Cascade Microtech, Inc. (NASDAQ:CSCD)
Q4 2015 Earnings Conference Call
January 20, 2016 05:00 PM ET
Jason Cohen - General Counsel
Mike Slessor - CEO, FormFactor
Michael Burger - CEO, Cascade Microtech
Michael Ludwig - CFO, FormFactor
Jeff Killian - CFO, Cascade Microtech.
Edwin Mok - Needham & Company
Craig Ellis - B. Riley
Patrick Hoe - Stifel Nicolas
Srini Sundar - Summit Research
Christopher Longiaru - Sidoti & Company
Thomas Diffely - D.A. Davidson
Thank you and welcome everyone to FormFactor and Cascade Microtech’s Fourth Quarter 2015 Conference Call. Before we begin here is Jason Cohen the company’s General Counsel to remind you some important information.
Thank you, operator. Good morning with me today are Mike Slessor, Chief Executive Officer of FormFactor; Michael Burger, Chief Executive Officer of Cascade Microtech; Michael Ludwig Chief Financial Officer of FormFactor; and Jeff Killian Chief Financial Officer of Cascade Microtech.
Today’s discuss contains forward-looking statements within the meaning of the Federal Securities Laws. Examples of such forward-looking statements include the anticipated benefits and synergies of the proposed transaction with Cascade Microtech, the anticipated timeline and closing of the proposed transaction, projections of financial and business performance, future macroeconomic conditions, business momentum, business seasonality, the anticipated demand for our products, our future ability to produce and sell products, the development of products and technologies and the assumptions upon which such statements are based.
These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed during this call. The information on risk factors and uncertainties is contained in our most recent filing on Form 10-K with the SEC for the fiscal year ended 2014 and our other SEC filings, which are available on the SEC’s website at www.sec.gov and in our press release issued today. Forward-looking statements are made as of today February 4, 2016 and we assume no obligation to update them.
Information provided in the materials include non-GAAP gross margin, operating margin, net income, earnings per share and EBITDA which are non-GAAP financial measures. Please refer to the description and reconciliation of GAAP to non-GAAP financial measures included in the Appendix in the presentation materials on the FormFactor’s website with respect to non-GAAP measures of FormFactor and the attachment to Cascade Microtech’s press release financials entitled reconciliation of GAAP to non-GAAP financial measures as well as the Supplemental Information posted on the investors page of its website with respect to non-GAAP measures of Cascade Microtech. Also available on the FormFactor website is a presentation entitled Transaction Summary relating to the transaction between FormFactor and Cascade Microtech.
With that we will now turn the call over to FormFactor’s CEO Mike Slessor.
Good morning. I’d like to start by thanking all of you for joining us on short notice so we can share some exciting news. Earlier today we announced the combination of FormFactor and Cascade Microtech. As you could see from the materials posted on our website this combination creates a unique set of benefits for both companies' customers, employees and shareholders, a set of benefits that neither company could achieve on its own. By joining forces we gained scale and diversification, we expand both our served and addressable markets and we unlock the significant financial synergies and earnings accretion shown on page 13 of our posted slides.
The efficiencies derived from scale are becoming essential for success in the maturing semiconductor industry. As our customers’ ramp new technology nodes and chip designs the winning suppliers consistently innovate to deliver ramp enabling products on ever shrinking timeline. To keep pace with the top semiconductor manufacturers requires significant R&D investments that are guided by extensive and close customer collaboration. Then is these new nodes and designs transition into volume production in the global manufacturing ecosystem these same customers required coordinated support infrastructure and processes to deliver identical results around the globe.
As shown on page seven, this customer channel has been centered to recent success of both FormFactor and Cascade and we plan to continue these investments. We also plan to realize cost and performance efficiencies from the increased scale provided by our larger product and revenue platform. It is also worth noting that we are creating scale from our respective leadership positions in closely related, but different markets with minimal direct product overlap.
As many of you know, FormFactor leads the $1 billion overall probe card market, the Cascade owns a strong position in the high growth RF area of the advanced non-memory probe card space. As a result, this combination add to FormFactor’s served market and application footprint inside our core probe card market. Driven by growth in discrete SAW and BAW RF filters the RF portion of the proven test market has grown impressively over the past few years and with the continued band and filter proliferation shown on slide eight is positioned to continue that growth even at handset unit growth slows.
In addition, as evidenced by our recently announced joint venture between two of our larger mutual customers, there is an emerging coupling between these RF front ends and the digital application processors and modem devices where FormFactor has a significant market positions. Although, our initial post-closing integration plans are measured in cautious where they touch products, technology and operations we would expect the expanded application footprints of the combined company to allow us to benefit from these trends.
At a broader level, test measurements and characterization from the engineering to production phases of new node and device ramps is becoming a more important enabler of our customer’s innovation. Our industry continues to advance with innovation such as FinFETs and logic and 3D NAND and memory as well as 2.5-D and 3D integrations. These integrations however create entirely new species of yield and reliability defects demanding more of test, measurements and characterization to detect, analyze and fix these new defects.
Cascade’s strong engineering systems and probes business have been enabling leading customers to solve these problems and improve yields more quickly and cost effectively. It enables a faster transition to volume production where devices are tested using FormFactor’s production probe cards. Over the longer-term we will be positioning the company to address these customer challenges and will provide more details of these opportunities and plans as we move through the closing and integration phases.
I’d also like to take this opportunity to extend the future welcome to Cascade’s employees and shareholders. You’ve built a great company that has consistently delivered top and bottom-line growth over the past five years and you will be key contributors to FormFactor’s future success. As I ensure you will find today’s FormFactor team shares your commitment to satisfying customers winning in the marketplace and creating shareholder value.
And finally, before I turn the call over to Michael Burger, Cascade’s President and CEO. I’d like to personally thank him for his leadership and guiding us to the transaction that unites Cascade and FormFactor. Michael?
Thanks Mike. This is a very significant milestone for Cascade Microtech. We are extremely proud of our heritage, reputation and performance. As a result we feel this combination between Cascade and FormFactor is the culmination of our hard work and commitment to our customers, employees and shareholders. FormFactor’s reputation is a technology leader in the markets that they served extremely well with Cascade’s legacy as well as our future. Our culture of supporting customers in their quest-to-solve very difficult technical challenges is aligned with FormFactor’s history and vision.
Throughout our conversation with FormFactor’s management team, we become comfortable that the two company’s cultures and practices are largely aligned. This is extremely important to our success and we’ll continue to be as we both value the knowledge based workforce that we employee. I want to thank Mike Slessor for the way this transaction has been handled to-date. And I congratulate him and his team for FormFactor’s success. I feel comfortable that Cascade Microtech will be in good hands.
I will now turn the call over to Mike Ludwig, FormFactor’s CFO.
Thank you, Michael and good morning. I’m going to start with the transaction summary which you can find no slide five. FormFactor will acquire all the outstanding shares of Cascade Microtech in a cash and stock transaction that values Cascade Microtech at approximately $352 million in equity value or approximately $21.13 per share based upon FormFactor’s closing stock price on February 3, 2016.
The deal provides that Cascade Microtech shareholders will receive an exchange for each share $16 in cash and $0.6534 of a share of FormFactor common stock as described in the merger agreement. To finance the purchase FormFactor will issue approximately 10.4 million new shares, borrow $150 million of new term debt and use approximately $120 million from its current cash and short term investments.
FormFactor will also issue approximately 1.2 million shares for assumed equity awards of Cascade Microtech employees. The new shares have investing period commensurate with the assumed equity instruments.
At the transaction closed the combined company will have a cash balance of greater than $100 million and a strong cash flow generation profile. We will prioritize deleveraging the company post transaction close with an objective to get below two times gross debt to EBITDA within 12 months.
In addition to the strategic benefits of the business combination mentioned previously. The financial aspects of the transaction are equally compelling. The transaction allows the company to leverage incremental scaling of its resources, accelerate the utilization of past net operating losses to minimize taxes on expected growing profits and leverage its strong balance sheet to achieve meaningful non-GAAP EPS accretion post close.
The company expects to realize $10 million to $12 million of annualized cost synergies within 18 to 24 months of the transaction close. These synergies will be realized in phases with early synergies coming from opportunities such as redundant field infrastructure and facilities and duplicate public company expenses.
FormFactor will realize meaningful tax savings as a combination of the two companies will benefit from close to $300 million of NOL tax assets available to offset U.S. income. As shown on slide 13 when we combine the results of the two companies for 2015 on a pro-forma basis and adjusted for expected cost synergies, tax benefits, interest on the debt and the incremental share count from the transaction. The expected non-GAAP EPS accretion is approximately $0.28 per share, a 76% increase on an approximate 18% increase in outstanding shares.
We will communicate a future financial model incorporating those businesses shortly after the close of the transaction. The combined company will retain the FormFactor name, Mike Slessor will lead the company as CEO and the leadership of the company will has strong representation from both companies across all functions.
FormFactor’s Chairman Tom St. Dennis will continue in his role and one board member from Cascade Microtech will join the combined company Board. The boards of both companies have unanimously approved the transaction. The transaction is subject to customary regulatory approvals and the approval of Cascade Microtech shareholders. We currently estimate receiving all approvals on a timely basis and the transaction to be funded and closed by mid-2016.
This is an exciting transaction that combines recognized technology leaders in their respective markets, utilizing increased scale to deliver hand solutions for our customers. The transaction is expected to drive profitable growth and facilitates the strategic use of FormFactor’s strong balance sheet to deliver increased value to our customers, employees and shareholders.
I’ll now turn my comments to FormFactor’s fourth quarter results of provided guidance for our first quarter. Financial performance of the company in Q4 was generally in line with our Q4 guidance. Revenues were seasonally strong. Our non-GAAP gross margin was at the lower end of our guidance as we prepare for a significant new node ramp at one of our large SoC customers and our non-GAAP EPS was in line with our guidance due to continued OpEx spending discipline.
Revenues for Q4 is $71.8 million increased $5.9 million or 9% compared to our third quarter of 2015. The increased Q4 revenues compared to the third quarter were driven primarily by a measurable increase in our SoC revenues and slight increases in both our DRAM and flash probe card revenues. SoC revenues in Q4 of $41.4 million increased $4.9 million or 13% compared to our third quarter. SoC revenues comprise 58% of our revenues in the fourth quarter compared to 55% in Q3. We achieved higher PC server based revenues from node overlap and a transition to new nodes as well as increased mobile processor revenues driven primarily by new designs in Q4.
Fourth quarter revenues for DRAM products were $28.2 million an increase of 3% compared to the third quarter. DRAM revenues comprised 39% of our revenues in the quarter compared to 42% in Q3. DRAM probe card revenues were positively impacted by the continued conversion to DDR4. Flash revenues were $2.2 million in the fourth quarter, a slight increase from the third quarter.
Fourth quarter GAAP gross margin was $21.2 million or 29.5% of revenues compared to $18.5 million or 28% of revenues for the third quarter. On a non-GAAP basis, gross margin for the fourth quarter was $24.6 million or 34.3% of revenues compared to $22 million or 33.4% of revenues for the third quarter. The increase in the fourth quarter non-GAAP gross margin resulted from a more favorable product mix, but also included increased cost to ramp manufacturing for a new product to address increased demand from a node transition at one of our largest SoC customers in the first half of 2016.
Our GAAP operating expenses were $22 million for the fourth quarter an increase of $0.2 million compared to Q3. Non-GAAP operating expenses for the fourth quarter were $18.9 million 26% of revenues an increase of $0.4 million compared to the third quarter. Variable compensation costs were higher in the fourth quarter due to increased profitability.
GAAP net loss was $0.6 million or $0.01 per share for the fourth quarter compared to a GAAP net loss of $2.5 million or $0.04 per share for Q3. Non-GAAP net income was $5.8 million or $0.10 per fully diluted share for Q4 compared to $3.3 million or $0.06 per fully diluted share for Q3.
Cash comprised of cash, short-term investment and restricted cash ended the fourth quarter at $188 million, $3.8 million higher than Q3. Excluding cash used for stock buybacks, the company generated $5 million of cash in the quarter. The company used $1.2 million to repurchase 140,000 shares in the fourth quarter.
With respect to the first quarter we see a continued strong SoC environment, but weakness in the DRAM demand environment due to lower device pricing and oversupply to negatively impact our revenues. We expect first quarter revenues to be in the range of $65 million to $70 million. We expect non-GAAP gross margin to be in the range of 31% to 35% with non-GAAP fully diluted earnings in the range of $0.03 to $0.07 per share. We expect cash flow will be positive $2 million to $5 million.
I will now turn the call over Jeff Killian who will cover Cascade Microtech’s results and guidance.
Thanks, Mike I will begin with the review of the income statement for both the fourth quarter and year ended December 31, 2015. As a brief reminder, Cascade reports revenue and gross margins in two segments. Our System segment and our Probe segment. The System segment includes our probe stations, thermal subsystems and reliability test products. The Probe segment includes our analytical probes and production probes.
Total revenue for the fourth quarter of 2015 was a record $40.4 million, an increase of 12.9% compared to $35.8 million in the third quarter of ‘15, an increase of 10.4% compared to the $36.6 million in the fourth quarter of 2014. We exceeded the high end of our revenue guidance for the fourth quarter, which was $37 million to $40 million.
Total revenue for the year were $144 million, an increase of 5.8% compared to $136 million in 2014. Revenue for our System segment for the fourth quarter of 2015 totaled $21.7 million, an increase of 13.3% compared to $19.1 million in the third quarter of 2015 and an increase of 1.5% compared to $21.4 million in the fourth quarter of ‘14.
Systems revenue for the year was $77.9 million, a decrease of 6% compared to $82.9 million in 2014. The annual revenue for systems was down primarily due to a soft first half of 2015 and has improved in the second half of the year based primarily on the strength of 300 millimeter systems and SourceOne revenue and is further supported with a book-to-bill ratio for systems in Q4, 2015 of over one. Due to the capital purchasing cycle of our customers the fourth quarter of each year tends to be the strongest for our System segment.
Revenue for our Probe segment of the fourth quarter of 2015 totaled a record $18.7 million, an increase of 12.5% compared to $16.6 million for the third quarter of 2015 and an increase of 22.9% compared to $15.2 million for the fourth quarter of 2014. Probes revenue for the year was a record $66.1 million, an increase of 24.4% compared to $53.2 million in 2014. Our Probe segment continues to benefit from demand in both the RF and parametric markets. Bookings in the fourth quarter were a record $48.7 million, which resulted in a book-to-bill ratio of 1.21 to 1.
Both reporting segments posted positive book-to-bill ratios for the quarter. Our systems bookings posted an increase of 29% compared to the third quarter of 2015 and an 8% increase over the fourth quarter of 2014. After setting an all-time revenue record in Q4, probes bookings posted an increase of 130% compared to the third quarter of 2015 and a 2% increase over the fourth quarter of 2014.
Our overall gross margin for the fourth quarter of 2015 was 56.3% compared to 56.7% in the third quarter of ‘15 and 53.4% in the fourth quarter of 2014. Overall gross margins for the year was a record 55.6% up from 51.7% in 2014. Our gross margins in 2015 benefited from overall increases in production volume and yield, shifts in product mix, favorable foreign currency exchange rates, product and facility integration and continued focus on operational improvement in the areas such as service and inventory management.
Gross margin for our System segment in the fourth quarter of 2015 was 49.8% compared to 50.3% in the third quarter of 2015 and 48.1% in the fourth quarter of 2014. Systems gross margin for the year was a record 48.9% up from 45.6% in ‘14 driven impart by the integration of our ATT thermal systems into our product portfolio. Gross margin for our Probe segment in the fourth quarter of ‘15 was 63.9% consistent with 63.9% in the third quarter of ‘15, but improved from the 60.8% in the fourth quarter ‘14. Probes margin for the year was a record 63.5% up from 61.2% in 2014.
Operating expenses for the fourth quarter was $16.2 million, an increase of $0.5 million compared to the third quarter of ‘15 and an increase of $0.8 million compared to the fourth quarter of ‘14. Operating expenses for the year increased to $62.2 million from $57 million in 2014. The overall year-on-year increase in operating expenses was driven by increased investment in research and development, headcount, incentives and selling expenses.
Income from operations in the fourth quarter set another record of $6.5 million, an increase of $2 million compared to $4.5 million in the third quarter of ‘15 and an increase of $2.4 million compared to $4.1 million in the fourth quarter of 2014. Income from operations for the year was a record $17.9 million compared to $13.3 million in 2014, representing a 34.7% improvement.
Total depreciation, amortization and stock-based compensation expenses were $2.3 million, an increase of $0.1 million compared to $2.2 million in the third quarter of 2015. And an increase of $0.2 million compared to $2.1 million in the fourth quarter of 2014. For further details please see the attachment to our press release financials entitled reconciliation of GAAP to non-GAAP financial measures as well as the supplemental information posted on the investors’ page of our website.
Our adjusted EBITDA for the fourth quarter of 2015 totaled $8.8 million or 21.8% of revenue, which compares favorably to our stated success model target of 22%. This level of financial performance was achieved while investing in our R&D roadmap for new product development to further expand and served to available markets. Our tax expense for the year was $5.5 million resulting in an effective tax rate of 31% compared to an expense of $2.7 million for 2014 and effective tax rate of 22%.
GAAP net income for the fourth quarter 2015 was $4.2 million or $0.25 per diluted share, compared to $3.2 million or $0.19 per diluted share in the third quarter of 2015 and $4.3 million or $0.25 per diluted share in the fourth quarter of 2014. Non-GAAP earnings per share for the fourth quarter of ‘15 was at the upper-end of guidance and a record at $0.28 per diluted share compared to $0.20 per diluted share in the third quarter of ‘15 and $0.26 per diluted share in the fourth quarter of 2014.
Turning to the balance sheet, cash, restricted cash and investments at December 31, 2015 totaled $35.8 million a decrease of $5.3 million compared to $41.1 million at September 30, 2015, and a decrease of $4 million compared to $39.8 million at December 31, 2014. The decrease in cash is primarily related to our share repurchase activity and capital purchases offset by cash flows generated from operations. During the fourth quarter of 2015 we purchased 514,300 shares for $7.5 million. The current repurchase program was originally authorized for $15 million and to-date we have repurchased 859,465 shares for a total of $12.3 million.
Capital expenditures were $2.7 million in the fourth quarter of ‘15 and $6.4 million for the year. These expenditures consist primarily of manufacturing equipment and research and development tools. Cash flow generated by operations were $5.4 million in the fourth quarter of 2015 and $14.7 million for the year.
For the first quarter of 2016 we are projecting revenue in the range of $33 million to $37 million, this projection is based on Cascade’s historical seasonality whereby Q1 revenue is typically 10% to 15% lower than the previous fourth quarter. We are projecting diluted GAAP earnings per share in the range of $0.08 to $0.14 and non-GAAP earnings per share in the range of $0.10 to $0.16 per share.
Our Q1 guidance assumes continued investments in R&D for new product development, the expense associated with our worldwide sales conference and an effective tax rate of 32%, consistent foreign currency rates and no significant one-time charges. As you know Cascade does not provide annual guidance, however based upon the momentum created in 2015 we believe we will outgrow the markets we serve in 2016 and financially outperform our 2015 results.
I will now return the call to Mike Slessor.
Thanks, Jeff. The combination of FormFactor and Cascade unites two leaders in their respective markets creating scale and diversification across a wide breadth of complementary test and measurement applications from engineering through production. As these complementary markets are closely related enabling us to generate leverage and efficiencies from our R&D and channel investments, we also expect to generate significant EPS accretion from realizing overhead efficiencies, changing our capitalization and by monetizing our NOL. As a result this transaction rapidly advances FormFactor strategically, operationally and financially and we are extremely excited about the future ahead.
With that we’ll open the call for Q&A.
Thank you. [Operator Instructions] And our first question comes from the line of Edwin Mok with Needham & Company. Your line is now open.
Hey thanks a lot for taking my question and congrats for the transaction. So first question I guess for Mike, my question is actually on calling the technical synergy there between the two companies. I think historically Cascade has this premier probe technology and FormFactor has strong technology in MEMS. Is there some opportunity down the road to integrate those two and is that valued to do that? And then I have two follow ups.
So Edwin I’m assuming we got a lot of Mikes on the call. I’m assuming that question was addressed to Mike Slessor, is that right?
Sorry for the confusion. The technical synergies although perhaps available down the road are certainly not a short-term priority or focus for us. One of the reasons you see the respective companies leading in different markets is they’ve developed and optimized their technology to serve these individual applications in a very efficient and differentiated way. Certainly FormFactor historically has hinted to enter the RF space. Obviously we have not been that successful and Cascade is growing pretty significantly there.
So I think in the short-term we are really going to focus on executing to get the synergies out of the areas that Mike Ludwig talked about. We will certainly be working to get the channel synergies. But when it comes to product, operations and R&D I draw you back to the example of the integration of FormFactor and MicroProbe where we were very measured with bringing product roadmaps and engineering teams together and let those things happen from the ground up as our teams began to work together.
So in the short-term call it 18 months to 2 years I don’t see any technical or product synergies that jump right out certainly over the long-term. If I draw your attention to for example the convergence of RF and digital I would expect we’ll be able to take the strength of the two companies technically from a product perspective and do a better job of competing and serving as our customers start to converge things like RF and digital.
Okay great, that’s helpful. And then on the cost saving I noticed you guys provide a pro-forma initial 2015 saving around $7 million. I was wondering what was included in that call it estimate? And then what else need to happen for you guys to get to your target saving of $10 million to $12 million?
Yeah, Edwin. So on the seven again what we’ve really kind of thought there about is some synergies relating to some field operations with respect to maybe overlapping facilities any other infrastructure in the field that are overlapping we think we’ll try and address relatively quickly and in addition we have on the G&A side we have duplicate public company expenses, Board expenses those types of things where we think we can get synergies very early. So that’s the $7 million.
In order to get to the $10 million to $12 million again I think as Mike said over the 18 to 24 months will be measured. But I think we’ll end up having some natural synergies similar to what we saw couple of years back when we combined Form Factor and MicroProbe. So again I think we’ll look at maybe deeper in the organizations and I think what we really want to do is look at processes and all areas take the best processes and where there is some overlap we’ll again try and recognize some synergies there.
Okay, that’s helpful. And then lastly on I guess guidance of both companies I’ll lump two in one I’ll try to ask the two in one question. On the FormFactor guidance you mentioned that you expect some weakness in the DRAM space. Last quarter really didn’t rebounce that much from what we considered trough in the September quarter. How do you kind of think about your DRAM business this year? Do you expect it to go even lower than call it lower 1Q level as you go through a year or how do you kind of think about that part of the business? And then for Cascade just quickly on the guidance you kind of imply gross margin will come in a little bit on this quarter I was wondering what contribute that?
So Edwin it’s Mike Slessor. I’ll start with the FormFactor guidance question around DRAM. Certainly we are seeing weakness in demand for DRAM probe cards, which I don't think is a surprise to anyone who operates in the DRAM space. The capital equipment guys are feeling it as well. As the way we look at 2016 is the tale of two halves. So the first half in DRAM we do expect to be weak, the demand probably from a Q1 standpoint will be at a low we do see some new design activity as Mike Ludwig said continued DDR4 transition, and some strong projects primarily around DDR4 server.
I will do want to draw your attention though to the fact that our SoC results are extremely strong as we see new nodes ramping while older nodes are still going on 10 nanometer obviously have big activity for us right now. And we see that at least partially offsetting if not fully offsetting the weakness in DRAM associated with our first quarter guidance. Again to tie this together that’s part of the reason we told you we want to and this transaction accomplishes our continued diversification into new markets with new customers and if you like reducing our dependence on DRAM in any given period. We’re still going to participate in DRAM, we’re still going to invest in DRAM, but the continued diversification is a big part of this transaction for us.
With that maybe I’ll turn it over to either Michael Burger or Jeff Killian for the comments on Cascade Q1 guidance.
Yeah Edwin this is Michael Burger. As you know we don’t really give guidance on gross margin, but if you pick the midpoint of our guidance $33 million to $37 million for Q1 of 2016. We expect to be up over 10% of the same quarter a year ago. In couple of weeks ago we gave some kind a color around what we expected in Q1, which is seasonal down from Q4 and in the script we talked about that. So we don’t see anything unusual we do see the growth trajectory from Q1 throughout the balance of the year very traditional which we’ve seen kind of year in year out.
Your next question comes from the line of Craig Ellis with B. Riley. Your line is now open.
Thanks for taking the questions and congratulations to both of the management teams on this deal. My first question is for Mike Slessor. Mike when you look at the combined company and look at the growth rate of the combined company do you think that the growth rate is the average of what we would see just looking at the pro-forma contributions that you’ve outlined or is there something about the way these two companies together in the end markets that they served that would cause growth of the combined company to be either above or below just a simple weighted average growth rate.
Yeah so Craig the question I think comes down to are there near-term available revenue synergies. Or can we increase our growth rate just by bringing these companies together. I think the simple answer and the honest answer is no. Longer term, as we discussed in the answer to Edwin’s question and in some of the prepared remarks in the script, we do view there being the potential for such thing. But if you look at the company’s businesses and how we’re executing in our respective markets, I think the right way to think about our top line growth is as the super position of the two existing businesses’ growth rates.
If we look our way down the P&L and you can see this reflected in the pro-forma however. There are some significant efficiencies that are unlocked. And so if you look at in particular an EPS growth rate as we execute towards the synergies take advantage of the NOLs. There is a significant acceleration of growth rate there as we bring together the cost savings and different financial synergies associated with the deal.
That’s helpful. The follow-up question is to Tom. Tom I missed it if you have provided earnings accretion guidance. But can you comment on that both on a near-term basis and a longer-term basis.
Yeah this is Mike so we did look at but we haven’t provided any guidance on accretion. We just looked at our 2015 sort of on a pro forma basis as if this had happened as of the beginning. And when you look at that we’re basically saying, hey go FormFactor had on a non-GAAP basis $0.37 on a standalone right and you put them together you get $0.28 of additional accretion for the year. So again that’s about 75%, 76% better than the FormFactor on a standalone basis. However that’s just is an illustrative example of how we think this makes a lot of financial sense. That being said we haven’t provided any forward-looking guidance with respect to accretion on the transaction.
Okay. And then two details one are there breakups and if so what are they? And two, how should we factor in the cost of debt that will be used to fund the transaction?
I’m sorry what was the first question Craig?
So yes there are breakup fees. We refer you the merger agreement to look for the details of those. I’ll ask Mike Ludwig to talk about the funding.
I’m sorry are you asking about funding or are you asking about when you said cost can you elaborate Craig on the question?
Yeah the just the cost of the debt funding that’s used on the deal?
Okay. So the cost of the debt funding. So in the example we used little over 3.25% is what we have. And we do have committed terms and conditions and in essence where it’s what we’ve used in our assumption was LIBOR plus 200 basis points.
Okay, that’s helpful. Thanks guys.
And our next question comes from the line of Patrick Hoe with Stifel Nicholas. Your line is now open.
Thank you. And first I also want to send my congratulations to both companies. First for Mike Slessor. Given some of the overlap of customers and as you mentioned, you kind of combine both now the engineering as well as the production capabilities of both companies. Do you see this longer term as a potential one stop shop for many of your customers both from the engineering side as well as on the production end?
Thanks for the question Pat. I think it’s a great question because as we look longer term, clearly one of the things we’re looking forward to creating is you could call it a one-stop shop, but maybe looking at it more broadly a more complete provider of solutions to help people both measure their yield, but also improve their yield. Obviously as we move upstream into the engineering and characterization space, one of the things we’re able to do is not just tell people what their yield is which is one of the fundamental things that probe card does, but we’re able to help people to fix yield.
And I think the insight that we gained from the upstream engineering activities is going to really help inform both our product decisions downstream, but also help customers as they ramp things aggressively and be in the right position to offer them a complete engineering to production solution as they ramp new nodes and new devices. So longer term that’s definitely one of the strategic benefits we see from the combination.
Great, that’s helpful. And then maybe just as a follow-up for you again Mike in terms of just the business environment on the probe card and for you guys as you look to 2016. You mentioned the continued strength in your SoC business. As you look at the year as a whole, given the lot of the mix data points in the overall semiconductor industry. Do you see the SoC strength coming primarily from one core customer or do you see the mobile application processor market also picking up strength particularly as you get to the more seasonally stronger period of the year?
So we do see there are many moving parts and not just the SoC business, but the overall probe card business during 2016 as we currently see it. The strength in SoC does have multiple dimensions to it. Certainly the current activity that we’ve indicated is associated with 10 nanometer ramp at one of our key customers is very strong momentum and we expect that to be persistent throughout the year. However if we look at new design activity from other customers on some of the foundry FinFET nodes there is some very strong initial design activity there as well, which as you say we typically find seasonal strength in the middle part and the latter part of the year associated with those designs. And so the simple answer to your question is we see both components of that strength in SoC as we move through 2016.
Great, thank you and congrats again.
And our next question comes from the line of Srini Sundar with Summit Research. Your line is now open.
Hi, guys thanks for taking my call. My first question is why now? What factors made you think that this is the best time for the merger?
Yeah Srini it’s Mike Slessor I’ll answer that one or start to answer that one. With any combination certainly you’re looking to satisfy several different objectives and as we’ve motivated for you in the conference call and in the support materials this one allows us to check the boxes on strategic operational and financial rational in a very compelling way in each of them. So the fundamental deal made sense. Given Cascade’s performance over the past year and the continued trajectory of that momentum you can infer from Jeff’s guidance and comments we felt like it was the right time to capture some of that growth, but the other piece of this is certainly associated with two companies finding the right ingredients and the right time to decide the deal.
Simply put it takes two to tango, the companies obviously known each other well this is a small neighborhood and we’ve been interacting for a long time, we found the right ingredients from a Board perspective, from a valuation perspective, and from adjust an overall timing perspective when we look at availability of debt, FormFactor’s track record now of putting up seven consecutive quarters of cash generation. We felt like all these things came together at the right time and we’re able fortunately to put this deal together at this time.
I’d actually like to ask Michael Burger to also talk about the timing from the Cascade side of this as well because as they said it takes two to tango.
Yeah thank you, Mike. The only thing I would add to what you said is that I think trajectory of the market is another factor. I think there was a great deal of uncertainty at the beginning of 2015 about what the market would hold and I think that obviously makes for nervous boards and conversations around what the future looks like. I think we have a pretty good feel for 2016 and feel like it is very positive and I think that’s great environment in which to put two companies are together. So I agree with everything that Mike said and I think the markets had something with that as well.
Okay. And my next question is who are the key customers of Cascade? I know that you have like thousand customers, but is there like one, two, three top three customers?
It’s Mike Slessor I’m going to answer that generally and then I’m going to ask Cascade guys to comment. Again part of this is about diversification and one of the interesting things about Cascade’s customer concentration and mix and then the combined companies customer concentration and mix is it is very diverse.
In fact, Cascade has no 10% customers and so they don’t publicly disclose who their top customers are. Having said that I can tell you it is the who’s who of the semiconductor industry. As Patrick inferred from his question we do have a lot of the same customers I want to emphasize that we’re selling these customers different product, but there is a great deal of customer overlap with the top customers in the semiconductor industry. Michael, do you want to address that as well.
Yeah, thank you. And we don’t really have customer that is over 10%, and so we don’t really give a lot of grief there [ph]. Obviously we have two different markets or segments that we report, the systems and market really represents the who’s who of the semiconductor space. We’ve got roughly over 10,000 systems installed in the field and it literally is almost everyone who does any sort of semiconductor manufacturing research et cetera.
And then on the Probe segment that is dominated primarily, as Mike Slessor said in the script around the RF frontend market segment, which is again in our investor presentation we talked about the big guys, Avago, Skyworks, Broadcom, et cetera. So we feel we really touch a lot of the same customers FormFactor and Cascade. It’s just the level of emphasis or concentration of each of our businesses is different and I think putting these two companies together will really kind of maximize that and I think that’s a real exciting opportunity I think for certainly our customers and our shareholders.
Okay. Just to clarify, would you say that all the foundries are kind of your customers, meaning in [indiscernible]?
Are you asking Mike Burger or are you asking…?
Go ahead Mike.
Yes, all the foundries are our customers particularly on the system side. They represent a large concentration of our current installed base in our future funnel. So yes.
Okay. Thank you very much.
And our next question comes from the line of Christopher Longiaru with Sidoti and company. Your line is now open.
Hey guys, I will add my congratulations. I was wondering if you could give us a little more clarity into the synergies. I mean is this more going to be kind of you are selling to the same customers and are going to recognize benefits from that? Is it wafer pricing could you just give us a little more granularity into what that $10 million to $12 million looks like and how it progresses over the timeframe that you laid out?
Yeah, I think what we are looking at again is as we get into the initial steps as we’ve discussed earlier I think we’ll find some facility overlap, some field overlap, some public company expense overlap, right. So I think those again are the easy, as easy items as we get into deeper planning. We look at the processes that are being done by both companies. I think we’ll find some synergies that will develop probably throughout the organization whether that be in G&A whether that be in sales and marketing and as Mike said we’ll take a very measured approach to anything that touches R&D or the manufacturing and operations of it.
But again I think over time we’ll find some synergies there as well. I think it’s just it’s not going to happen in the first 12 to 18 months. It’s going to take some time to get deeper into the organization to do that and also I think one of the things that we talked about that’s pretty significant for us that we’ll get immediately right our tax synergies and with the ability to utilize the FormFactor NOLs that were created in literally like the 2009 through 2013 timeframe those will carry on for a number of years. So I think while we haven’t touched on those two much with respect to Q&A I certainly want to point those out to be very significant synergies and benefits on a go forward basis as well, Chris.
Can you lay out some of your expectations for how cash flow looks over the next few quarters as you move into this? Because I know that you mentioned that one of the uses of cash is going to be to delever the balance sheet. Just give us an idea of kind of what a combined company cash flow might look like?
Okay. Well again we will publish a model shortly after post close. But if you just sort of look at probably 2015 if that’s a decent example right FormFactor prior to any stock repurchases generated somewhere in the ballpark of $32 million and as Jeff pointed out if you do the math there I think there are a free cash flow of somewhere around $8 million or $9 million once you exclude stock repurchases.
So if that’s any indication then it would suggest that going forward the two companies together should be able to generate somewhere north of $40 million of cash flow on an annual basis. And again with expected increasing revenues, synergies and particularly tax synergies I would expect that number to go further north as we move along in the next ‘16 and ‘17.
Do you have a goal for how much that does to paying down debt?
Well for us again we’re going to really again focused on de-lever and we don’t have we have an established policy that suggest that a certain percentage of excess cash flow will go to pay down the debt, but from our perspective again we want to look at the what alternative uses of cash are but to the extent we don’t see any other transactions on the horizon and that sort of thing we definitely will focus on paying down the debt within the excess cash that we have.
Great, that’s all I have guys. Thank you for taking my questions.
And our next question comes from the line of Thomas Diffely with D.A. Davidson. Your line is now open.
Yes, good morning. First a question on the deal structure. Why did you decided to use stock as well as debt and not just debts alone?
I think, look I think the one thing that from company standpoint we knew we would have to use some debt. At the same point in time there was certainly a limited appetite for everybody’s limited appetite for the amount of debt. And we really sort of felt as well that it would be good in terms of when you put the companies together if they had a continuing interest in the combined success of the company that wouldn’t be a bad thing either. So I think that’s kind why we decided to use some stock as well.
Okay, alright. And then when you look at the NOLs that FormFactor has, what percentage of Cascade’s business is in the U.S. and would be and would benefit from the NOLs?
Right so we understand that somewhere in the 70% to 80% of their income is generated within the U.S. So again I think our NOLs will provide a nice synergy around that.
Okay. And then you have some nice slides on the diversification that the combination provides. Curious though when you look at the relative seasonality and the relative cyclicality of the two companies is it -- does the diversification help you there or is it really just customer specific diversification that benefits you?
This is Mike Slessor talks. There is couple of different components of diversification. The first as you’ve noted in the slides it is really associated with customers and lowering the combined company’s dependence on any one customer or any one set of customers. If you look at the seasonality profiles of the business interesting and Cascade’s Q4 calendar Q4 ends up being one of the very strong quarters of the year. And although it hasn’t happen recently for FormFactor that was often one of the weaker seasonal quarter for FormFactor.
So to the extent there is this historical seasonal pattern that still imposes on most of our business. We actually diversify or damp out some of that calendar seasonality as well as we put these two businesses together.
Okay. I was actually surprised to hear Mike Ludwig say that they came off of a seasonally strong fourth quarter, I’ve never heard you guys say that before. Alright so when you look at well just maybe couple of quick FormFactor questions here. First on the flash, it seems like the flash is running a little below where we would have thought several quarters ago. I’m curious how you see the traction with your new products there and how you view it on a go forward basis?
Right so the new product vector as we’ve talked to you in the past. We spent much of 2015 working our way through the production qualifications of two customers. And really focusing on making sure our internal yields, quality, cycle times and costs were within a window where we were prepared to ramp it. With some of the investments our customers are making in 3D NAND we are beginning to see the initial parts of that ramp. Certainly they were not evident in Q4 results as you can see from flash.
And in the first part of the year they’re going to be slow and steady. I think the guidance or the expectations we’ve set before, that Vector will be sort of call it $2 million on a quarterly run rate as we come through 2016 continues to be our exception, continues to be what we’re planning for. And as we begin to ramp these designs for volume 3D NAND production here in the first part of the year we’re tracking to that.
Okay. And then finally Mike Burger in your comments you talked about how the timing of this acquisition merger was it partly driven by the uncertainty in the marketplace a year ago in 2015 implying that the uncertainty in the marketplace is less this year. I’m curious if you could just expand on that thought.
Yeah I actually believe if less for certainly for Cascade in the context of our current customer base as we talked about our bookings for Q4 were exceptional over 1.2 to 1. So we felt really good about kind of the trajectory going forward and actually in all segments not just the RF side of it. So I think that builds a lot of confidence on both sides of the transaction about our ability to deliver what we said we’re going to do. And I think that does have some barring on timing.
Okay great. Thanks to all of you.
And we have a follow up question from Craig Ellis with B. Riley. Your line is now open.
Asked and answered but thank you.
And we have another follow-up from Srini Sundar with Summit Research. Your line is now open.
Hi, thanks again. My current question is I know China does not become a worry for FormFactor because of the end market profile. But does China potentially affect Cascade given its weakness?
So Srini China is an important market for both companies. And we have when we talk about footprints and customers both companies have pretty significant market presence in China. So as China continues to grow, as China continues to internalize more of the semiconductor manufacturing we certainly have FormFactor has done more and more inside of China with our local team and partnering with key customers and other suppliers inside of China.
So China remains for the semiconductor industry overall at a key area where you need to be present to win, where you need to be engaged in a material way with a local team that’s embedded there. And we’re going to continue on that theme as we move forward with closing and take advantage of this expanded product profile and footprint from engineering through production all of those activities happen in China as well.
And actually my question was is the current weakness in China is that going to affect Form or Cascade?
So from a macroeconomic or demand perspective.
Macroeconomic yeah. How it will affect?
Yeah certainly the overall demand dynamics associated with just take handsets, for example, are I think well understood by everybody. Both companies are certainly linked to the overall handset demand whether it’s Cascade’s RF filter business or FormFactor’s application processor and memory businesses. There are certain components of those businesses that are driven by handset unit demand. I think the interesting thing for both companies businesses and I’ll use an example that’s in our slide deck that’s of particular interest for the Cascade RF business is even as handset unit growth slows the number of discrete RF filters that are going into each of these units is expanding pretty rapidly as the bands proliferate.
And so even within end market weakness on the unit front we do see some growth trajectories inside as if you like the two companies take a bigger chunk of the share of the bond is inside these things. So macro economy certainly a concern, but we think there are some underlying structural dynamics that help us out there as well.
Thank you so much.
And we have no further questions. I’d like to turn the conference back to management for closing comment.
Thanks again for joining us today on a very important day in both companies’ history. We look forward to continuing to execute in our respected business, closing this transaction and delivering on the combined results and potential we have shared with you today. Thanks again.
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