Broadcom - Earnings Call - Q2 2015 & Acquisition
May 28, 2015
Transcript
Operator (participant)
Good day, ladies and gentlemen, and welcome to the Avago Technologies Limited Conference Call to discuss its definitive agreement to acquire Broadcom. My name is Steve, and I'll be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. If at any time during this conference you require assistance, please press star zero, and an operator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Director of Investor Relations, Ashish Saran. Please proceed, sir.
Ashish Saran (Director of Investor Relations)
Thank you, Operator, and good morning, everyone. We will be covering two topics today. First, Avago's Chief Financial Officer, Tony Maslowski, will review Avago's second quarter financial results and business outlook. Then, he will turn the call over to our CEO, Hock Tan, to introduce our guests and discuss our proposed acquisition of Broadcom. We will only take questions after prepared comments. Press releases on both topics and supplemental information on the transaction are available in the investor section of Avago website at avagotech.com. In addition, this conference call is being webcast live, and a recording will be available via telephone playback and will also be archived in the investor section of our website. During discussion of earnings, Tony will be providing details of our second quarter fiscal year 2015 results, background on our third quarter fiscal year 2015 outlook, and some commentary regarding the business environment.
In addition to U.S. GAAP reporting, Avago reports certain financial measures on a non-GAAP basis. Reconciliation between GAAP and non-GAAP measures is included in the tables attached to today's press release. Comments made during today's call will primarily refer to our non-GAAP financial results. As a reminder, today's call will include forward-looking statements regarding our future business performance and the expected timing and completion of the proposed transaction, as well as financial impact to Avago. These statements include risks and uncertainties that could cause our actual results to differ materially from the statements made on this call. Please refer to our press releases today and our recent filings with the SEC for information on specific risk factors. Now, let me turn the call over to Tony.
Anthony Maslowski (CFO)
Thank you, Ashish, and good morning, everyone. In light of the Broadcom announcement this morning, I will provide an abbreviated review of our recent business highlights and second quarter fiscal 2015 financial results. Complete second quarter financial results and third quarter guidance is included in our earnings announcement, which was released earlier today. As you are all aware, we closed the Emulex transaction on May 5, two days into our third fiscal quarter. Accordingly, Q3 guidance will include expected contributions from Emulex. I want to remind you that my comments today will focus primarily on our non-GAAP results from continuing operations, unless otherwise specifically noted. Revenue of $1.65 billion in second quarter represents a decrease of 1% from the prior quarter. Revenue from the industrial and wired segments came in better than our expectations. The wireless segment performed as expected, as we saw weaker-than-expected revenue from the enterprise storage segment.
Gross margin and earnings per share came in much stronger than expectations, driven by favorable mix. Moving on to our segments, starting with wireless. In the second quarter, revenue from our wireless segment declined by 13% sequentially, and compared to the same quarter last year, wireless grew by 66%. Looking at the third quarter of fiscal 2015, we expect growth to resume in our wireless business, with a high single-digit sequential revenue growth. We are expecting the start of a ramp at a large handset OEM as they transition to their next-generation platform. We also expect to continue the product ramp we started in the prior quarter at another large handset OEM. Turning to our enterprise storage segment, in the second quarter, enterprise storage revenue came in below expectations, declining by 4% sequentially.
The sequential decline in enterprise storage was primarily due to the well-known weakness in the HDD end market. Our server and storage connectivity businesses had a strong quarter, driven by broader adoption of our PCI Express switches. Starting with our third fiscal quarter, Emulex products will become a part of our server and storage connectivity businesses. In our third fiscal quarter, we expect a seasonal uptick in our HDD business and our custom SSD controllers to continue to ramp. We expect our core server and storage connectivity businesses, not including Emulex, to maintain their momentum and contribute a similar level of revenue in the third quarter. Collectively, with Emulex, we expect our enterprise storage segment revenue to grow close to 25% sequentially. Moving on to the wired infrastructure segment, our wired segment performed better than expected in the second quarter, with revenues increasing by 10% sequentially.
ASIC revenue was up by double digits sequentially. Fiber optics revenue was also up from the prior quarter, led by an increase in 40 gig shipments. Please note that prior to the third fiscal quarter of this year, Avago sales to Emulex were included in the wired segment results. But starting with the third quarter, these sales will become intercompany transactions and will be eliminated from externally reported wired segment results. For the third quarter, we expect our wired segment revenues to decline by low single digits sequentially. The decline is entirely due to the impact of previous Emulex revenue-generating transactions being eliminated. Turning to our industrial and other segment, in the second quarter, our industrial and other segment revenue increased by 38% sequentially, well above expectations due to higher-than-expected licensing revenues. Industrial resales were up slightly from the prior quarter.
Looking into the third quarter of fiscal 2015, we expect to continue to see replenishment of our industrial product inventory at our distributors and expect industrial resales to sustain from the prior quarter. However, after the sharp spike in the second quarter, we expect a large decline in licensing revenue in the third quarter, which will drive overall segment revenues to sequentially decline by about 20%. So, in summary, at the midpoint of guidance, our third quarter consolidated revenues are projected to grow to $1.74 billion, or up close to 6% sequentially. Now, turning to a few items on our financial results. Foxconn was a greater-than-10% customer in the second fiscal quarter. Our second quarter gross margin from continuing operations was 61%, which was above our guidance range of 57.5%-59.5%, primarily due to the higher-than-expected licensing revenues, which carry a higher gross margin than our corporate average.
Total operating expenses for the second quarter were $297 million, $3 million above guidance, primarily because of higher-than-anticipated spending on certain R&D engineering materials and higher payroll taxes due to stock option exercises. Taxes came in at $40 million in the second quarter, slightly above our guidance. This was primarily due to higher net income than forecast. Second quarter interest expense was $53 million. Other income, net was $12 million, resulting from a number of items, including gains from foreign exchange and interest income. Our share-based compensation in the second quarter was $57 million. In the third quarter of fiscal 2015, we anticipate share-based compensation will be approximately $82 million. In the second quarter, we spent $177 million on capital expenditures. During the quarter, we also paid $605 million to reduce our outstanding term loans.
As announced earlier this month, on May 5th, 2015, two days into the third quarter, we paid $583 million in cash to acquire all outstanding shares of Emulex Corporation. With the completion of the Emulex acquisition, Emulex's 1.75% convertible notes are convertible at an increased conversion rate until June 30th, 2015, under the fundamental change make-whole provision of the notes. As a result of the acquisition, upon conversion, note holders will receive cash based on the $8 per share acquisition price. If all holders elect to convert their notes during this period, it will result in a cash payout of approximately $180 million in the third quarter. However, at this time, we do not know how many note holders will elect to convert their notes. As mentioned, we will take questions on our Q2 results at the end of this call.
Now, I will turn over to our President and CEO, Hock Tan.
Hock Tan (President and CEO)
Thank you, Tony. Good morning, everyone. First, I would like to mention that with me on this call today are special guests from Broadcom, Dr. Henry Samueli, Co-founder, Chairman, and CTO, Scott McGregor, President and CEO, and Eric Brandt, CFO. I'm also privileged to have Avago's Chairman, James Diller, with us today. Now, this is an important day in the evolution of both Avago and Broadcom. The combination of our companies creates a global diversified leader in communication semiconductors, with a combined enterprise value of approximately $77 billion. This transaction adds a significant number of category-leading franchises to the Avago platform. As you know, Avago has established a strong track record of successfully integrating companies onto our platform. We currently estimate annual run rate synergies of at least $750 million to be achieved within 18 months after the close of the transaction.
Over the medium to longer term, we intend to bring the combined company to a level of operating profitability consistent with Avago's long-term target financial model. This transaction will immediately be accretive to non-GAAP earnings per share and cash flow, which we believe significantly enhances long-term shareholder value for both Avago and Broadcom shareholders. Turning to the next slide, slide four, the combined company will have annual revenues of approximately $15 billion, which makes it, in our view, the third largest semiconductor company in the world in terms of revenue. Moving on to slide five, this combination creates a diversified communications semiconductor company with a balanced mix of revenue across wired and wireless end markets. Additionally, Broadcom's broadband business provides new end markets within our wired segment.
It is important to note Avago maintains a strong position within its enterprise storage and industrial segments, and we will continue to strongly invest in these businesses. Turning to slide six, in the past, we have communicated the importance of delivering proprietary and differentiated technology to drive leadership positions in the markets in which we compete. As you already know and see in this slide, Avago has a proven roster of leading franchises across a diverse set of technologies, RF, Fiber, ASIC technology, which have contributed to a strong financial performance and highly profitable business model. As you further see on that slide, with Broadcom, we will add several new category-leading franchises where we do not overlap today, enabling us to continue building the leading communications platform in the semiconductor industry. Broadcom's heritage is rooted in delivering broadband and video service to the world.
And as such, the company is a category leader in silicon solutions for broadband access and set-top boxes. Within the data center and networking infrastructure, Broadcom's leadership in Ethernet and PCIe is a testament to its significant investment in proprietary silicon and software products. Lastly, to capture the opportunity afforded by the proliferation of wireless and connected devices, Broadcom has established a leading position in integrated and discrete connectivity products. On slide seven, you can see that the combined business will be leveraged to numerous secular growth trends in the wired infrastructure and wireless communications markets. The proliferation of LTE, 4G otherwise known, and other wireless devices around the globe is driving an increase in the amount of semiconductor content per device and explosion in the amount of data traffic running through public and private data centers.
We believe we are in the beginning stages of enhanced networking within the home as people use their wireless devices to connect to various entertainment, security, and comfort functions that are all driven by pervasive broadband access. The acquisition of Broadcom will allow us to leverage these secular growth trends more deeply across all of our business segments to drive our financial. Over to Broadcom President and CEO, Scott McGregor, for his remarks.
Scott McGregor (President and CEO)
Thank you, Hock. This is a landmark day in the history of the industry, and we at Broadcom are very much excited to be part of it. It's been an amazing journey in the 10 years since I've been CEO of Broadcom. We've successfully expanded our leading franchises for the wired and wireless end markets. We've successfully expanded our footprint and franchise in a range of markets, including set-top boxes, broadband access platforms, connectivity for portable devices, and switching for the enterprise data center and service provider, all as we strive to realize our mission of connecting everything. The company generated just over $2.5 billion in revenue in my first year as CEO, and we grew that to over $8 billion in 2015. We've worked hard to establish a reputation for financial discipline, profitable growth, and returning capital to shareholders.
I'm proud of the Broadcom team for these accomplishments and thank them for all of their hard work and tireless dedication. The journey's not over, though. Today's news is exciting because it better prepares the combined company for the next step in that journey. As we've discussed at previous Broadcom Analyst Day events and investor events, the industry is changing, and we believe that to deliver success for both our customers and shareholders, significant size and scale are becoming increasingly important. The combination of Broadcom and Avago makes us better prepared for that next step. We believe the transaction benefits all of Broadcom's key stakeholders. Our customers will gain access to greater breadth of technology. Our employees will benefit from opportunities as part of the third largest semiconductor company in the world.
For our stockholders, the transaction provides both compelling upfront value as well as the opportunity to participate in the future upside of the combined business. We are very proud that the entity that emerges from the combination of Broadcom and Avago will carry the Broadcom name. The new Broadcom will build on the strengths of both companies to emerge as a leader in both the communication markets as well as the broader semiconductor industry. With that, I'll turn the call back to Tony.
Anthony Maslowski (CFO)
Thanks, Scott. On slide eight, we highlight what the combined business will look like from a financial perspective. As you have seen, Avago has a proven operating model with industry-leading margins and a history of successfully integrating companies onto our platform. Using last 12 months' data, the combined company will have over $15 billion of revenue and approximately $5 billion of combined EBITDA before any synergies. We expect to achieve $750 million of annual run rate cost synergies within 18 months from the close of the transaction. As Hock previously mentioned, we intend to bring the combined company over time to a level of profitability consistent with Avago's long-term target model.
Under the terms of the definitive agreement, Avago will acquire Broadcom for $17 billion in cash consideration and the economic equivalent of approximately 140 million Avago ordinary shares valued at $20 billion as of May 27, 2015, resulting in Broadcom shareholders owning approximately 32% of the combined company. Based on Avago's closing share price as of yesterday, the implied value of the merger consideration for Broadcom is $37 billion. For each share of Broadcom, shareholders will have the ability to elect $54.50 in cash or 0.4378 ordinary shares in a newly formed Singapore holding company, HoldCo, or a restricted equity security that is the economic equivalent of 0.4378 ordinary shares of HoldCo, that will not be transferable or exchangeable for HoldCo ordinary shares for a period of one to two years from the closing of the transaction or a combination thereof.
The shareholder election will be subject to a proration mechanism based on the total merger consideration of $17 billion of cash and approximately 140 million shares and share equivalents, which is anticipated result in the payment in the aggregate in the range of 50% cash and 50% equity for the transaction. Upon closing of the transaction, Avago shareholders will exchange their ordinary shares for HoldCo ordinary shares on a one-to-one basis. We'll be financing the transaction consideration with a combination of newly issued equity, $8 billion in cash from the balance sheet of the two companies, and $9 billion in fully committed debt financing. Closing of the transaction is expected by the end of the first calendar quarter of 2016 and is subject to regulatory in various jurisdictions as well as approval of Avago and Broadcom shareholders.
Moving to the final slide, we provide some additional detail on the transaction financing. Avago has secured $15.5 billion in committed financing for the transaction, $6.5 billion of which will be used to refinance existing Avago and Broadcom debt facilities. Current debt to last 12 months' EBITDA today is at 1.8 times, which is down significantly from the 3.8 times at the time we announced the LSI transaction. Pro forma for the transaction and inclusive of the $750 million of expected synergies, debt to LTM EBITDA will be 2.7 times. The committed financing is in the form of fully prepayable bank facilities with limited financial covenants. We'll provide more details on financing towards the close of the transaction. I will now turn over the call to questions. Operator, can you please open the line?
Ashish Saran (Director of Investor Relations)
Okay. Audience, in posing your questions, I would suggest if you choose to direct the questions specifically to one of those who are on the call, please do. You are welcome to do so. Otherwise, you could direct it to me and I could redirect it appropriately. Please go ahead.
Operator (participant)
Thank you. If you wish to ask a question, please press star followed by one on your touchtone telephone. If your question has been answered or you wish to withdraw your question, press star followed by two. Attendees are asked to restrict themselves to one question and one follow-up. Thank you. Press star one to begin and stand by for your first question, which comes from the line of Vivek Arya from Bank of America. Please go ahead.
Vivek Arya (Managing Director)
Thank you for taking my question and congratulations on this announcement. Hock, just two quick questions for you. Do you see any areas of potential divestiture in the combination, anything that might be needed either from a regulatory perspective or to meet your profit goals? And part B is what is driving the $750 million in cost synergies? If you could give us some color, whether it's from a COGS perspective or OpEx perspective, and I have a small follow-up.
Hock Tan (President and CEO)
Okay. Let's take the first question first. And the two are obviously somewhat interrelated, but let's handle the first one first. First, of which you have a couple of points. The first point is there is very little, if any, overlap of the products of the two companies. That is a very interesting part. They're both fairly substantial companies in the semiconductor space, but the overlap is zero. Minimal overlap, but zero. And even though we may serve common customers, common strategic customers on our side, so that's very good in terms of consideration on divestments from any regulatory requirements. We don't believe there's any overlap. In terms of the second part, which is for financial considerations, it is very premature at this point for me to be able to comment on it simply because we are not as familiar as we should be with Broadcom's various businesses.
We are very well aware of the strong, sustainable franchises, I would say, that exist out there. We'll apply the same criteria we have applied in the past when we look at a portfolio, but that's not something we will do immediately, and so at this point, I really don't have an answer for you except to say we'll apply the same methodology we have used before very successfully to hook very sustainable, successful franchises on a common platform. On the second part of synergies, the straight simple answer is this: the synergies' run rate, annual run rate we're talking about, of at least $750 million a year, first of all, it does not include any anticipated portfolio restructuring.
These are purely synergies arising from overlapping support functions, be they sales, SG&A, the usual function of G&A, and probably some common engineering functions that both companies have in order to support the various product lines. So these are straight off purely support functions. We have not factored in as yet any portfolio benefits from portfolio restructuring. Okay. Tony, you want to add anything to it?
Anthony Maslowski (CFO)
No. Again, similar to the game plan with LSI, this is purely in the area of synergies as Hock mentioned. It's not contemplating any type of portfolio restructuring, so it's really in that first bucket. And again, similar to the LSI transaction, we're talking about 18 months to get there. So some of it will come fairly quickly, and some of it will come near the end of those 18 months as we integrate the two companies.
Vivek Arya (Managing Director)
Very helpful. And maybe as a follow-up, if I may, to Henry or Scott, congratulations also on this transaction. And I'm just wondering if this was a competitive bidding process. Were there other discussions? Are there any kind of restrictions? If you could give us some background, some color behind this transaction. Thank you.
Scott McGregor (President and CEO)
Vivek, we'll be able to share more about that when we put our proxy out, which will come out as fast as we can here in the next months. But you'll be able to read all the details of the transaction in the proxy.
Vivek Arya (Managing Director)
Thank you.
Hock Tan (President and CEO)
Next question, please.
Operator (participant)
The next question comes from the line of Ross Seymore from Deutsche Bank. Please go ahead.
Ross Seymore (Managing Director)
Hi, guys. Echoing the congratulations on a big deal. I guess on the cost side of the equation, Hock or Tony, getting to the 30% gross margin you put in the slide deck, the 750 gets you there. From the 30% to the 40% long-term target, I know you're not going to give us any specific details, but conceptually, can you talk to whether you think that's more cost-driven, revenue-driven? Any sort of general framework would be helpful.
Anthony Maslowski (CFO)
Again, as I mentioned earlier, Ross, Phase I is really around the pure synergies, and we might outperform those synergies. That's one category you can count on. Then we get into some level of potential portfolio restructuring. And then obviously, like I said, as you know, with the LSI transaction, our long-term goal is the same get it to the Avago model.
Ross Seymore (Managing Director)
Great, and I guess as my follow-up, both for Hock or Scott or Henry, you guys haven't mentioned anything about revenue synergies. That's typical at this point in the deal, but can you just talk about where you think the two companies can be complementary from a revenue perspective?
Scott McGregor (President and CEO)
I think it's early days and hard to really get a good assessment of that, Ross, at this point. But one of the things we did observe when we were going through talking about our businesses with each other is how often we appear in the same kinds of boxes and the same kinds of devices. We might do an SOC on one device, and Avago's in the connectors. Or in the phones, they're in the FBAR filters right next to many of our components. And so I think the opportunity here is to look for those kinds of synergies and also to bring a lot more value to our customers in providing a more complete solution.
Hock Tan (President and CEO)
And to add to that.
Ross Seymore (Managing Director)
Yep.
Hock Tan (President and CEO)
To add to that, Scott is 100% correct. We believe with this broader portfolio of products under one umbrella and common customer base, which we see very, very clear across, we believe we can add a lot more value to be more relevant to those key strategic OEM customers.
Ross Seymore (Managing Director)
Great. Thank you.
Operator (participant)
And your next question comes from the line of John Pitzer from Credit Suisse. Please go ahead.
John Pitzer (Managing Director)
Yeah. Good morning, guys. Let me echo my congratulations with everyone else. I'm going to keep my questions, I think, onto the Avago core business.
Hock,
Hock Tan (President and CEO)
could you give me a second, please? Operator, either could you speak up? Operator, for some reason, the line is kind of hard to hear.
Operator (participant)
I have increased the volume on John's line.
Hock Tan (President and CEO)
Okay. Thank you. John?
John Pitzer (Managing Director)
Hock, is this any better?
Hock Tan (President and CEO)
Much better.
John Pitzer (Managing Director)
Okay. Perfect. My congratulations along with everyone else. Hock, I guess I'll keep my questions more to the wireless business at Avago. Just on the FBAR, you mentioned that the fiscal third quarter is going to see a ramp at a large OEM customer for their new product. I'm wondering if you could help us understand how you think FBAR content will trend with that new product. And I guess more importantly, I'd love to get an update of FBAR penetration into the China LTE market and kind of how the capacity plans are going for FBAR for the remainder of this calendar year. Thank you.
Hock Tan (President and CEO)
Three questions then. We'll try to take it one by one. On the first question, you should know, I mean, the general trend in high-end smartphones is that the number of bands, those high-end smartphones, as the generation progresses, continue to support, continue to increase very, very linearly. It's obvious. So from one generation to the next, we are seeing significant increase in our content. And by the way, in many of those, we are selling not just discrete FBAR. I would extend it to say we are selling RF front-end modules, which includes an integrated in the module, not just multiple filters, FBAR filters to cover multiple bands, but also power amplifiers with it. So it is definitely a continued increase in content, dollar content.
On the second question related to FBAR in China, yes, there is continuing increase in demand for FBAR for use on China LTE bands as penetration of those phones increases. We continue to be somewhat limited in our ability, obviously, to directly support this market except in an indirect manner through large OEM or large global OEMs, and our limitation, obviously, relates to the third question you had, which is our capacity. Our capacity increase in our FBAR fab continues to expand and continue to expand according to plan, which is what is enabling us to significantly, as Tony indicated, increase our revenue in our wireless business sequentially this quarter from last quarter and will likely continue to increase our revenue in wireless next quarter compared to this quarter.
John Pitzer (Managing Director)
That's helpful, Hock. Thank you very much.
Operator (participant)
And your next question comes from a line of Craig Hettenbach from Morgan Stanley. Please go ahead.
Craig Hettenbach (Executive Director)
Yes. Thanks so much. Hock, it looks like a very exciting opportunity within networking, particularly within the data center where both Avago and Broadcom have strong franchises, so can you comment a little bit in terms of the combined portfolios and what type of leverage you could see as you look to attack the data center?
Hock Tan (President and CEO)
At this point, I mean, we are still operating very clearly as distinct separate companies. In the case of Avago, we offer solutions on enterprise storage. And in the case of Broadcom, they are offering switches, Ethernet switches, and Ethernet controllers. And I'll let Scott expand more on that. And both are all very distinct products to the same customers. As I say, we like to believe there is some synergies in terms of our broader range of products supporting the same customer in a much more value-added way. But at this point, it's kind of early for us to predict how we're going to manage this in any fashion.
Craig Hettenbach (Executive Director)
Okay. Okay. Any comments from Scott on the Broadcom side?
Scott McGregor (President and CEO)
No, I agree with Hock. I mean, I think we have a number of complementary products, and there'll be opportunities to provide just both a broader footprint within many of those customers and offer more value to them.
Craig Hettenbach (Executive Director)
Okay. And if I can move to the core business, Tony, as you mentioned, not a big surprise at this point, the weakness in ASICs, but it sounds like that business improves into the July quarter fiscal. Can you talk about storage, the split between kind of servers and what you're seeing maybe on the PC front?
Anthony Maslowski (CFO)
Again, I think what we see is the HDD, some seasonal recovery in the back half. Remember, we're more focused on desktop and enterprise.
Hock Tan (President and CEO)
Let me expand slightly on that. Thank you, Tony. And Tony is 100% correct. We saw, as we reported in Q2 our last quarter, a decline in our businesses in both SOC channels as well as pre-amps into the hard drive in the space. And unavoidably, however, the positive side is our concentration. I'll say our focus, our sockets in the HDD, in the hard disk drive industries, are largely in the nearline space, which are largely in data centers, some in enterprise, high-end enterprise drives, and almost nonexistent in notebooks and mobile two and a half inch drives. So while we are affected, obviously, from some of the enterprise and some from desktops, nearline continues to be holding up very well. And this is where we have a very strong market position. And we are not affected by the softness that exists in notebooks.
Overall, while our business declined in Q2 in hard disk drives, as we reported, our decline is probably less than you would expect reading hard disk drive industry trends. We are also seeing stabilization of demand from our key customers on our components into the hard disk drive market. We also see, and keep in mind, our current quarter, Q3, extends to the end of July as opposed to a calendar quarter. We are seeing definitely a level of stabilization. As Tony indicated in his remarks, likely uptick by the end of this quarter in demand on hard disk drives. Part of it is because we're very much in data centers, nearline demand, and that business continues to be pretty strong.
Craig Hettenbach (Executive Director)
Got it. Appreciate all the color. Thanks, Hock.
Operator (participant)
Your next question comes from the line of Harlan Sur from J.P. Morgan. Please go ahead.
Harlan Sur (Executive Director and Equity Research Analyst)
Thank you and congratulations to both teams. This question is for Henry. Broadcom had a very strong model of centralized engineering to kind of maximize the developed IP across to be used in the product lines. As you look at the Avago capabilities in the R&D model, can you just kind of compare and contrast the development styles?
Henry Samueli (CTO)
Sure. Broadcom does leverage a lot of centralized IP development across our different product lines, especially given the fact that we are so SOC or system-on-a-chip focused. And I think we will be able to incorporate some of that activities in the Avago model because there's some SOC activities there as well. For the non-SOC type businesses, obviously, they're very different and can operate fairly independently. So I think it's going to take some combination. And it'll just take a very close look after the deal closes. We'll sit down and see where we can leverage centralized and where we can't. And we'll just make intelligent decisions on partitioning engineering to be the most efficient possible to maximize the profitability of the company. So it's still premature, but I think it'll probably be some blended approach as we go forward.
Harlan Sur (Executive Director and Equity Research Analyst)
Great. Thanks for that. And then can the team help us understand how we should think about the tax rate of the combined entity on a go-forward basis?
Anthony Maslowski (CFO)
Yeah. Sure. So obviously, we have our tax rate at Avago ticked up slightly during the LSI thing. So we were traditionally at this kind of 3%. We're now currently at 6% on a non-GAAP basis. Broadcom has a very good tax rate in the low single digits as well. The combined rate will be somewhere between the two. But obviously, we have to take our time because it's a pretty complicated structure going forward. So I would say it's going to be no worse than the Avago trending down to a number between the two over time.
Harlan Sur (Executive Director and Equity Research Analyst)
Great. Thanks, Tony. Thank you very much.
Operator (participant)
And your next question comes from the line of Steve Smigie from Raymond James. Please go ahead.
Steve Smigie (Managing Director)
Great. Thanks, Hock. And I'll add my congratulations as well. I was just curious, as we look at combining some of these products on the wireless side, I guess if I look at a typical, say, Broadcom Wi-Fi solution that requires, I think, or other connectivity solutions require some sort of power amplification, would it be the case now that when Broadcom or the combined client provides a reference design that would now automatically include the Avago power amplifier or other RF components, or would that still be open to other RF players?
Scott McGregor (President and CEO)
Certainly, there's an opportunity to provide some value. Many of the, for example, wireless LAN chips we do today already integrate power amplifiers. But there are many opportunities for filters and other parts. And so I think one of the great opportunities of putting these two companies together is now that we offer so many more technologies, we can create better integrated solutions and create a much more complete platform. So I think that's a real added value going forward.
Steve Smigie (Managing Director)
Okay. Great. Thank you. And then, Hock, just a follow-up question on the wireless business. Is there anything that Broadcom brings to the table that can allow you to create more sophisticated SOCs going forward or front-end modules?
Hock Tan (President and CEO)
On the RF front, it's a bit premature for us to really get into it. As you probably know, our strength and that by itself offers an opportunity, obviously, that we don't know what we don't know exactly. Because Avago has been focused in the RF front, wireless front, very much on cellular bands related to the RF side, especially filters and power amplifiers. There's obviously a lot of silicon SOC requirements that Avago has never been able to or have never focused on leveraging on or taking advantage of. And obviously, with this combination, our managers, we will be much more sensitive to such opportunities. And it could offer that. But at this point, it might be a bit premature to speculate.
Steve Smigie (Managing Director)
Okay. Great. Thanks. Congratulations again.
Hock Tan (President and CEO)
Thank you.
Operator (participant)
And your next question comes from the line of Stephen Chin from UBS. Please go ahead.
Stephen Chin (Managing Director)
Hi. Thanks for taking my questions. And congratulations on the deal as well. But my first question is regarding sort of the use of the combined cash of the company. I just, given the Singapore Holding Company for the final entity, just wondering how the usage of Broadcom's offshore cash will be handled. Will it immediately be available for use in this deal that was mentioned in the presentation slide first of all?
Anthony Maslowski (CFO)
Yes. So we intend to repatriate some of their cash. And there'll be a small tax burden connected with that. And then long-term, we'll be able to use the cash produced by Broadcom onshore as well as the Singapore cash will remain the ability to move it anywhere around the world. There will be a portion that will continue to build up offshore in the long-term model.
Stephen Chin (Managing Director)
Got it. Thanks, Tony. And as a follow-up question on the custom SSD controller business, I was wondering if some of the growth that you're seeing there now, is that on the enterprise SSD market still? And is there any client share gains there potentially as well? Thank you.
Hock Tan (President and CEO)
On that question, and to clarify, I assume you're referring to customized controllers for SSDs. We are largely, as in hard disk drive side, in enterprise. And the growth we are seeing a lot is in demand for SSDs in data centers, especially on the nearline side. So we're seeing a strong demand. As I mentioned earlier, when it comes to hard disk drives, there's a lot of demand for storage in data centers, especially from cloud guys, and for SSDs. And we are seeing a strong demand in those sectors for our products.
Stephen Chin (Managing Director)
Great. Thank you, Hock.
Operator (participant)
Your next question is from the line of Vijay Rakesh from Mizuho. Please go ahead.
Vijay Rakesh (Managing Director)
Hi, guys. Congratulations, Hock. Just a couple of questions. Wondering what the combined company will look like in terms of mix between the different segments, the wireless infrastructure and storage, and also if there is any customer concentration between the segments.
Hock Tan (President and CEO)
In slide number, I forgot, I think five, we have attempted to put the combination in terms of revenue by end market. Without having the specific numbers, eyeballing it, I would say wired infrastructure would be the largest segment, and that might probably be about less than 40%, 35%-40%. Wireless would be about 30%. Between enterprise storage and, excuse me, industrial, it will be another 30%. In round numbers, we would have wired wireless as the biggest component with enterprise storage still a significant component.
Vijay Rakesh (Managing Director)
Got it. Any customer concentration there? And also, interesting breakup fee.
Hock Tan (President and CEO)
It's an interesting question you asked on customer concentration because I'll be direct about it. In Avago, as you know, our business model turns on the fact that we develop proprietary, very differentiated solutions customers can use to expand, to grow their market position. Maybe not surprisingly, and because of that, we get customer concentration on Avago side. Not surprisingly, Broadcom follows a similar strategy, and so combining the two companies, yes, I would continue to see the kind of customer concentrations that exist in these two separate companies, and there will be customer concentrations.
Vijay Rakesh (Managing Director)
Great. Thanks for that, Hock. Any thoughts on any breakup fee here? Thanks.
Hock Tan (President and CEO)
We like to think there never will be.
Vijay Rakesh (Managing Director)
Thanks. Thanks a lot. Congratulations.
Hock Tan (President and CEO)
Thank you.
Operator (participant)
Your next question is from the line of Romit Shah from Nomura Securities. Please go ahead.
Romit Shah (Managing Director)
Yes. Thank you. The long-term margin target that you set out for Broadcom, does that exclude stock option expense for both companies? Tony, as you probably know, Broadcom includes ESO and their non-GAAP EPS, whereas I think you guys exclude it.
Anthony Maslowski (CFO)
Yeah, so this is excluded.
Romit Shah (Managing Director)
Okay, and then I have to ask, Hock, are you worried about someone coming in and outbidding your offer?
Hock Tan (President and CEO)
Well, it's good to be paranoid. And to be honest, I don't know the answer to that. We do the best. We put our best foot forward. There's a lot of synergies. There's a lot of common culture thinking between the two companies. And I like to believe that the company and that with the structure of this transaction, which is both cash but also shares of the final combined entity, that it would be hard-pressed for anyone to try to match it on an equivalent basis. Let's put it that way. So yeah, we feel a little paranoid. But at the end of the day, we think we put a pretty strong deal forward to what I believe is a very great company.
Romit Shah (Managing Director)
Okay. Thank you. Congratulations.
Hock Tan (President and CEO)
Thank you.
Operator (participant)
Your next question comes from the line of Srini Pajjuri from CLSA. Please go ahead.
Srini Pajjuri (Managing Director and Senior Semiconductor Analyst)
Thank you. Let me add my congratulations to both teams here. Tony, on the balance sheet, you're raising about, I guess, the gross debt is going to be about $15.5 billion. Just wondering, in terms of the debt capacity, how do you feel about it? If going forward, if there are further opportunities that come along in terms of M&A, how should we think about it? The combined entity is probably going to generate anywhere from $6-$7 billion in free cash flow fairly soon. If you can talk about the priorities for the use of the cash.
Anthony Maslowski (CFO)
Okay. So first things first, and you won't believe me, but we always have some capacity, and we'll take some time to digest this deal. The debt we're putting on is smaller than what we did on the LSI thing. So there is still some capacity there. This is a big deal to digest going forward. So we'll be opportunistic at best in the next couple of years. The other side of it is use of cash. It's still the traditional Avago use of cash in that first off, it's for internal use for our CapEx needs. Secondly, it would be some type of debt pay down to a level that is one to two EBITDA to debt ratio type thing. And then finally, the last one is the dividend and then a long distance and each type of share repurchase. So that priority is the same.
Srini Pajjuri (Managing Director and Senior Semiconductor Analyst)
Okay. Great. And then maybe one for Hock. Hock, I mean, looking at your long-term model, I think the margin profile looks pretty solid. But top line, 5% is not bad. But given how much you guys are growing and given, I guess, if you exclude baseband business from Broadcom, I think they're probably growing north of 5%. Just curious as to why only 5%? Why not a bit more? Thank you.
Hock Tan (President and CEO)
Let me clarify something. Broadcom doesn't have baseband any longer, if I hear you right. So please take that out. But that aside, no, you're right. But see, our key focus on our business model long-term, as you put it, is very sustainable growth. So various multiple sustainable franchises in very strong niche markets that we like. And our keyword is sustainability. And I know over the last couple of years, short-term, that's very in my view, that's still short-term. For a long-term model, we like to believe that we still continue to grow. But I don't think I want to put in a very what has been a period of very strong growth over the last two years as representative of what we can sustain for the next five years. For us, we put 5%.
It's probably conservative, but it's certainly something we believe is very achievable and very consistent with a concept that we are in multiple sustainable franchises that keeps grinding on nicely for us even five years from now.
Srini Pajjuri (Managing Director and Senior Semiconductor Analyst)
Great. Thank you.
Operator (participant)
Now our last question from Ian Ing from MKM Partners. Please go ahead.
Ian Ing (Senior Semiconductor Equity Research Analyst and Executive Director)
Yes. Congratulations on creating a tremendous entity here. The long-term target, 60% gross margins, I mean, Broadcom running below that, I mean, do you expect to get there through product mix like FBAR, or can you get some procurement scale in things like sourcing of wafers?
Hock Tan (President and CEO)
To be honest, all of the foregoing. We don't lose any opportunity. We turn over every rock. But you're right 100%. We believe that by a broader portfolio of products, greater value added to our core group of customers, that we will be able to offer higher value products and with it, higher margins, obviously. We also, as you correctly say, we have on a more unique basis, our FBAR fab continues to expand. And we're going to, by the beginning of next year, as you know, 8-inch from 6-inch. And that has, it's not just about supplying more wafers and more revenues. It's also about reducing our wafer cost by at least 30%. So that's cost reduction.
Ian Ing (Senior Semiconductor Equity Research Analyst and Executive Director)
Then finally, as you also indicated, combining two supply chain organizations under one umbrella would also create synergies and help, obviously, reduce our cost of goods sold or improve gross margin on a marginal basis. So all the following, we believe, will get us sustainably above 60% gross margin long-term.
Great, and then my follow-up is
Hock Tan (President and CEO)
go ahead.
Ian Ing (Senior Semiconductor Equity Research Analyst and Executive Director)
Go ahead.
Hock Tan (President and CEO)
Go ahead.
Ian Ing (Senior Semiconductor Equity Research Analyst and Executive Director)
Yeah. My follow-up is on your taxes. I mean, obviously, domiciled in Singapore, you've got tax holidays and tax breaks. I believe those are more of a fixed nature. So if anything, we should expect tax rate to increase, or there's some ways to increase the Singapore tax holidays.
Anthony Maslowski (CFO)
So again, the two entities, Avago will continue down its tax rate. And obviously, as the LSI acquisition gets further along, it'll actually decline over time. And I think the Broadcom tax structure is very safe and very sustainable as well. You'll get to a melded number there at the end of the day.
Hock Tan (President and CEO)
Okay. Since Henry Samueli is here, to ask Henry to say a few things about his perspective on this combination and the opportunities that will likely arise from it.
Henry Samueli (CTO)
Well, thank you, Hock. I am very excited about this transaction. I mean, we've taken two great companies and created an even greater company, the third largest semiconductor company in the world with an amazing breadth and depth of portfolio of products, very complementary, almost no overlap. It's going to be a remarkable future for us once this deal closes. And I am really honored and privileged to be able to serve as the Chief Technology Officer of the combined company and look forward to working with all the employees, both on the Broadcom side and on the Avago side, to drive this company to even greater heights in the future. So thanks, everybody, and look forward to the future.
Hock Tan (President and CEO)
Equally, I'm very excited, especially by the fact that Henry has a belief in it to come over as Chief Technology Officer because, as you guys know, Avago and Broadcom have shared a common culture in this respect. We compete first and foremost on innovative and technology-based solutions. That's where we have our strength in this marketplace, and it's great combining two companies with strong heritage of engineering, execution, and technology innovation into under one umbrella to be, frankly, the largest communication semiconductor platform in the world. Thank you.
Operator (participant)
Thank you for your participation in today's conference. This concludes the presentation. You can now disconnect. Have a very good day.