Good day, welcome to the Texas Instruments Capital Management Strategy Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Dave Pahl. Please go ahead, sir.
Thank you. Good morning, thank you for joining our 2019 Capital Management call. This call is being broadcast live over the web and can be accessed through our website at ti.com/ir. A replay will be available through the web. This call will include forward-looking statements that involve risks and uncertainties that could cause TI's results to differ materially from management's current expectations. We encourage you to review the notice regarding forward-looking statements contained in our most recent earnings release, as well as our most recent SEC filings for a more complete description. During today's presentation, we'll begin with a quick recap of our capital management strategy and our scorecard for 2018. We'll provide a historical summary of our capital allocation and take a deeper look into specific areas of investment, including 300 mm analog. We'll also discuss our free cash flow per share performance.
Finally, we'll wrap up with a review of our cash returns. We believe the key points that investors can take away from our discussions today are, first, we remain focused on consistent execution of our capital management strategy. Second, our business model is designed around four sustainable competitive advantages, we continue to strengthen and leverage those advantages with a view towards long term. Third, our disciplined allocation of R&D and investments in our initiatives is delivering growth from the best products, which are analog and embedded, and the best markets, industrial and automotive. Fourth, our 300 mm analog manufacturing strategy is a unique advantage and will provide benefits for a long time. Lastly, we remain committed to returning all free cash flow to owners. These points are consistent with past capital management presentations.
As we said, our objective is to maximize long-term growth of free cash flow per share, which we believe is the best metric to judge our performance and to drive higher intrinsic value for the owners of the company. Our strategy to achieve this objective has three elements. First, by having a great business model that is built on our four competitive advantages in which we are continuing to invest and make even stronger. Second, by being disciplined in how we allocate our resources, focusing on the best product opportunities, as well as areas that strengthen and leverage our competitive advantages. Third, by striving to constantly increase our efficiency, which is about achieving more output for every dollar of input. As a reminder, we believe TI is in a unique class of companies that can grow, generate, and return significant cash.
We are focused on the best products and the best markets in the semiconductor industry. We believe analog and embedded are the best products. They're large categories of products that are used across a diverse set of applications and customers, and also have a fragmented competitor base. In addition, over decades, these products have generated profitable returns and significant amounts of cash. We believe industrial and automotive are the best markets and will drive growth in our industry and for TI. These markets are the fastest-growing due to their increasing semiconductor content, a trend that's fueled by products becoming more intelligent, more connected, safer, more efficient, especially as mechanical and electromechanical features are replaced with solid-state electronics. This year, we'll provide more insight into the opportunities we see within the industrial market later in the presentation.
Next, our strategy is designed around four sustainable competitive advantages that, taken in combination, provide tangible benefits that are difficult to replicate. They're manufacturing and differentiated technology. The second is our broadest portfolio of analog and embedded products. The third, the reach of our market channel, and the last is diverse and long-lived positions, which results in a high terminal value. With that, I'll turn it over to Rafael, and he'll review our capital management strategy. Rafael.
Thanks, Dave. Our capital management scorecard is one that we have shared with you every year since 2013. Consistent with prior years, in 2018, we again met our multiple metrics. We are pleased with the consistency of these results that have been enabled by our business model and strategic decisions. You can see that the scorecard continues to include descriptions of our long-term objectives for each metric, as well as the target range. The long-term objective provides insight into how we make decisions and run the business, as opposed to only a number that reflects a single data point. There's one change I would like to highlight, as well as some additional insight. First, as we have mentioned before, we expect our long-term CapEx to run 6% of revenue, as opposed to our previous target of 4%.
It is higher primarily because we're assuming a higher percentage of the equipment for our 300 mm factories to be new equipment, not used equipment. I will point out that with the higher levels of CapEx, our expectation for free cash flow generation remains unchanged at 25%-35% of trailing 12-month revenue. We believe that we can run near the 35% consistently when markets are stable. Second, our inventory range remains 115 to 145 days, even though we're currently running above that range. I will remind you that we believe there is strategic value in owning and controlling our inventory. Our objective with inventory is to maintain high levels of customer service, minimize inventory obsolescence, and improve manufacturing asset utilization.
We highlighted earlier that we're implementing our next phase of consignment with distributors, and also building strategic inventory buffers of low volume products that will continue to put upward pressure on inventory. In fact, depending on demand, we may run above this target range for a number of quarters. Lastly, as a reminder on debt, our objective is to increase rates of return with some leverage on the balance sheet when the economics make sense, while avoiding concentrated maturities and ensuring strategic flexibility. In 2018, we added $1.5 billion of 30-year debt at 4.15%, while half a billion dollars came due. Besides this debt, our future maturities range from $300 million to $750 million in any given year, making rollover risk minimal. Of our other objectives, pensions remain unchanged, and I will comment on the others later in the presentation.
In summary, our capital management strategy continues to serve the owners well. Free cash flow per share continues to grow steadily while we continue to strengthen and leverage our long-term competitive advantages. Now, I would like to provide additional insight into how we allocate our capital, and I will give you updates on several key investment areas. Over the last 10 years, we have allocated about $77 billion of capital. Given that magnitude, you can quickly appreciate why capital allocation is a job we take quite seriously, and one that has a significant impact on owner returns.
You can see our largest category of capital allocation is investment in critical areas that drive organic growth, such as R&D, sales and marketing, capital expenditures, and inventory w ith our approach of funding strategies, not projects, we spend significant time ensuring these investments are delivering long-term competitiveness and generating returns greater than our cost of capital. The second largest category is share repurchases. Here, our objective is the accretive capture of future free cash flow for long-term owners. We focus on consistent repurchases when the present stock price is below the intrinsic value, using reasonable growth assumptions.
Next is dividends, where our objective is to appeal to a broader set of investors, and we focus on their sustainability and growth for obvious reasons. Finally, potential acquisitions are evaluated through two primary factors that have remained unchanged. First, it must be a strategic match, meaning catalog analog focus with high exposure to industrial and automotive. Second, it must meet certain financial metrics, such as generating a return greater than our weighted average cost of capital within about four years. For simplicity, we have not included changes in net debt, which over this period increased $2.1 billion. With that framework set, let me ask Dave to comment on our investments in several specific areas.
Thanks, Rafael. I will first focus on our R&D investments that we've allocated to higher value growth opportunities. Slide 11 summarizes the direction of our R&D investments across 10 markets and also provides the revenue breakout for 2013 through 2018. This directional bias of our R&D investments has been consistent for a number of years. As you may recall, our broad portfolio of analog and embedded products is an important competitive advantage. This breadth of portfolio allows TI to identify more customer projects, win more sockets and revenue on those projects, and bring significantly more visitors to ti.com each year. It is also critical that we continually grow and strengthen this portfolio with highly differentiated products that are developed with an eye to the best market opportunities over the next 10 years.
At the highest level, we see good opportunities in all of our markets, but we believe that industrial and automotive will be the best opportunities over the next decade. As I mentioned earlier, this is primarily because the semiconductor content in industrial and automotive applications will significantly increase as companies make their equipment smarter, more connected, safer, and more efficient. In industrial and automotive, we continue to increase investments broadly across sectors and product categories. We're excited to see the continued progress in revenue growth as these markets comprise about 56% of TI revenue, up from about 42% in 2013. Personal electronics is an important market, and while investment level in total is down, we do invest selectively.
In communications equipment, we announced several years ago that we were reducing our embedded investments, but we continue our investment in the expanding analog growth opportunity, primarily focused on products for 5G macro base stations. Our investments in enterprise systems and others have been flat and at low levels. Given the importance of the industrial market, we wanted to include additional insight this year for investors. As you recall from the prior slide, the industrial market is about 36% of TI's revenue in 2018. Industrial is also our most diverse market today. We break the industrial market into 13 sectors that are shown at the right side of this slide. Within each of these sectors, there are typically hundreds of end equipments and thousands of customers, and almost all offer a unique semiconductor content expansion opportunity.
To provide some sense of the opportunity in the industrial market, just take the example of a motor. Six-speed electric motors have existed for over 100 years and use very few semiconductors. Motor designers discovered that by adding microcontrollers and analog semiconductors, they could make those motors variable speed, thus reducing power consumption by up to 40%. Continuing, designers are now adding sensors to the motor to identify vibration or temperature changes, and thus trigger service alerts for predictive maintenance. This example repeats itself across all the sectors in industrial, from grid infrastructure to non-automotive transportation. Think of things like airplanes and high-speed trains to power delivery, to medical electronics, to factory automation, building automation, digital signage, and more. For customers who want to make their products smarter, safer, more energy efficient, the only way is to add intelligence. Adding intelligence requires semiconductors.
This is the heart of the semiconductor content story we refer to. The unit growth of our customers' equipment is compounded by the growing semiconductor content in each product. Finally, connecting back to our competitive advantages, when you think about the industrial market, it starts to highlight the importance of our broad product portfolio, as well as the reach of our channel. Our portfolio of products, including power management, signal chain, low power processors, wired and wireless connectivity, and sensors, all help our customers design and improve their systems. Our channel, which includes our direct sales and applications team and our website, lets us efficiently and effectively get to thousands of customers around the world. These advantages have translated into results with broad-based growth over the last several years across our 13 industrial sectors and hundreds of end equipments.
Looking ahead, we believe the industrial market is one of the best opportunities given the content opportunity and our ability to address the needs of this large and diverse market. We'll now walk through our manufacturing advantage. As a reminder, for those not familiar with the semiconductor industry, a chip, meaning an unpackaged product made on a 300 mm wafer costs about 40% less than a chip built on a 200 mm wafer, the size used by most of our competitors. This translates into a great competitive advantage. The source of this advantage is because a 300 mm wafer has 2.25 times more area, which in turn means we get about 2.3 times more chips. It doesn't cost 2.3 times to process that larger wafer. This translates into a structural cost advantage.
To understand how a 40% less expensive chip impacts gross margin, it's easiest to use an example of a part on a 200 mm compared to a 300 mm wafer. This example shows a theoretical part that sells for $1 with gross margins of 60%. The chip itself would cost about $0.20 built on a 200 mm wafer, and this would be reduced to $0.12 on a 300 mm wafer. In this example, the remaining cost of assembly tests are the same regardless of the size of the wafer. The net result is that gross margin improves by 8%. As this example illustrates, our 300 mm manufacturing capability and the resulting cost structure provide a unique competitive advantage for TI. As we've discussed before, we currently have two 300 mm factories, our Richardson Fab and DMOS6, located here in Dallas.
In 2018, we built about $4.8 billion of our analog revenue on 300 mm wafers, which used about 60% of our capacity. As we've said in the past, we put our 300 mm capacity in place to support growth. In 2018, we added about $900 million of analog revenue, and most of that growth was supported by 300 mm. Moving forward, the majority of our incremental analog revenue will continue to be built on 300 mm. We remain committed to strengthening and leveraging this competitive advantage for the long term. To continue to strengthen this competitive advantage, we've indicated we would need to begin to invest in our next 300 mm analog factory in the next year or two. At this time, we would envision that the new factory would be sized to support an additional $5 billion of analog revenue.
For now, it's more likely that we will build a new facility versus purchase an existing one. As we mentioned earlier, we expect to fill this factory with mostly new 300 mm equipment. Based on this assumption, we anticipate our CapEx will run about 6% of revenue in the future. We will keep you updated as our plans develop. With that, I'll turn it back to Rafael to talk about our free cash flow growth and outlook.
Thanks, Dave. As we described at the beginning, our overall objective is to maximize long-term free cash flow per share. We believe this is not only the best metric to judge our performance, but it is also the one that owners ultimately care about. 2018 continued a long-term trend of growing free cash flow per share, which had been growing at about 12% through 2017. In 2018, we had multiple drivers of free cash flow per share growth, top-line growth, incremental free cash flow margin expansion, and share count reductions. Additionally, the tax benefit we received will shift the longer-term trend line up into the future. Specifically, in 2018, revenue grew by 6%, free cash flow margin increased 720 basis points to 38.4% of revenue, and we reduced share count by 3.9%. Taken together, this resulted in free cash flow per share increasing by 33% in 2018.
We believe these three drivers of free cash flow per share growth will continue. Our analog and embedded segments have a proven track record of growth. Combined, they have recorded both five and 10-year revenue CAGRs of 8%. Part of that growth are market share gains, where we have seen on average 30 to 40 basis point improvement annually over time. With analog and embedded comprising more than 90% of our revenue, we expect they will be able to continue to drive the top-line growth. Now let me change gears and talk about cash and returns. It may be helpful to frame our performance versus others in the S&P 500. Our free cash flow generation, cash returns, and return on invested capital puts us above the 90% when compared to the S&P 500.
We believe our strong relative performance versus the S&P 500 is a reflection of our focus on growing free cash flow per share over the long term and the three elements of our strategy. First, by having a great business model that is built on four competitive advantages in which we're continuing to invest and make even stronger. Second, by being disciplined in how we allocate our resources, focusing on the best product opportunities, as well as areas that strengthen and leverage our competitive advantages. Third, by striving to constantly increase our efficiency, which is about achieving more output for every dollar of input. We believe if we can continue to do these three things well, we should be able to grow free cash flow per share for a long time into the future. As our cash return to owners has grown, so too has our dividend.
We continue to believe a sustainable growing dividend is an important element of our capital management strategy. Our objective in repurchasing shares is the accretive capture of free cash flow for long-term investors. We focus on consistently repurchasing shares when the intrinsic value of the company exceeds its market value. By using realistic discount factors and reasonable growth assumptions to calculate intrinsic stock value, we're aiming to have confidence that investments made in stock repurchases are, in fact, earning rates of return greater than our cost of capital. While the ultimate assessment of return on investment depends on the future cash flow stream, the track record of this approach is encouraging. We have reduced shares outstanding by 45% since 2004, including the 3.9% reduction in 2018.
We ended 2018 with $16.1 billion in open authorizations, having bought back $5.1 billion worth of stock in 2018, including $2 billion in the fourth quarter. As we commented earlier, our objective with dividends is to appeal to a broader set of investors, and our focus is on both growth and sustainability. We have now raised the dividend for 15 consecutive years, including a 24% increase in 4Q 2018. We have increased the dividend at a compounded annual growth rate of 21% over the last five years. Our consistent growth of free cash flow resulted in our dividend in 2018 consuming only 42% of free cash flow, supporting our objectives of sustainability and growth of dividends. Let me now wrap up my prepared remarks with a few summary comments. TI is in a unique class of companies that can grow, generate, and return cash.
Our business model is designed around four competitive advantages that deliver tangible benefits unique to TI that are difficult to replicate. Those competitive advantages are, first, manufacturing and differentiated technology, second, breadth of products, third, broad reach of our channels, and fourth, diversity and longevity of products, markets, and customer positions. We will continue to focus on growing free cash flow per share. It is the ultimate objective, and we believe focusing on it will deliver the highest growth in the value of the company. In the coming years, we believe that we will have three drivers contributing to free cash flow per share growth, top-line revenue growth, free cash flow margin expansion, and share count reduction. Top-line revenue growth will be driven by our position in the best products, analog and embedded, and in the best markets, industrial and automotive.
Our 300 mm analog manufacturing strategy is a unique advantage and will provide benefits for a long time. Finally, owner returns will continue to be driven by dividends and share repurchases. We have a disciplined culture and processes to ensure that we're strengthening our competitive advantages and generating the maximum return for the investments we make. Thank you. With that, I'll turn it back to Dave.
Thanks, Rafael. Operator, you can now open up the lines for questions. In order to provide as many of you as possible an opportunity to ask a question, please limit yourself to a single question. After our response, we'll provide you an opportunity for an additional follow-up. Operator?
Thank you. Our first question comes from Ambrish Srivastava with BMO. Please go ahead.
Hi. Thank you very much. Dave and Rafael, I just wanted to focus on the allocation methodology. You guys are, I think correctly so, averse to chasing after the next shining object. If we were to dig a little bit deeper into R&D, and just help us understand the portfolio allocation between segments that are cash generating, cash cows, versus going after newer opportunities. How does that process work at TI?
Sure. Maybe I'll start off, and Rafael, if you want to comment. When we think, and I'll talk specifically about R&D, we can talk about other areas. In R&D, really think of that as three major buckets. The first, which is probably about two-thirds or 60% or so of our R&D spend, goes directly into product development. We produce about 300 to 400 new products a year. Those decisions are initially made by our product line managers, we have about 65 to 70 product lines at the company. If you've got the product line at TI, you've got your own design engineering teams and application team and marketing team. You're very close to your customer, very close to our field sales and application teams, and you understand the market very well.
Those product line managers, on average, will have three or four new products that they will generate a year. As we go through and review the plans that those product line managers have and the results that they've delivered, they will answer more qualitative questions on those opportunities. They'll look at how is that product differentiated versus other products in the market? How long do we think we'll have that differentiation? How many customers, how many end equipments, how many sectors, how many markets do we think we can sell that product to over time? What's the longevity of that revenue? We'll look at standard things like looking at return on investment as well. The qualitative nature of those questions are probably most important.
As a product line manager, of course, we believe managers are always good at optimization decisions, they're going to pick the best opportunity that they can find to invest in. As they roll up into our business units, a typical business unit manager will have three to five different product lines. They'll judge that and ensure that if one product line manager has two great opportunities and the next two don't look so great, they'll move the resources inside of their business unit to the best opportunities that they can see. I think our senior managers, as they sit through that process, if there are more good opportunities on the table that we can get to, that's when we'll take up the level of investment overall.
The other two areas, just real quickly, are centralized R&D, think of that as our process technologies, our packaging technologies, the tools the engineers need to create the great products, SPICE models, and other things like that. We get some leverage off of that versus our smaller peers, because if we had 70 product lines or 10, that investment would be close to the same. Finally, the last part of that spend, it's probably the most interesting, which is Kilby Labs, named after Jack Kilby, who invented the integrated circuit. That's an area where it's over-the-horizon investments, longer term in nature, higher risk. You really need to have that outside of the product line structure, because you can't measure a product line manager on a three- and five-year type horizon when you've got high-risk investments inside of their portfolio.
Those are projects like our GaN-based semiconductors that are new materials, new techniques of design, kind of breakthrough. That's overall how we think about it.
Yeah. Let me add a few other things. That's a really good question, Ambrish. It could probably be answered from multiple angles. Dave just gave you two or three angles on that. Let me give you another one. First, step back. Remember, what are we trying to do? The ultimate objective is to maximize the long-term growth of free cash flow per share. As we're making decisions, it's almost a $16 billion company with 70 some product lines. On each one of those product lines, there's multiple kind of product categories. In a company that large, you're always going to have different areas that are in different stages of their life cycle. Some are growing, some are mature. And some are on the downward slope of that maturity, and you have to manage those differently, right?
That doesn't mean you take all resources away from the mature and put it all on the growth. Sometimes the mature product needs some resources to maximize, again, the free cash flow per share. Think of it as kind of the area under the curve into the future, right? All the cash that those products can generate, and in the case of industrial automotive, that can be decades. We think in those terms, then we reallocate resources through the life cycle of those products as it makes sense to maximize that free cash flow over time.
Ambrish, you have a follow-up?
Yeah, I had a quick one. Thanks, actually, thanks for a detailed look into that. The quick one is on the free cash flow target staying the same. If I remember my free cash flow correctly, the way to think about the profitability or the way to think about the business is that CapEx is going up. Working capital is not really going to help on the margin. It's really a more profitable business longer term, is the right way to think about it, right?
If I understand, I'm not quite sure I understood the last angle there. Maybe let me address that one and go back. Working capital, at the moment, we're at the 152 days of inventory. That is above the target, eventually, that will come back down. You're right, over the long haul, that stays within a certain range, that's not the key driver. We have to be smart about and disciplined about allocating resources to drive free cash flow. Working capital is another source or use of cash, we have to be smart about that. Maybe the broader topic on free cash flow. Our goal, as I said many times, is to maximize long-term growth of free cash flow. That's in terms of dollars, not percent. It's helpful to think of the percent. We have that target of 25%-35%.
We think we can operate at the high end of that target in stable markets. We just delivered 38%, that was a 38% despite having CapEx at 7.2%, right? Hopefully that gives you some framework on that.
Yeah. The context, which I think we talked about before, was the three drivers, revenue growth, margin expansion, and share buybacks. Even with our free cash flow margin being at 38.4%, there's no natural lid on that certainly as we build more 300 mm analog, that number can go higher. Okay, thank you, Ambrish, we'll go to the next caller, please.
Our next question is from Vivek Arya from Bank of America. Please go ahead.
Thanks for taking my question. Just following up on the free cash flow. You're keeping that free cash flow midpoint the same. You exceeded it last year, and I know, Dave, you said that there's no natural limit to that. If I look at the effective tax rate that is expected to come down, I think three or four points this year. What is driving the conservatism? Why shouldn't free cash flow, just that range have grown just from the benefits that you get from a lower tax rate?
Let me address that question specifically. As we said last year at various times, maybe not in the last earnings call, that's why you may not be remembering. Even though the tax rate in 2018 was about 20% and it's coming down to 16%, on a cash basis, nothing's changing. Meaning, we were already enjoying, they call it about 16% operating tax rate already in 2018. There's not gonna be a cash lift going into 2019. In fact, if anything, we have a little bit of headwind on some one-time items that I mentioned at some point during various earnings calls in 2018. The bigger picture is our ability to generate free cash flow of dollars and growing that over the long haul, not the percent. That's why even though we hit the 38% of revenue of free cash flow, we're not changing that metric.
We think the metric where it is, it's a good reflection of where we want to operate. As we said, we can operate at the top end of that metric in stable months.
You have a follow-up, Vivek?
Yes. Thanks, Dave. Probably an unfair question and sort of counterfactual, but in the last five years, TI has spent about $15 billion in buybacks, and that has reduced share count by 10%-11%. When I look at a lot of the M&A and consolidation in semis, that has managed to drive that level of synergies within the first one or two years. What gives you the confidence that buybacks have been a better use of cash than perhaps considering M&A, and how does that sort of inform you about how you should be thinking about M&A going forward? Thank you.
Yeah, no, that's a very good question. First, let me step back and remind everybody, I just said it during the prepared remarks, but just remind the audience how we think about M&A. It has to be strategic, first of all. There's two criteria. First, strategic. Catalog, analog, industrial, automotive focus so that we can leverage or even strengthen our competitive advantages. The second piece is that the return has to exceed our cost of capital. Within a reasonable timeframe, let's say four years. Think of it, you invest $100. If your cost of capital is 10%, you want to get $10 per year within year three or four and then grow that beyond that.
Well, many of the acquisitions that you see happening in the last five, six years, they invest $100, and on day one, they're getting maybe $2- $3, and it's difficult to see how they can get more than maybe $5- $6 per year, even after the synergies. At least the way we've looked at it, the way we've done the analysis, the way we've done the math. In our case, when we bought National, that was not the case. We actually were confident that we had pre-acquisition free cash flow a year that was pretty high to begin with. We were able to increase that beyond our cost of capital within two or three or four years. The other angle to your question is, well, how does that compare to buybacks? We actually do a thorough analysis.
Every so often, we go back and refresh it, of every share that we have bought over the last 15 years. At what price we bought it, what was the free cash flow at the time, and how that free cash flow grew from that point on. That's essentially a return, right? That's a comparison to whether it's M&A or other capital allocation. If we can get that return on that buyback, because now every time I buy back now, that owner that just left is no longer entitled to the free cash flow that is not only high as a yield, but is growing. You can think of it as free cash flow saved from that purchase. That's the return that you get.
We have done the analysis on that and are confident that has exceeded and continues to exceed our cost of capital. The purchases we just did in the past couple of years, that remains to be seen because that's dependent on what happens in the future with free cash flow. The starting point at about 6% free cash flow a year is really a good one.
I'll just add, when you're allocating that much capital to buybacks, you really need to have a good understanding of what those returns look like. As Rafael said, when we think of that acquiring that share, it really is the free cash flow that share will produce in the future is how we look at that return. That's a great question. Thank you, Vivek. We'll go to the next caller, please.
Our next caller is John Pitzer with Credit Suisse. Please go ahead.
Good morning, guys. Thanks for letting me ask the question. My first question is just on the CapEx intensity, Dave and Rafael. I just want to be clear, the 6% kind of a new target, that excludes the $600 million-$700 million, the actual 300 mm shell will cost. One, is that factually correct? Two, when do you think you'll actually start to see cash flow expenditures for that shell this year?
Yeah. Good question, John. You're correct in that assumption. That is the current assumption both the 6% going forward and also that it does not include the shell. As I said at the earnings call a couple of weeks ago, that shell would probably cost $600 million-$700 million, and we'd probably spend that over a couple of years. On that, which is the second part of your question, we're looking at our options now. As we said during the prepared remarks, over the next year or two, we'll probably make that decision. There's still multiple options to look at from location and other factors that we want to look at. As you know from the presentation, we generate about $4.8 billion of analog revenue on our existing footprint. We have a capacity of about $8 billion.
We still have over $3 billion to go in our existing footprint. At the moment, we have some room to maneuver on that.
Yeah. I'll just add, John, when we look at that capacity footprint, we're looking at kind of three, five, and 10-year views from a planning cycle. Once we make that decision, we expect to have that factory in use for decades, right? It is something that we want to be thoughtful and work through all of the options that we have and ensure it's the best opportunity and the best path forward. Do you have a follow-on, John?
Yeah. I appreciate all the color you gave us on kind of where you're focusing your R&D dollar by end market. It's probably not appropriate to talk about R&D intensity by end market, because I suspect given the growth profile you see in industrial and autos, that R&D intensity there might be higher than other areas. I'd be kind of curious, longer term, how should I think about the ROI of that R&D dollar going into industrial and auto versus other end markets? I guess as you continue to focus on those two end markets, what's the implication on ROI? Because I'm assuming the life product cycle of a dollar spent in R&D in those two end markets generates products with a significantly longer tail than perhaps other end markets, which would improve ROI. Am I thinking about that the right way?
Yeah, it does. That's why we're investing there, right? That's where the content is happening, so that's where the growth is happening. Maybe where you're going, the advantage is that it lasts for decades. It ramps up slowly. That return happens over a long period of time. The experience that we've had with industrial for many years, and automotive as well, gives us confidence that when we invest there, we are going to get those returns. The area under the curve, as I said earlier, is pretty sizable over those many years, even decades as we get those returns from industrial in particular, but also automotive.
Yeah. Just to give you another view on that, John, I think as we look for investments in personal electronics, if I were to describe the home run investment, maybe it's a part that senses and pulls action off of a button on a smartphone, right? All smartphones have buttons. That's a product that we could sell across to multiple customers. The buttons from one generation to a phone obviously don't change much, so you actually may get more than one model of a phone. You get a little bit longer longevity, versus if you're doing a product for one particular instantiation of a model. In addition, you can take manufacturers that make phones, usually make tablets, right? Those tablets have buttons, and PCs have buttons. Now you can jump what we call selling across different sectors inside of a market.
In that example, geez, things in industrial, things in medical device will need to have that same need, or a piece of industrial equipment, maybe in automotive. Again, this is the ideal type of investment that you could find in personal electronics. Not all of them look like that. We wish they did. What we'd like to stay away from is a custom product that runs in one instantiation of a phone. Now, out of the 300 or 400 parts that we do, of course, we're pragmatic. We do some custom products in that mix, but the majority of them, and what we're trying to look for and go to is more of that ideal. Thank you, John. We'll go to the next caller, please.
Thank you. Your next caller is William Stein with SunTrust. Please go ahead.
Great. Thanks for taking my question. The call's very helpful. I'm hoping, though, that you can remind us of the manufacturing strategy in the embedded business. Is that all outsourced today? Is there any opportunity as you're buying new equipment for 300 mm in the next go round that maybe we'd see more insourcing of that? Thank you.
You bet, William. Great question to clarify those that aren't familiar. I'd say our embedded footprint uses a mix of what I'll describe as advanced CMOS. That's a footprint that we no longer invest in. It needs the latest manufacturing equipment in our industry. When you hear of other peers on the digital side of the world going from 20 nm down to lower geometries, that's the footprint that they're talking about. We outsource that part of our manufacturing. You really can think of anything that's at 45 nm and below is outsourced. In total, that's for the total company, is a little less than 15% of our total wafer needs. Obviously, that sits primarily inside of the embedded space. We just feel that we can get that manufacturing footprint from our foundry partners.
We also don't believe that one flavor of 45 nm is different than another flavor of 45 nm, so there's not much differentiation in that footprint. There is part of the manufacturing footprint that integrates, and products that integrate analog functionality, especially in microcontrollers. That part of the footprint we build inside. We have peers that do that as well, so again, we don't see that as a major source of differentiation. If I contrast that to the analog side, we continue to invest in process technologies and development because think of that as really the baseline tools, kind of the rocket fuel and the engine that our engineers can differentiate our products with.
Not only do we get benefits from owning and controlling those assets, but by being able to invest and differentiate on process technologies, we believe that incrementally over time, our products will become more and more differentiated. Do you have a follow on?
I do, and it relates to the last part of your answer there. Some of your peers have talked about, while still potentially disclosing analog and embedded or microcontroller revenue, we're sort of led to believe that perhaps the distinction over time will become somewhat more blurry because these products sometimes get integrated, and then do they get allocated to the analog bucket or the microcontroller or embedded bucket? Are you seeing that trend? Are you seeing that trend in your business where how you allocate the revenue is maybe becoming more of a judgment call and maybe the distinction between these two segments is less important than it once was?
I would just say for us, it's not confusing because we have embedded segments, so if that business generates a product, even though it's basically a microcontroller, and it uses either one of our proprietary cores or an Arm core inside of it, and it may integrate some analog, but we think of that as an embedded product. It's the embedded group that's developing it. We don't really have that line of confusion. Just given the breadth of our portfolio, we're introducing 300 or 400 new products a year. It's much, much wider than any of our peers in the industry would have. Anyway, I hope that's not a source of confusion.
Yeah, I'll comment and, Dave, please chime back in because this is more your topic. My sense in industrial specifically, you don't have a lot of verticals there because of the nature of industrial, right? You have hundreds of end equipment. Each one of them with relatively low volume. There are fewer opportunities for verticals, hence fewer opportunities for integration. That's where our catalog portfolio works really in analog. Our catalog portfolio works really, really well. I think one angle of your question was, is there integration opportunities that could do away with some of the catalog opportunities? My sense is the answer is no, specifically in industrial applications.
Yeah. Okay. Thank you, William. Appreciate those questions. We'll go to the next caller, please.
Next caller is Stacy Rasgon with Bernstein Research. Please go ahead.
Hi, guys. Thanks for taking my questions. First, I wanted to ask you about the cost reduction on 300 mm versus 200 mm. Do you think the magnitude of that cost reduction that you've talked about is still valid when you're using new equipment to build out the new fabs rather than used equipment, given the higher cost of the equipment itself?
Yes. The short answer is yes. The example, the way to illustrate it, is as follows. A new factory or a factory using new equipment, ballpark would cost $4 billion- $4.5 billion, all in, when it's fully equipped, right? One with used equipment or a combination of used and new, because you're always going to use some new equipment, you're probably looking at $3 billion or so. Maybe there's a saving of a billion, a billion and change on that equipment. Remember, that factory, virtually with all that equipment, some of it you have to replace, and of course, there's spare parts and different things. But for the most part, with that equipment, can operate 20, even 30 years. I mean, the factory we're selling, that we were shutting down in Scotland, and now we're selling, operated for 50 years, right?
If every year it could sell up to $5 billion of revenue at very high cash flow throughs, and with the low tax rate that we now enjoy, do the math. $5 billion times about 80%, times about 80%, times 30 years, and compare that to whether it's a $3 billion investment or a $4 billion, $4.5 billion investment. At the end of the day, it doesn't make a significant difference. Would I want to get it used and existing and save the billion? Of course. That's part of being more efficient and allocating capital in a more disciplined way. That's a key tenet of our capital management strategy. In the big scheme of things, it's not a significant difference.
I just accentuate that illustration with the competitive advantage we have in 300 mm is just that. It is the structural cost advantage that we get. Whether we buy it new or used is more of a detail. You have a follow on, Stacy?
I do. Thank you. I had thought when you bought the assets from Spansion and SMIC, whenever it was, 10 years ago or nine years ago, I thought you had acquired empty 300 mm shells as part of those transactions. Is my memory wrong, or was that true, or have you done something else with those assets in the meantime? I'm just wondering, if that was the case, why you still need to build a shell.
We did acquire from Spansion an operating 200 mm factory. Sitting next to it was a partially equipped 300 mm factory. It is actually fairly small. Just describe it as undersized. We've moved that equipment to Richardson, as we had talked about before. That, and we've got an operating facility in Chengdu, China, 200 mm. We've used that extra floor space for bump capacity. It is in our manufacturing footprint, and we just have repurposed it for other needs.
The one in Chengdu. Yeah. The one in Aizu, we talked about options. That's one of the options. Yeah, those are some of the things we're always contemplating. A good memory on that, Stacy. Was that his second one? Or?
That was his second, yeah.
All right. That's it. Thank you.
Thanks, Stacy. We'll go to the next caller, please.
We also have Timothy Arcuri with UBS. Please go ahead.
Thank you. I wanted to get an idea of what the target leverage is for the balance sheet. You said that I think you took on, like, $1 billion worth of net debt last year. You're sort of I think back to where you were in terms of leverage back in the sort of early part of this decade. Is there a target level that you're marching toward and sort of how do you think about that? Thanks.
That's a great question, Tim. No, there's not a target leverage, but let me back up and give you something to think about on that. As we have on our objective for debt, it is increased rates of return with some leverage on the balance sheet when the economics make sense. Avoid concentrated maturities for risk mitigation and ensure strategic flexibility. Today, our net debt is about $900 million, I think, at the end of the year as our cash reduced to $4.2 billion and we ended up at $5.1 billion of debt. As you pointed out, maybe the first time in a while, we have some net debt. But at the end of the day, it's still pretty small. Our debt rating is A1, A+. Under that debt rating, we have plenty of capacity to go on that net debt.
At the end of the day, we step back and think about, can we increase the rate of return of the owners with some leverage on the balance sheet as it makes sense? You've seen us do net last year was an extra $1 billion. I think the year before was $600 million or so net debt. Something in that range we think is reasonable given the economics. Economics is the interest rate that's available, and we look at that compared to our free cash flow yield, and more importantly, where we think the free cash flow is going in the future. That's one comparison.
if we can get beyond that criteria, the next one, we look at the yield curve and see where it makes sense, if we're going to borrow, where it makes sense to borrow given the shape of the yield curve. Hopefully I gave you some good framework to consider.
Maybe just to add the obvious, certainly as our free cash flow grows, that capacity opens up as well over time. You have a follow-on, Tim?
Yes, I do. I wanted to ask about the mix between R&D and SG&A. If I just look over, say, the past three years, R&D has sort of tracked revenue growth, but SG&A is down about 4% on 22% growth in top line. How have you done that on the SG&A line, and how sustainable is that having SG&A so constrained when you're actually growing revenues that much? Thank you.
Yeah. Let me first step back and give you a broader answer, and then I'll try to get to some of the specifics. OpEx, at the end of the day, is a knob that we have to drive long-term growth of free cash flow per share. As we've said many times in this call and many years, that's the ultimate goal, growing long-term free cash flow per share. Inside of OpEx, R&D is the obvious one that helps us strengthen the broad portfolio as we invest more in certainly the product lines and also some of the things that Dave described earlier that also go into R&D. In SG&A, we also consider some parts of SG&A as investments.
The best example is the sales force, more so what we're doing on the web to strengthen demand creation in the web and everything that goes with that. Over the last few years, we have been able to reallocate from SG&A, decreased resources in SG&A, increased resources in R&D by a little bit. It's been a few percentage points over the years. Overall OpEx has stayed about flat. I would suggest that you think of overall OpEx kind of together like that versus the pieces. Our sense is about where we're running now is reasonable given the opportunities that we have in terms of dollars. Could that grow a point or two over time, just given inflation pressures and so forth? It could. Maybe you could think of it that way.
Ultimately, that is there to drive the top-line growth, which then drives the free cash flow growth over time.
Okay. Thanks, Tim, we'll go to the next caller, please.
Our next caller is Ross Seymore with Deutsche Bank. Please go ahead.
Hi, guys. Thanks for letting me ask a question. On the 300 mm side, it's clearly a competitive advantage you guys have. How do you prioritize the market share benefits that it could yield versus the margin benefits it could yield? Shouldn't both of those metrics accelerate to the upside as 300 mm becomes a bigger and bigger percentage of your mix?
Yeah. Ross, you've followed the analog market for some time, as our customers go through and decide which product they're going to use, there can be tens, if not hundreds of specs that an engineer is considering. The average sales price of a product in the market overall is about $0.35. Out of those hundreds of specifications they're looking at, pricing is always a concern, but it just very rarely is one of the top concerns. You can't sell a $0.35 part for $3.50, but that's just not usually one of the top things that a customer is concerned about. They're really looking at the functionality of the device and how it works inside of their design.
You've seen as we build more 300 mm, that has just structurally lowered our cost, and you've seen how that's worked its way through our financial statements. The second part of your question, did I answer that?
I think you answered both sides of it.
Okay. Do you have a follow-on?
Yeah. Just on the days inventory target. I know you guys aren't changing the days, and you've been very clear why you're above it right now. Can you remind us what percentage of your business goes through consignment today? Is there any upside limit to how high that can go? And if it's going to continue to go up over time, would that rightly lead us to conclude that the days that you would carry would go up because what formerly was on the books of your distributors will now be on your books?
Let me start off, and then I'll hand it over to Rafael. If you look at our amount of our revenue that goes through consignment last year, 2018, we ended the year with about 65% of our revenues in total. That's been drifting up over the last few years. Specifically, if you look at our revenues inside of distribution, which also happens to be 65% of our total revenues, inside of our distribution revenues, that number has moved up to 70%. We talked about on our last call and the call before that we're implementing the next phase, as you talked about, to put more parts on consignment and in some cases, bring some additional customers or other distributor sites onto consignment, and that will drive that number up overall.
Now, as it works its way through the finances, that will put upward pressure on our inventory days. Even though there's not any more inventory collectively in the channel, it'll just show as more inventory on our balance sheet. Rafael, you want to comment on that?
Yeah, no, Ross, let me just add a few other things. Step back and think about what's the objective for inventory. It's to maintain high levels of customer service, minimize inventory obsolescence, and improve manufacturing asset utilization. At the end of the day, inventory is one more knob in how we allocate capital. It's a use of capital, right? I'm happy allocating capital there if it's going to help us drive longer-term growth of free cash flow. That's one of the tenets of the manufacturing, the capital management strategy. The other one is efficiency. We also want to be efficient in how we use inventory and from an operations standpoint, how that inventory works in the company. With that, we want to have more consignment because there's strategic value in owning that inventory. We get better signals from the distributors, from the customers.
We can manage that inventory more efficiently. As you pointed out, that does put upward pressure on the inventory days. As Dave mentioned, the overall inventory in the entire chain doesn't change. We just have more of it on our books versus our distributors, right? At the same time, I just talked about efficiencies, right? There better be some efficiencies as we make that change. That will put downward pressure on the inventory day. It remains to be seen exactly where that ends. When it makes sense, if it makes sense to change the inventory range target, we will. Just keep in mind, at the end of the day, what we're trying to optimize is not that particular range.
It's the long-term growth of free cash flow, and we'll do whatever is necessary on the inventory front to optimize that very important metric of growing free cash flow per share for the long term.
Great. Thank you, Ross. We'll go to the next caller, please.
Our next caller is Harlan Sur with JP Morgan. Please go ahead.
Morning. Thank you for hosting the call. On the growth and market share front, just trying to chew up your performance in 2018 with the recent release of the WSTS data. If I look at the overall analog sector, looks like it grew about 10% last year versus your 9%, and MCUs grew about 3% versus your sort of 1.5%- 2% for embedded. I know that we probably have to break it down further into subsegments, and there are some mix impacts. Just given all of this, does the team think that they gained share in 2018 in your served markets?
I think, Harlan, when we look at those numbers. Again, WSTS is one reporting service. There's other analysts that follow the market. We look closely at the numbers posted by both our largest peers and smaller peers. If you look over five and 10 and 15 years, we've been gaining 30 or 40 basis points of share a year, so not a lot. We believe last year we continued to gain share, and we will over periods of time. We don't get caught up on one particular year, either get too excited or too depressed in either way, because it really is something that takes place over a longer period of time. You have a follow-up?
Nope, that's all the questions I had. Thank you.
Thank you, Harlan. We'll go to the next caller, please.
Our next caller is Tore Svanberg with Stifel. Please go ahead.
Yes, thank you for hosting the call. First question, when you look at the R&D you're allocating by end markets, automotive is obviously a big area. For obvious reasons, there's a lot of content growth there. I guess the other side of that coin is that a lot of your peers know that too. It does sort of seem like it's going to be a market that will get pretty crowded over the next few years. Just wondering if you believe that or do you think there's plenty of opportunities for TI so that the automotive market can remain a good market for many years to come?
Yeah. I'll start if Rafael wants to add something. I think, Tore, of course, the numbers for 2018 aren't out yet of how much people are estimating or content per car. The year before, that was around $375, most analysts have that number doubling or tripling in 10 years. That's driven by content going to places where it doesn't exist today. Some of that content growth is in new things like ADAS and other things that are new inside of a car. A lot of that content is also going into places that are making things more reliable, taking out weight. If you look at cabling inside of a car, that's the second most heaviest item inside of a car after the power plant and the engine.
Just reducing the amount of cables and using bussing techniques to move information around the car is just one small example of a great opportunity. We've been investing in five sectors of growth or five sectors inside of that market. ADAS, as I just mentioned, infotainment, powertrain, safety systems, and body and lighting. We've seen growth coming from all five of those sectors, very broad-based growth from the sector standpoint. When you drop down into that, we now have about 45 of our 65 to 70 product lines that are shipping product into automotive, so it's very broad-based. We've got nearly 1,000 customers, OEMs that we ship to, and of course, that's going to be dominated by the largest OEMs from a revenue percentage standpoint. But even those largest tier 1 OEMs will ship 1,000 to a couple thousand different devices into.
Just think of it as very broad-based. That's what gives us confidence that that market will be a good market for us for a long time to come.
Yeah, let me just chime in. Here's how I think about it. It all comes down to our strategy. Let me take you back to the three elements: great business model, discipline, allocation of capital, and efficiency. On the great business model, you have to have it, and then you have to strengthen it. In our case is analog and embedded, auto and industrial, and they're built around the four competitive advantages. If it was only analog and embedded and auto and industrial, anybody could just raise some money and go start a company and go after that, and it would change the industry. It's not just about those two. It's about the competitive advantages. Let me just name a couple to remind the audience. Manufacturing and technology.
If you're going to build a new factory, you've got to size it for $5 billion of revenue per year. Otherwise, it's not efficient. Very few companies, in fact, I can only think of one, TI, can do that, and then have a factory like that that's cost-efficient and it makes sense to have. We have two of them, and now we're planning the third one. Let me give you another example. The broad portfolio. We have over 80,000 parts that happened over decades of investing in this space. It's very difficult for a new company or even existing companies to go and try to achieve that portfolio. By the way, as they try to do that, we're just extending our lead. We're just continuing to invest in that space and extending our lead on our broad portfolio.
That's where the competitive advantage is really coming to play because they're unique, they provide a tangible benefit, and they deliver results.
Great. You have a follow-on, Tore?
Yeah, that was very helpful. On CapEx, I remember about a decade ago, when you went out and bought all this equipment for 300 mm, and I guess that's when you came up with a 4% CapEx target, and now it's 6%. Is the main difference there just the fact that you haven't found sort of old, depreciated equipment that somebody wants to get rid of? Is there something else?
That's it. The availability of this equipment is less. It's an assumption that we're making right now with the 6%. Yeah.
Great, Tore. Thank you.
Great. Thank you.
I think we've got time for one more caller.
Okay. Our next caller is Shawn Harrison with Longbow Research. Please go ahead.
Hi, morning, everybody, and thanks for getting me under the wire. Two questions. There was an announcement yesterday of a, I think, a fab that you were looking to close anyway, being sold to Diodes. Just maybe if you could elaborate a bit on whether that helps out capacity utilization at all of any significance this year or any free cash flow benefit, considering I thought production was already being transferred out of that fab.
I'll start, Dave, you want to chime in. Remember, the focus here is free cash flow generation. It's not a particular utilization metric, right? From a cash standpoint, first we're going to get a gain. Not a gain, but we're going to get paid for the factory. It also avoids having paid some of the severance. There's an immediate cash benefit of doing that. Then we're actually going to have availability of that factory with a supply agreement for several years, so that as we dwindle some of the production that we had there that we're moving to other factories, it actually helps with that process of doing that.
As we move those products, the remaining ones, to other factories, because that factory was not as cost-efficient as other factories, then we actually improve our position to continue manufacturing those because the variable cost, the cash cost, if you will, goes down on a per unit basis at those factories where we're offloading versus this Scotland factory.
Maybe I'll just add, Shawn, we make these decisions on fabs, and especially when we're building a new one, we talk about expecting to run that fab for decades. This one next year will be opened about 50 years ago. That is a long time to have an asset in use. Certainly, we don't expect it to be in our factory footprint forever, but that is a very long time. We announced that we were in the process of closing that fab or looking for an alternative to sell it, three years ago. This process, and as Rafael said, that we'll have access to build products in that fab for several years, so it does take a long time to move those products into other factories. It's just not easy to do, I think is a great example. You have a follow-on, Shawn?
I do, brief, just kind of following on that theme of fabs being open decades. As you add in the new 300 mm capacity, maybe if you could just speak about the P&L impact for the shell, it would seem de minimis, but as you begin to add in capacity, is there any significant P&L impact, or should it be also the kind of basis points of potential hit over the next couple of years?
Yeah. First, from a CapEx standpoint, remember that it's all about investing to support new technology, revenue growth, and extending our manufacturing advantage, and ultimately to drive a longer-term free cash flow growth. Frankly, the depreciation, how it workflows through the P&L is almost incidental. Let me answer a specific question. The $600 million, $700 million of the shell, if we end up building a shell, that is depreciated over decades. Yeah, the P&L impact on that will be minimal. The equipment is depreciated over five years, whatever we put in. Remember, it lasts a lot longer than five years. Back to the cash, that's why cash is really the best way to look at it. The equipment we would put in as needed, depending on revenue growth expectations.
The impact on the P&L also should be de minimis because you're only doing it as revenue grows, right?
That's right.
At least over the long term. Of course, any one quarter, even any one year, that could swing, but the long term is the way we're thinking about it. Hey, since that was the last call before I turn it over to Dave, let me just finish the call with just a few remarks. I want to thank all of you for taking the time today to go through our capital management strategy. Let me emphasize a few points. We remain focused on consistent execution of our capital management strategy. Our discipline allocation of R&D is delivering growth from the best products, analog and embedded, in the best markets, industrial and automotive. We have a great diversity across all the sectors within these markets. Our 300 mm analog manufacturing strategy is a unique advantage and will continue to benefit TI for a long time to come.
We remain committed to returning all free cash flow to the owners of the company. Dave?
Okay. Thank you for joining us. A replay of this call will be available on our website as well. Thank you and have a great day.
This concludes today's call. Thank you for your participation. You may now disconnect.