Aviat Networks, Inc. (6701) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Aviat Networks Investor Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Andrew Fredrickson, Head of M&A and Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Thank you for joining this Aviat Networks' Investor Call. On the call today for Aviat is Pete Smith, President and Chief Executive Officer; David Gray, Chief Financial Officer; and Gary Croke, Vice President of Marketing, who will make remarks on the announced acquisition of NEC's Wireless Transport Business. We will then open the call for a question-and-answer session. An archived webcast of today's call will be available on the company's website. During this call, management may make forward-looking statements, which involve risks and uncertainties that could cause our results to differ materially from management's current expectations. We encourage you to review the cautionary statements and risk factors contained in the press release, which is available on our website and in the company's SEC filings such as its 10-Q and 10-K. Additional information about NEC can be found on their website and their filings with the Japan Securities authorities. Aviat Networks undertakes no obligation to publicly revise or update any forward-looking statements to reflect future events or circumstances. Furthermore, during the call, the company will discuss non-GAAP financial measures. A short presentation was added to our Investor Relations website, which will be referenced on today's call. I will now turn the call over to David Gray, our CFO. David?

Thanks, Andrew, and good morning, everyone. As announced earlier today, Aviat Networks and NEC have entered into an agreement for Aviat to buy NEC's wireless transport business in an asset purchase for $70 million. The transaction has been approved by the Boards of Directors of both companies. We expect the deal to be completed within the calendar third quarter of 2023, subject to regulatory review and other specified closing conditions. First, I'll start with an overview of the terms and financial implications of the microwave acquisition and then turn the call over to Pete for further commentary on the transaction rationale and outlook for Aviat. Please note all subsequent figures will be stated in U.S. dollars only. Beginning on Slide 3. Under terms of the agreement, Aviat will pay $70 million for the business via an asset purchase transaction. The deal consideration will be comprised of $45 million in cash to be funded via a bank term loan and $25 million in Aviat shares. This is a moderate amount of debt and represents approximately 1.2x gross leverage and 0.7x net leverage as compared to Aviat's stand-alone trailing 12-month EBITDA. Now let me give you some perspective on the potential contribution NEC's microwave business brings to Aviat Networks. We anticipate that the revenue contribution will be approximately $150 million annually. The business today has gross margins around 30% and operates at breakeven EBITDA levels. Through leveraging the scale of the combined entities, we believe that this entity will reach a run rate EBITDA similar to Aviat's recent range of 11% to 13% by the end of year 2. We expect the transaction to be accretive to normalized earnings by the end of the first year. With that, I'll now turn over the call to Pete to provide additional commentary on this exciting development for Aviat. Pete?

Thank you, David, and thank you to our shareholders who have dialed in for this call. I'm pleased to report today on our proposed acquisition of NEC's microwave division. As you know, Aviat is a leading provider of wireless transport solutions worldwide. Over the past few years, we have discussed our capital allocation strategy and the desire to pursue a transformational acquisition to make Aviat the leading wireless specialist in the industry and to scale our business. This transaction represents that transformative opportunity. We have found a highly complementary business in NEC's microwave division as detailed in the transaction rationale on Slide 4. NEC's microwave business is a Japan-based organization of point-to-point microwave and millimeter wave solutions for service providers and private networks worldwide. NEC delivers connectivity solutions for critical applications that require high levels of reliability and security, very much aligned with Aviat's value proposition today. Also, this acquisition builds on the successful deployment of the operating -- Aviat operating system used in the highly accretive Redline transaction and the 2019 North American partnership between NEC and Aviat. The addition of NEC microwave business immediately increases Aviat's presence in the international market with a long list of brand name customers. Combined, the new business will have over 20 Tier 1 customers. This is an exciting opportunity for Aviat and NEC. As shown on Slide 5, the acquisition creates the third largest microwave player and positions the combined entity to best compete with the microwave generalists of Huawei, Nokia and Ericsson as well as the fiber optic players who collectively hold 35% to 40% share of the backhaul market. We believe the acquisition of NEC has 3 significant benefits for Aviat, our combined customers and our shareholders. First, the transaction will immediately improve our financials. On Slide 6, you will see we anticipate an additional $150 million in revenue from the transaction, and we expect this will be accretive to adjusted EBITDA, non-GAAP EPS and free cash flow by the end of the first year. We will use cost synergies to pay for the acquisition, which will primarily come from complementary businesses and built from our learnings of the 2019 channel partnership with NEC for North America. These cost savings will come from both sides and a mixture of COGS and SG&A synergies. We have complementary products and customers with little overlap in key product offerings and very few common accounts, representing an opportunity for sales synergy in both Aviat and NEC customers. And despite these benefits, we have not assumed any revenue synergies in our financial model. Second, this acquisition enhances Aviat's portfolio and provides scale to innovate. Please turn to Slide 7. The combination creates what we believe will be the leading product portfolio in the industry with the broadest and deepest technology set to address customers' needs for both service providers and private networks. This includes best-in-class products for split mount, all in door and all-outdoor microwave millimeter and millimeter wave applications along with point-to-multipoint access, LTE routers and a complete portfolio of network management software. The combined R&D budget will enable the most compelling next-generation solutions from the specialist microwave player with scale. And third, this transaction makes us a more diversified business based on geography, see Slide 8. Aviat's business is currently over 60% from North America. And with this transaction, we'll shift the combined entity to 60% international, increasing Aviat's exposure to global 5G spend and private network opportunities and giving us a stronger presence in fast-growing international markets. There's very little country overlap. Vertical markets, see Slide 9. Aviat's business is currently about 2/3 private networks, and we'll move to approximately 45% private networks and 55% service provider, balancing impacts of different CapEx cycles between private networks and service providers. We will have diversified customers. The business will have very few overlapping customers, and post close, no customer will make up over 10% of revenue. And finally, we will see diversification of our portfolio. NEC's business is approximately 90% split mount. The new business will be a balanced mix of split mount, all indoor, all outdoor, routers, access, including LTE and software. This improves our portfolio offering and increases our ability to cross-sell. These are 2 complementary businesses no matter how you look at them. Before opening the call to questions, I'd like to briefly talk to the employees of Aviat and the NEC employees who will be joining the largest microwave specialist player. This transaction will be hard work, but we will forge a winning organization. Throughout the diligence process, we have seen the strength of the NEC team and know that the 2 businesses will be stronger together. I ask for your support in building this winning team. In summary, we believe this transaction will improve our financials in a meaningful way, bolster our portfolio offering and increase our differentiation, all of which will make Aviat a more attractive company to customers, employees and shareholders alike. We would like to reiterate that our full year fiscal year 2023 guidance remains unchanged. With that, we would like to open it up for questions.

Thank you. [Operator Instructions] Our first question comes from Scott Searle with ROTH Capital Partners. Scott, your line is live.

Congratulations on the transaction. Pete, maybe quickly to get calibrated. You've given, I think, the initial revenue for NEC and I think their EBITDA breakeven. But to dive in a little bit more, can you give us an idea about what their trajectory of growth has been. I'm not sure if there are OpEx synergies that you specifically highlighted, but if you could talk about that and plans for gross margin expansion on the NEC front. And then I have a couple of follow-ups.

Yes. So on the gross margin front, we will run the Aviat operating system and drive cost out. We think that over the past couple of years, we performed well with respect to supply chain. So we think that there's going to be some supply chain cost out. And then there's certainly overlap in SG&A, particularly in R&D. So we think that, that -- those combined will allow us to pay for the transaction. With respect to growth, what we have in our model is mid-single digits, and we're pretty confident that, that will materialize. And we didn't put more in to cross -- what we learned from the Redline transaction is the cross-selling opportunities take about a year to develop. So we think that, that would be -- as we make our way in the transaction and get to closing and get more intimate with the business, then we can revise that upwards.

I apologize, Pete, did you give an OpEx synergy number? And then as it relates to the complementary product aspects, certainly, there are geographic aspects and customer aspects. But do they bring some mid-band opportunities for you? And I think you mentioned point to multipoint as well.

I don't think I mentioned point to multi-point, but Gary will jump in on the products in the mid-band. And for modeling purposes, we think $20 million would be the right number to put in your modeling, right, on the cost synergy side, Scott. And Gary, why don't you jump in on the -- go ahead.

Right. On the mid-band, Scott, their products are licensed band point-to-point from 6 to 90 gigahertz. So nothing below 6% and no point to multipoint. So it's all in the license point to point bands.

Great. And lastly, if I could, just the expected borrowing costs that you're expecting on the $40 million, $45 million and congrats.

Yes. So as disclosed in 8-K that was just filed this morning, it will be a delayed draw term loan, which will be SOFR-based variable rate plus an interest margin. So obviously, a little higher cost -- higher now than it was a year ago, but certainly manageable and not burdensome to us.

Our next question comes from the line of Erik Suppiger with JMP.

Congratulations. Looks like a good combination. Can you speak to how your products compare with NEC. Explain a little bit about why they're so complementary, where they fit into the network. And then does this imply a greater focus on Tier 1 service providers going forward? And is that going to imply a significant change in terms of your product road map and in terms of your sales model, maybe moving more to direct sales.

Yes. So we are mostly direct sales in our private network and in our existing Tier 1s. Certainly, this will change the mix of customers to now combined will be over 20 Tier 1s. And we think that this is really good for our combined private networks businesses because the adoption curve is typically the Tier 1s drive the technology innovation and then it gets reengineered and tailored for private networks. So we think that this combination is going to make our leading private network business even stronger. And then on the portfolio side, our intent is to maintain the current portfolios of both companies. But as we come into the next generation to make one leading portfolio out of the R&D and the R&D capabilities of both sides and the technology kernels that we have in both of our portfolios.

Our next question comes from Tim Savageaux with Northland Capital Markets.

Congratulations on the deal. It really does seem good. So first question, I guess, is on technology platform and kind of your respective strategies there. Is NEC merchant based? And is there any kind of synergy or overlap amongst your suppliers, I guess, would be the first question.

So NEC's micro division -- microwave division, they leverage a kind of a big company model where there's centralized manufacturing. So we think that there's going to be COGS synergies between our contract manufacturing approach and theirs. That would be one. And then secondly, there are a lot of overlap in the supply base. So we think that that's a good place to look for cost synergies.

Okay. Great. And can you say at least currently configured how many employees the organization has. And obviously, APAC is a big a big part of the business. Can you call out any -- well, a, how much of that is Japan or how significant is Japan? And b, can you maybe call out some representative kind of Tier 1 customers around the region to give us a sense of kind of the footprint there?

Yes. So the -- there's not -- there's very little business in Japan. Japan is mostly fiber. On the Tier 1s, what I can say is there's a significant -- I can't name the customers at this point. The -- there's a significant presence in Indonesia, which is a geography that's well suited to microwave. They also have a reasonable presence in India, Mexico and Australia.

Great. That's really helpful. Did we hit the employee thing or no?

So you want to -- there's about 350 to 400 employees on their side. Yes.

Thanks very much. Thank you. Well wait I have one more. Yes. And my final question, I guess, is kind of on the tax impact and the use of the NOL. I know you got a bunch of them. I know a lot of it's U.S. and probably a fair bit of it foreign, but how do you think that's going to shake out in terms of your current kind of de minimis cash tax position?

Yes. So I think in general, most of the business in this deal is going to be international. So we'll obviously have some impact on our utilization of U.S. NOLs, but we also have foreign NOLs, a lot of which have full valuation allowances against them. And depending on the final ultimate organizational structure that we go with from an [ NAD ] perspective, could be an opportunity to more fully utilize those and potentially -- reverse that [ VA ]. But time will tell on that one.

[Operator Instructions] Our next question comes from the line of Paul Essi with William K. Woodruff.

Congratulations on the acquisition. A couple of real quick ones. Have you guys gone up against NEC in the past? And how have you fared, if so?

On the chart in the investor deck, there's a list out 10 -- approximately 10 competitive. So yes, we have gone up against NEC in the past, and I would say we've won some and lost some.

Okay. And then I understand that the cross-selling opportunities, you are not -- are not in your numbers, it's a year out, but it would seem to me that the possibilities are fairly significant. Would you be able to share how significant you think it might be a year from now as you move in that direction?

When we did the Redline transaction, we justified it with no revenue synergies, and we've done that again here. And I think we said that the funnel was building in Redline [ in a year ]. And I think it would be -- it's fair for you to ask, but it's a little premature until we are together and can get all of our customers in the same sales force database and start to work on. So you're right that it could be significant, but it's premature for me to put a number on it, Paul. But you're right to add.

I would now like to turn it back to CEO, Pete Smith, for closing remarks.

All right. So to follow up on one of Erik's questions. On the portfolio side, the split-mount plus our all indoor, all outdoor radios, we think that's compelling from the product side. So just a follow-up there. To move to closing, I'd like to thank everyone for joining on short notice. We look forward to our next update after we close our fiscal year. And we will keep everyone informed as the transaction progresses from signing to close. Thanks, everybody, for joining.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.