-looking statements.
Our actual results and performance may differ materially from what we have projected due to risks and uncertainties, including those detailed in our Annual Report on Form 10-K for the period ended December 31, 2016 and our other public filings. Any forward-looking statements, including those related to the Company's future results and activities, represent our estimates as of today and should not be relied upon as representing our estimates as of any subsequent date.
Also, as much of our -- much of our today’s call will focus on our estimated non-GAAP results, which we believe better represents the ongoing economics of the business, reflects how we set and measure our incentive compensation plans and how we manage the business internally. The difference between our estimated GAAP and non-GAAP results are outlined in the earnings release we issued today which can be found on our website under Press Releases.
Additionally, any material financial or other statistical information presented on the call which is not included in our press release will be archived and available in the Investor Relations section of our website. A replay of this call will also be available for one week at the same location on our website at harvardbioscience.com.
I will now turn the call over to Jeff Duchemin. Jeff, please go ahead.
Jeffrey Duchemin
Thanks, Corey. Good morning, everyone.
And thank you for joining us. We’re excited to announce our agreement to acquire Data Science International Incorporated for $70 million and simultaneously announced the sale of Denville Scientific Incorporated, our consumable distribution business for $20 million.
We believe this is a historic day for Harvard Bioscience and a major step forward in transforming the company. These transactions diversify our customer mix, add to our revenue base and strengthen our profitability.
We are addressing you this morning from DSI’s corporate headquarters in St. Paul, Minnesota.
And before I discuss the strategic advantages of acquiring and integrating a company like DSI, I'd like to introduce Kristen Knox, DSI's President and CEO, to provide some brief remarks about DSI. Kristen, please go ahead.
Kristen Knox
Thank you, Jeff. It is a great pleasure to be here in our office just north of Minneapolis, St Paul with our each [ph] bio team.
And I'm excited to share more about Data Sciences International. DSI's headquarters are in Twin Cities of Minnesota.
We currently have 180 employees globally, of which approximately 150 are located in our corporate office. For the 12 months period ended December 31, 2017, our revenues are approximately $44 million and our adjusted operating margins were in the mid-teens.
DSI is the recognized global leader in preclinical physiologic monitoring. We were founded in 1984 and have been committed to advance in science since that time.
In the early 2000s, there were changes to the guidelines which requires that any new drug seeking FDA submission for clinical trials must be tested in two animal models using telemetry. DSI is a market leader in telemetry and therefore I'm confident in saying that most new pharmaceutical drugs that have entered the market since that time have been tested using our telemetry system.
In short, we are incredibly relevant to new drug development. DSI develops, manufactures and market telemetries, instrumentation, software and services that help advance science.
Our products are used in four primary research areas of basic drug discovery, safety pharmacology and toxicology research. DSI serves many industries including pharmaceutical, academia, contract research organization, biological and chemical defense, the medical device industry, government and biotechnology company.
Additionally, we have a global presence with our headquarters here in Minnesota an office in Shanghai and representatives throughout the world. I am enthusiastic about our future, we have been executing on strategies that expand our business into new research areas such as diabetes, adding more value to our customers through services and developing a big data platform that will give better utility of the physiologic data collected with our system.
Joining an organization like Harvard Bioscience will only strengthen our presence in the market and support our efforts and growing the business. Now I will turn it back over to Jeff.
Thank you.
Jeffrey Duchemin
Thanks Kristen. As I said earlier, acquiring DSI and selling Denville transforms Harvard Bioscience by diversifying our customer mix, adding to our revenue base, and strengthening our profitability.
First let me start with diversified customer mix. One of the most exciting aspects of this acquisition is the instant diversification of the combined companies' customer base.
As most of you know, Harvard Bioscience is heavily weighted in Academia. More than 70% of our global revenue comes from customers in academic labs, with the remainder from a mix of pharma, biotech, government and others.
For the past several years, the global academic markets are growing slower than the biopharma markets, and we have continued to focus on diversifying our customer mix to take advantage of a faster growing market. Executing on these two transactions does just that.
DSI's revenue from academic customers amounts to approximately 30% and almost inverse of Harvard bioscience customer mix. On an ongoing pro forma basis, our mix will now be closer to 60% revenue from academic customers and 40% from biopharma contract research organizations and government.
This diversification makes our organization less susceptible to fluctuations in academic research funding. Additionally, DSI is a highly complementary company to our existing electrophysiology business.
We see a tremendous cross-selling opportunity of DSI products into academic labs as well as our legacy brands into pharma, biotech and CRO markets. Nothing exemplifies this opportunity more than each company’s top customers.
There is almost no overlap in each company’s top 25 customers. Now, let me talk about revenue.
Along that line, the acquisition of DSI and the sale of Denville will make us a larger organization increasing our revenue base. As of today, we’ve agreed to acquire approximately 44 million of revenue from DSI and so approximately 25 million from Denville.
Rob will get into our guidance shortly. But upon closing, Harvard Bioscience will be an approximately a $120 million pure play life science instrumentation company.
In regards to strengthening our profitability, in addition to the top-line by acquiring DSI an instrumentation company and selling Denville a consumer distributor, our company becomes more profitable on day one. We expect our adjusted pro forma gross margins will increase to within a range of 54% to 57% compared to 46% to 47%, while adjusted operating margins will increase to within a range of 10% to 13% compared to mid to high single-digits.
When I took over as Harvard Bioscience President and CEO four years ago, I knew we would become a successful company if we executed on four corporate initiatives, commercial excellence, operational efficiency, product development and acquisitions. We acquired three companies early in our tenure but we knew all along the only way to acquire an integrated company like DSI was to build a solid commercial and operational foundation.
In that time, we worked tremendously hard to organically growth the top-line, develop and bring new products to market, implement ERP systems, consolidate facilities all while focusing on cost containment initiatives. We experienced several headwinds along the way but that never deterred us from our goals.
Today is not the end of the story. Today is the beginning of the new chapter for Harvard Bioscience, a pure play life science instrumentation company with new top-line and bottom-line growth potential and several new competitive advantages that differentiate ourselves from our competitors, especially in electrophysiology market.
Before I conclude, I would like to thank the employees of Denville for their contributions to Harvard Bioscience and wish them success in the future. I would also like to welcome the employees of DSI to Harvard Bioscience.
I am confident together we will make Harvard Bioscience into a successful company with long-term shareholder value. With that, I will turn the discussion over to Rob Gagnon, who will provide more insight into our financials and guidance.
Rob?
Robert Gagnon
Thanks, Jeff. And good morning, everyone.
For my comments today, I will spend a few minutes discussing pro forma guidance for the company on the acquisition of DSI and the sale of Denville, followed by a brief discussion of the company’s tax asset usage. I would then like to take a minute to discuss leverage and the deal financing.
As a result of the DSI acquisition and the sale of Denville, we expect to report 2018 revenue of between $118 million and $123 million. In addition, we expect to report annual non-GAAP adjusted gross margins of between 54% and 57% and annual non-GAAP adjusted operating margins of between 10% and 13%, and annual non-GAAP EPS of between $0.19 and $0.23.
The acquisition of DSI is important for all the reasons that Jeff and Kristen previously outlined. But we will also believe there is significant synergies in the acquisition.
We anticipate to realize combined revenue and cost synergies of between $2.5 million and $3.5 million 12 months following the closing. We expect those synergy target to increase over the first three years following closing.
In addition, the revenue and cost synergies, we require deferred tax assets as part of the acquisition. Adding these tax assets to the approximately $25 million currently in our books, we will have over $30 million to use and we do not expect to be a significant cash taxpayer in the U.S.
over the next 3 to 5 years. As our press release outline last night, the acquisition of DSI will be financed through a combination of debt the proceeds from the sale of Denville and cash on hand.
At the time of the Denville closing, our existing term loan from Bank of America and Graham Brothers will be paid in fall. We anticipate closing on the DSI acquisition at the end of January.
At which time, we will enter into a new term loan as well as and up to $25 million revolving line of credit. Total borrowings between the term loan and the revolving line of credit will be approximately $67 million at the time of the DSI closing.
The new credit facility will mature in 5 years from the day it's executed. Borrowings under the new credit facility will accrue interest at a rate of LIBOR plus the margin of 6.25%.
With principal amortization payments of 2.5% in year one, 3.75% in year two and 5% thereafter. We expect to use an interest rate derivative to fix the variable interest rate on at least of portion of the debt balance.
And the new credit facility is subject to a 50% excess cash flow suite and other customary provisions as well as financial covenants that require the company to maintain certain financial ratios on a consolidated basis. Total leverage at the time of closing on a gross pro forma TTM December 31, 2017 basis will be slightly more than 4 times the company's EBITDA.
Based on expected cash flows we expect to delever to around 3 times EBITDA by the end of 2018 and to under 3 times EBITDA by the end of 2019. These leverage estimates do not contemplate any future acquisitions.
Before I turn the call over to questions, I'd like to reiterate Jeff and Kristen's comments. This is a tremendous day for the employees of both Harvard Bioscience and DSI as well as our shareholders.
We will now open the call for questions from participants. Operator?
Operator
Thank you. We will now begin the question-and-answer-session.
[Operator Instructions]. And we do have a question from Paul Knight from Janney Montgomery.
Paul Knight
Hi, Jeff. Could you go over what you think are the low hanging items in terms of is it revenue synergy with the no overlapping customer base, is there any cost cuts, is it offices selling additional product lines?
Could you kind of outline the top couple of three things that make you excited? And congratulations on the deal by the way.
Jeffrey Duchemin
Thanks, Paul. As you know and most of our investors know, for years, we’ve tried to get in position to balance our portfolio, not being so reliable on the NIH and academic labs, and today we’re able to do that with the acquisition of DSI and their biopharma customer base.
Sales synergies are very attractive with these two companies coming together. Legacy Harvard Bioscience products will now be able to be pulled into some of the key customers that DSI has in the biopharma space.
And on the flip side, DSI’s products will now be able to be pulled into academic labs where they basically haven’t had a presence. I believe our global sales and marketing capabilities will be able to derive these sales initiatives both short-term and long-term for the company.
So, we are very excited about sales synergies. On the cost side, there’s also cost synergies.
Here in St. Paul there is a very large facility that we’re in the process of renegotiating the lease.
There will be some savings there along with other initiatives that we will be working on over the next several months. But we are very excited about this opportunity to great business, great management team, great products.
Thanks, Paul.
Operator
[Operator Instructions]. We do have question from Matthew Campbell from Laridae Capital.
Matthew Campbell
Good morning, everybody. And congratulations on this acquisition.
I just had a quick question regarding DSI. What were the reasons that DSI who is seeking to sell itself, and what’s been the historic growth rate for DSI?
Jeffrey Duchemin
Well let me jump in and I’m going to let Kristen jump in here too. DSI was owned by a private equity group.
They had owned the company for 10 plus years. It was time for them to exit.
We have been speaking to DSI for three years. This isn’t a deal that just happened overnight.
We have been negotiating with DSI since 2015. The timing was right for their Board.
The timing was right for our company. And that’s how the two businesses came together.
I don’t know if I missed anything.
Kristen Knox
You covered it. It was a question of timing and it's a good time for us to work together with Harvard Bioscience to grow our business into the academic space and we think there is great synergies on the pharmaceutical and biotechnology side.
Robert Gagnon
Matt, hi. It’s Rob.
And just to talk about the long-term growth rate. The business in five years expanded double-digits and other years it’s been lower single-digits.
But over the long run if you look at over decades in terms of planning purposes it would be kind of 5%, 6% in that range, kind of midpoint.
Matthew Campbell
Great. That’s very helpful.
Thank you very much and congratulations on this deal. And regard to Denville, I didn’t catch this.
When is the closing of that sale?
Jeffrey Duchemin
Denville closed yesterday.
Matthew Campbell
Okay, good. And so, there’s a $3 million earnout provision.
So, are you getting 17 upfront and then $3 million thereafter?
Jeffrey Duchemin
Yes, Matt that's correct. So, 17 upfront and then there is an earnout provision for the next two years, there are two annual measurements.
The first year so 2018 the earnout potential is up to $2 million and for 2019 it's an additional $1 million. And it's based off of gross profit targets.
Matthew Campbell
From my recollection, the Denville facility had overall the gross margin for that business were a lot lower, correct?
Jeffrey Duchemin
Yes. So, the gross margins for the Denville business, they're on the lower side of our portfolio of businesses and brands.
And they would fall anywhere in the range of 32% to 35%, 36%. And in terms of operating margins for that business the past couple of years it's been in the range of up to 6% to 7%.
Operator
And we do have a question from Will Settle from Woodmont.
Will Settle
Yes, good morning and congratulations on the transactions. Question regarding the 2018 guidance.
How did you think about DSI in that context just in terms of visibility that you're having or stepping into new business? How did you get comfortable with putting out a 2018 guidance and retention of the revenue base etcetera?
Robert Gagnon
Hi, Will it's Rob, thanks for the question. So as Jeff had mentioned, this isn't a new business to us.
We've been in contact with DSI for a while now. And we've had a chance to do a fair amount of due diligence over the past several months.
And when we looked at the guidance of the combined companies, we want to remain conservative but also recognize that our business has started to experience a bit of an uptick over the last couple of quarters. And we've basically factored for the combined companies 2% to 3% for the next year in terms of organic growth.
And then on top of that the synergies that Jeff has mentioned. And when you add those synergies it gets you to essentially mid-singles on the organic side for the next year.
And that's how we thought about it.
Operator
And we have no further questions at this time. I'll turn it back over to Jeff for closing remarks.
Jeffrey Duchemin
Well thank everyone for calling in this morning. And once again I'd like to thank the DSI and welcome the DSI employees to Harvard Bioscience.
We appreciate the team effort here from both Kristen's team and the management team at Harvard Bioscience to get this deal done. It's an incredible day for Harvard Bioscience.
So, thank you once again everyone. We'll speak you soon.
Have a good day.
Operator
Thank you, ladies and gentlemen. That concludes today's call.
Thank you for participating. And you may now disconnect.