Good evening. Welcome to Aviat Networks' investor update call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to your host, Mr. Andrew Fredrickson, Director of Investor Relations. Thank you. You may begin.
Good evening, and thank you for joining Aviat Networks' investor update call to discuss our proposal to acquire Ceragon Networks and demand for an extraordinary shareholder meeting. You can find our press releases and the accompanying investor presentation in the IR section of our website at www.aviatnetworks.com, along with a replay of today's call in approximately two hours. With me today are Pete Smith, Aviat's President and CEO, and David Gray, Aviat's CFO, who will provide an overview of our proposal and the strategic and financial rationale behind the proposed transaction. We will then open the call for Q&A. As a reminder, during today's call, management may make forward-looking statements regarding Aviat's business, including, but not limited to, statements relating to financial projections, business drivers, new products and expansions, the impact of COVID-19, and economic activity in different regions.
These and other forward-looking statements reflect the company's opinions only as of the date of this call and involve assumptions, risks, uncertainties that could cause actual results to differ materially from those statements. Additional information on factors that could cause actual results to differ materially from statements made on this call can be found in our annual report on Form 10-K, filed with the SEC on August 25, 2021. The company undertakes no obligation to revise or make public any revisions of these forward-looking statements in light of new information or future events.
Additionally, this call and the investor presentation does not constitute an offer to sell or exchange or the solicitation of an offer to buy or exchange any securities, nor will there be any sale of securities in any states or jurisdictions in which such offer or sale or exchange would be unlawful prior to registration or qualification under the securities laws of any such jurisdiction. No offering of securities will be made except by means of our prospectus, meeting the requirements of Section 10 of the Securities Act of 1933 or an exemption therefrom. At this time, I would like to turn the call over to Aviat's President and CEO, Pete Smith. Pete.
Thanks, Andrew. Good evening, everyone. We will use the presentation on the Aviat investor website as a guide. Thanks for joining this special Aviat investor call about our proposed offer to acquire Ceragon. Since I've been at Aviat, many shareholders and analysts have suggested we can create a lot of value through the combination of the two companies. Today, we are taking action to realize that value. We have publicly offered $2.80 per share in cash for Ceragon, valuing the company at approximately $257 million, assuming $22 million of net debt. Turning to slide four, Aviat's proposed acquisition of Ceragon will create a global wireless transport specialist capable of competing with the large-scale generalists on a technological basis. By that, I mean both hardware and software.
As I'll describe later, this opens up new growth channels for us and ensures that we can stay ahead of the industry on innovation. In addition, there are significant cost synergies, some of which can be used for growth and some for savings. We have modeled $35 million in cost savings that we plan on realizing in the first two years after close. Importantly, this combination accelerates our strategic plan and is expected to be accretive to our shareholders by the end of year one. Turning to slide five. Before I get into the detail about our offer and why we are confident it would create substantial value, I wanna discuss some of the mechanics. We have worked for several months to engage in discussions with Ceragon, making various proposals, including with a mixture of cash and stock. We're going public because all of our previous approaches have been rebuffed.
We have actively sought to engage with Ceragon's board, as detailed in a letter we released publicly today. Despite our efforts and the tremendous value this presents for Ceragon shareholders, the board continues to refuse to engage with us and has responded only with a series of unreasonable conditions we consider far outside market practice. Therefore, today, we made our offer public. Further, we have established a 5% equity position in Ceragon. With that level of ownership, we have the right to request changes to the board and have requested that Ceragon convene an extraordinary shareholder meeting. We are seeking to expand the size of the Ceragon board and elect five independent nominees proposed by Aviat, replacing three existing Ceragon directors who have not demonstrated the independence to evaluate our proposal properly.
We hope that our nominees are elected and that our proposal then receives proper consideration. While we are fully prepared to pursue this step, we remain hopeful that the Ceragon board will agree to negotiate a transaction with us. Turning to slide six. We see significant benefits from scale, enabling us to compete in more geographies and more verticals. We have strength in North America and will benefit from Ceragon's significant presence in many high-growth markets that we currently don't serve, including India. We anticipate a pro forma geographic mix of approximately 40% North America, 60% rest of the world. Our businesses are highly complementary, which gives us confidence that the combination would yield significant financial benefits. We are modeling adjusted EBITDA margins of +15% for the combined company post synergies in year three, which exceeds both companies' existing stand-alone margins.
On slide seven, you can see that Ceragon has seen significant value destruction in recent years under the leadership of the same board that refuses to engage in discussions with us about a value-creating transaction. That said, we see tremendous opportunity from a combined platform and new oversight of Ceragon's assets. We doubt that Ceragon's stock price and business performance will significantly improve while the company remains a stand-alone organization under the current strategy and management team. In the near term, under the current management teams and board stewardship, Ceragon's gross margins has declined from 34% in calendar year 2019 to 30% over the last 12 months. As I noted above, we anticipate significant margin expansion by combining the two companies, and we've been demonstrating the ability to make operational improvements that drive tangible financial improvement.
In the mid to long term, while Ceragon would have shareholders believe that the delayed rollout of its next-generation chip will unlock value, we believe a combined company could provide far more value to both shareholders and customers by offering Aviat's next-generation system on a chip in partnership with MaxLinear, which is based on a newer generation of technology that we believe will offer significant differentiation. By offering this chip across a broader geographic footprint and in more verticals, underpinned by a leaner and stronger organization, the combined company will offer technological advantage to customers in the medium to long term, while also providing meaningful growth to shareholders. To summarize, without our offer for and stewardship of Ceragon's business, we do not expect to see significant change in the company's stock performance nor its operating results.
On slide eight, you can see that our cash offer is far superior and carries much less execution risk for Ceragon shareholders than the continued execution of Ceragon's stand-alone strategy. The transaction we propose really is a win-win for both Ceragon and Aviat shareholders. For these reasons, we are confident that Ceragon shareholders will support our board nominees. We're also asking Ceragon shareholders to make their views heard to their board and urge the board to work towards a negotiated transaction. Now on slide nine, I'll get into more detail about the strategic fit and financial benefits of the proposed transaction for Aviat shareholders. We compete against several large generalist players. We think this combination will provide the scale, efficiency, technology, and innovation that will separate us from the pack.
This opens up an entire new market segment for us and allows us to operate more efficiently so we can compete even more effectively. Moving to slide 10. We have discussed our strategy with regards to end markets, and this combination would make a stronger presence in private networks, in 5G, and in rural broadband. These are attractive growing markets. Slide 11 shows the geographic diversification that the combination would yield. This again opens us to increased geographic exposure and reduced customer concentration. We have minimal customer overlap, so we don't anticipate cannibalization. This is almost entirely new opportunity we're pursuing. On slide 12, you can see the significant cost savings we anticipate, which all leads to margin expansion and greater ability to invest in growth over time. Moving to slide 13.
This industry evolves rapidly, and this combination ensures that we'll have the resources and capabilities to lead the industry in the future. You can see some of the growth opportunities we anticipate on slide 12. A stronger leader company with more resources and more technology leadership is a great result for our customers, in addition to the benefit it provides to our shareholders. On slide 14, I'll share some financial perspective on the proposed transaction and combined company. We anticipate pro forma revenue of $590 million and approximately +15% adjusted EBITDA margins. We're maintaining a strong balance sheet with modest debt of $215 million, which we expect to refinance over time. All of this yields earnings accretion one year after close.
With all of that, you can see why we're so excited about the combination and hope the Ceragon board will act in the best interest of their own shareholders and support the combination. On slide 15, I'll walk through our path forward. As I mentioned, we have requested a meeting of the Ceragon shareholders, at which shareholders will be able to vote to expand the board and elect our nominees. Today, we issued a press release with additional detail about our nominees, who, if elected, will act as independent fiduciaries serving the best interests of Ceragon shareholders. We expect that extraordinary meeting of shareholders to be held in early September. In the meantime, we hope to engage in negotiations with Ceragon's board. We are confident we have a clear path forward to executing this transaction.
To move to conclusion, over the past 2.5 years, Aviat has implemented an operating system to achieve top line growth, margin improvement, notwithstanding the inflationary environment, and improved profitability. Given Ceragon's drop in share price, margins, and profitability, we submit that the acquisition by Aviat would improve the business as well as the customer and supplier experience. Our offer is a very compelling 51% premium to the 60-day volume weighted average price of Ceragon stock. We are offering a 14.5x multiple of EBITDA. This is compelling and represents certainty for Ceragon shareholders, as well as significant and de-risked value creation, potential for Aviat shareholders. Operator, let's open it up for questions.
At this time, if you'd like to ask a question, please press star one on your touchtone phone. Again, that is star one to ask a question. One moment while we queue. Once again, that is star one. One moment while we queue. We'll take our first question from Scott Searle of Roth Capital Partners. Your line is open.
Hey, good afternoon. Thanks for taking the question. Hey, Pete, just want to clarify quickly again, the cost synergy timeline that you're talking about was three years to recognize the $35 million. On the debt front, I'm wondering, have you already secured financing, and what's the rate that you're looking at on that debt?
We have highly committed financing letters that we've shared with Ceragon. We're pretty confident in the debt markets. We get the $35 million out in the first two years. Year three, you know, the beginning of year three, you could model, you know, $35 million cost out.
Gotcha. If I could, just to follow up in terms of the current conditions and the timing of the bid. You know, what's the update in terms of the demand picture, supply chain? Is there any change on that front that's kind of driving the outlook right now or just being opportunistic in terms of being able to add a lot of scale in a relatively short period of time?
You know, look, we've said that, you know, when we talked about our capital allocation strategy, that if we had an opportunity to do a transformative acquisition, we would. You know, this opportunity, we started working on it in November. You know, we haven't been able to negotiate a transaction outside the public eye. You know, we've let seven months transpire and thought this is the time to do it. Then the second point is we did amass a 5% threshold. We do have a filing requirement. You know, as we crossed that threshold, we needed to go public.
Okay. Lastly, if I could, and I think you've already answered this, but in terms of the vertical integration strategy that Ceragon has and today's announcement with MaxLinear, of you continuing to solidify that relationship in terms of working with third parties on that front. Is that kind of how we would think about the evolution that ultimately you would be going, you know, completely to work with third parties and not going the vertical integration route that has posed some problems in terms of Ceragon's, you know, new products and time to come to market? Thanks.
Yeah. Thanks for that question, Scott. Aviat has the highest capacity radios on the market, and that derives from our system architecture. We also have good margins because we invest in embedded software and standalone software. We do leverage MaxLinear for our current modem. In the future, we think leveraging the innovation of MaxLinear will, in a combined company, decouple the problems that Ceragon has encountered and allow us to innovate more on the system architecture and the software.
Great. Thanks.
Thanks for the question.
Yep.
We'll take our next question from Tim Savageaux of Northland Capital.
Hi. Good afternoon.
Hi.
Can you guys hear me?
Hi, Tim. Yeah.
Great. Just wanna follow up in terms of breaking down the synergy assumption in terms of what you might expect from cost of goods and OpEx. You know, if you look at it in total, it's around 20% of the combined OpEx base. Obviously, that's a much lower number if you add in the COGS. Is it incorporated in that assumption that, you know, you'll see some gross margin improvement as a result of the shift to merchant products, or are we mostly talking about OpEx here in terms of the synergy?
It's mostly OpEx, Tim. Mostly OpEx.
Well, yes and no in terms of overlap then. Well, maybe, you know, as you execute that strategy on the merchant side going forward, can you see Ceragon gross margins coming up to Aviat levels over time? It sounds like that's not assumed in your synergy forecast.
No, that's not assumed. Right. Look, you know, some of Ceragon's business is in India, and that's, you know, that's a tough place to get higher prices. You know, a lot of their business goes to mobile network operators, and they, you know, don't have the engineering or the value-added services that we have with private networks. We didn't model an improvement in gross margins.
Got it. You know, I'll circle back to Scott's question, I guess, briefly in terms of, can you give us any guidance at all for what sort of rate you might expect on the debt, given that's, you know, those numbers have been moving around a lot recently?
Sure.
Might have been different, you know, when you started this process. Do you have anything, any comment, commentary given where we are in terms of the end of the fiscal year on Aviat's kind of standalone results or outlook?
Yeah. So I'll let David jump in with the financing and the debt rate. I would add, you know, to kind of talk about the gross margin question, we, you know, we've been rebuffed with respect to diligence and, you know, perhaps there's something in diligence that we could figure out. You know, we only wanna talk about the transaction because we're, you know, we're in our quiet period for results, so we'll keep the supply chain and the demand environment until August, Tim. Sorry about that.
No, that's fair enough.
David, do you wanna comment?
Yeah.
As far as the.
Last one from me, and I'll pass it on.
Okay.
Oh, I'm sorry. Go ahead, David.
Yeah, Tim, you want me to finish off your question on the debt?
Yeah, of course.
Yeah, so you know, we've been talking throughout this process with a number of banks and you know, we feel you know, we have a clear line of sight to stay within the pro rata Term A market, not have to get into institutional Term B. That market is much more stable than what you're seeing out in the institutional side of things. Having said that, we still took a fairly conservative view in our internal modeling as far as what interest rate we'd be paying. I don't wanna go into that kind of specifics 'cause it still is a bit in flux, as you say. I think we're pretty comfortably covered there.
Fair enough. Last one from me before I pass it on. You know, this is on taxes, I guess. Obviously you guys got some very substantial NOLs sitting around both in terms of you know, U.S. and internationally. Do you feel like, you know, a transaction like this would really allow you to monetize those in a meaningful way?
The way I would put it, Tim, is, you know, as we get through the integration, it would certainly allow us to generate significant amount of cash. Yeah, to answer your question simply, yes. You know, post synergy realization, the cash generation of the combined entity is significant.
Yeah. I think.
Got it.
The majority of the NOLs are in North America anyway, so I think those would, you know, be, you know, not very impacted by this transaction.
Yeah.
Thanks.
We'll take our next question from Erik Suppiger of JMP Securities.
Yeah, thanks for taking the question. Congrats on an interesting announcement here. Just curious from a pricing perspective, as a combined company, do you think that you would be able to increase pricing across any particular markets? Do you think this will allow you to move upmarket into the tier one service providers very effectively?
Yeah. I don't think any pricing power will be derived from this transaction. There's very little overlap in the customer base. Ceragon, you know, we're heavily weighted into private networks, and Ceragon is more in the service provider. The combined entity would have, you know, less private networks than Aviat has today and more service providers. I would say no on pricing, and I would say the overall mix of the business would increase in weight towards service providers.
Okay. Would you keep the sales organizations largely intact? It sounds like you've got pretty different footprints. Is there synergies derived from that, or is that largely kept as it is?
There would be some overlap in the sales organizations that we would, you know, rationalize over time.
Very good. Thank you.
Good.
We'll take our next question from Dave Kang of B. Riley.
Thank you. Good afternoon or good evening. My first question is, how big is the India market? For that matter, how big is the Latin America market? What do you think of Huawei's market shares are in those regions?
Huawei has got about 20% overall market share. Both of those regions are, you know, $200 million-$300 million. We can give you the specific Latin America, India market sizes in a follow-up date, but just as a ballpark.
Mm-hmm.
That's where we are. You know, Huawei is not strong, or their strength in India is waning given geopolitics, but they still have a reasonable presence in Latin America.
Is it fair to assume that those market shares will be up for grabs going forward?
Well, you know, on previous earnings calls, we've talked about the Aviat share gain funnel from Huawei being about $60 million. In a combined entity, I think, you know, we get more competitive versus Huawei. I don't wanna say it's up for grabs, but I think there's opportunity.
Right. Especially since you mentioned that Ceragon is more levered to service providers where you're more-
Correct.
to private networks. Right. Okay. Got it. Thank you.
Thank you.
Our next question is from Theodore O'Neill of Litchfield Hills Research.
Thanks very much. Pete, it looks like, correct me if I'm wrong, both you and Ceragon have DISH Network as clients. Would this merger impact that at all? Correct me if I'm wrong on this too, it looks like DISH is buying the same thing from both of you.
You know, the DISH situation is we compete city for city. We had DISH signed up a year before Ceragon made their announcement. You know, they have their product, and we have ours, and we're in a city-by-city competition. There are, you know, 6-10 players. I think that DISH has choice.
Okay, thanks very much.
Thank you. We'll move next to Alex Henderson of Needham. Your line is open.
Thanks. To management, thanks for finally getting this thing going. You know, I think we've been urging.
Alex, it was your suggestion at the Needham conference.
Yeah. It's been ages that we've been recommending it. So I guess my primary question is, you know, as your bankers have looked through the mechanics associated with the defenses that Ceragon might have in place, the structure of its board or any other impediments, how likely do you think it is that, given the 5% ownership plus a position that you can actually get them to execute a you know a vote on the subject? Or is that something that they are going to just flat resist, in which case, how does this transaction go any further?
Yeah. Our read of the legal landscape is, as a 5% shareholder, we are entitled to nominate our directors, and that'll go to a shareholder vote. You know, we think the offer is compelling, and there will be support from the shareholders that we've heard from thus far. You know, the reason we went ahead with buying the 5% and, you know, making an offer in late November and in April, and our chairman and I went to Israel, is because we think there's a lot of logic.
We think that if we'd much prefer a negotiated transaction and diligence, but if we can't come to that conclusion, we are confident in our offer and in our nominees and the Israeli legal process for getting a fair hearing on our offer with a new board. That's Alex, we wouldn't have spent the time and energy if we didn't have a degree of confidence that led us to invest all of the effort that we've put in so far. I really appreciate your support in wanting to see this.
In structural terms, the expansion of the board, it's one thing to limit to replace three board members, but the expansion of the board, are there any encumbrances against that particular piece? You know, what is the structure of the vote that has to occur? Is it just a 50% majority of the shareholders or h ow does that mechanically get approved?
The bar for winning is 50% of the shareholder vote. There is a quorum bar that eludes me at this moment. You know, the Ceragon bylaws, they have seven board members. Their bylaws permit nine. We nominated five.
All right. Okay. I see. Going back to the fundamentals that you talked about on the cost savings and particularly around the chip. The 100 gig chipset that Ceragon has been working to bring to market, it sounds like you're suggesting that you would not use that chip, that you would in fact prefer to go with MaxLinear and decommission that program. Is that what I'm hearing?
Look, we would like diligence, right? In the absence of diligence, you know, we need to use the MaxLinear chip. If we were able to get diligence, then we could determine whether you know, the MaxLinear chip was better or the Ceragon chip is better, and we can make that choice accordingly. Based on the information that we have available today, we believe that the MaxLinear roadmap is more powerful in terms of the core channel sizes. The frequency bands we know are more expansive than what Ceragon has. We match on capacity. We have similar interfaces. I would like to learn more. If we can't learn more, you know, we would stick with MaxLinear in a combined entity.
I see. Okay. Those were my questions. Thank you very much for letting me ask them, and thanks for getting this process going.
Thank you, Alex.
We have a follow-up from Tim Savageaux of Northland Capital. Your line is open.
Yeah, I wanted to follow up on revenue synergy potential and also kind of accretion potential. First on revenue synergies. I thought it was really interesting in your slide deck that the combined entity that you estimate to be bigger than Nokia and not that much smaller than Ericsson. You know, I think it's pretty clear that you don't have any revenue synergies implied in your model here. But given that scale, you know, is there potential to, you know, accelerate share gains that you've been seeing from Nokia, you know, at present, to be better positioned in Huawei replacement opportunities in general to accelerate the growth rate you've been seeing over the last few years?
Yeah. We didn't model any revenue synergies, right? You know, the, you know, I get criticized, and rightfully so, for being conservative. Revenue synergies are very difficult to perfect. But on a, you know, if you think about it, the there would be better competitors from a combined Aviat, Ceragon entity that could give customers that are dependent on Huawei more comfort and more consideration. You know, Tim, we've known each other for a while. You ask a strong question, and I gave you the kind of careful answer, right?
I certainly never criticize anybody for being conservative. I don't know what you're talking about. I guess the last question was on accretion potential. Given that your synergy target is essentially equivalent to, you know, at least my estimate for the company's net income this year, fiscal 2022 that would suggest a fair, you know, obviously we have to, you know, deal with the debt cost. You know, even taking that into consideration, it seems like accretion that, you know, well north of 50% is, you know, in play here from what you're looking at currently.
Yeah, I guess, I don't know if I'd go quite that high, just yet. I mean, there's a lot of things we don't know as of now. Based on what we're modeling, I think we're taking a conservative view towards it. You know, I think the $35 million that we're looking at, again, as Pete said, you know, there's mostly OpEx, some amount of COGS in that. Those will play well into the overall financial performance and, you know, more than you know take care of the interest coverage that we would need to generate and, you know, the businesses itself should be, you know, throwing off a fair amount of cash.
I think, you know, I think there's certainly, you know, potential, I'll say, potentially upside, but there's a lot we don't know right now, so we're taking a normal conservative view, as far as what it could be.
Fair enough. Just tossing a number out there that seems pretty reasonable. Anyway, and congrats on the, again, getting the ball rolling here. Looks like a very interesting opportunity. Good afternoon.
Okay. Thanks, Tim.
We'll take our next question from George Iwanyc of Oppenheimer.
Thank you for taking my questions. Pete, do you anticipate any regulatory challenges or, you know, things that might have to happen from a product portfolio standpoint?
We don't anticipate any regulatory challenges. You know, it's we would be in third place competing, you know, against the likes of Huawei, Nokia, and Ericsson, so we don't see that. We have very little exposure to China, so the CFIUS risk is limited. You know, in terms of product rationalization, I think, you know, you have to keep the portfolios going for a couple years, and then, you know, as you move to the next generation, you would rationalize the product portfolio. The combination of Ceragon and Aviat's portfolio, we'd have a broader array of products that would better enable the combined entity to compete with Huawei, Nokia, and Ericsson. You know, where we don't have product overlap, we'd keep those.
What we do on the next generation, we would rationalize the portfolio where there's overlap. It's kind of classic product management, George.
Okay. You know, given the generalists out there that you mentioned, do you expect that there's any potential of a competing offer?
You know, I would submit that if that were the case, it would've already been made, and it's not clear that the generalists are. The generalists seem to us to be focused on the RAN part of the network and not as focused on the microwave piece. You know, over the next couple months, I'm sure if there's interest, we will address this.
Maybe one final question from me. When you look at the kind of the regional landscape and, you know, the two companies' exposures, are there any markets that you would potentially de-emphasize after the merger? Or would you stay equally committed to India, given, you know, the challenges from a pricing and margin standpoint?
Yeah. You know, in my background, I've run a pretty successful Indian business in energy storage. I think some of the strategies we used in that business would be applicable to, you know, the challenges of doing backhaul in India. I think we, with our operating system, we could improve the India business on behalf of, you know, with Ceragon in the Aviat portfolio.
Thank you.
We would remain equally committed.
Yeah, thank you very much.
Once again, press star one if you would like to ask a question. It appears that we have no further questions at this time. I'd be happy to return the call to Mr. Smith for any concluding remarks.
Yeah. I'd like to thank all the interested investors and analysts for calling in on short notice. It's an exciting time. It's an exciting opportunity for the microwave backhaul industry, and we will keep you updated on Aviat's standalone progress. We'll give our full year results in August. As the transaction develops, we'll be sure to keep you all informed. Thanks for calling in.
This does conclude today's call. You may now disconnect your lines, and everyone have a great evening.