Good day and welcome to the Texas Instruments Second Quarter 2014 Earnings Conference Call. At this time, I'd like to turn the conference over to Ron Slemmaker. Please go ahead, sir.
Good afternoon and thank you for joining our Q2 2014 earnings conference call. As usual, Kevin March, TI's Chief Financial Officer is with me today. In addition, Dave Paul has joined us. As many of you know, I will retire in August and Dave will replace me as Head of Investor Relations. Dave has worked at TI for 25 years and has worked directly with me for 10 years.
With that consideration, you probably should allow him some time to come up to speed. Dave has also been recently elected by TI's Board through the position of company Vice President. Dave will moderate today's call. With that, let me turn it over to Dave.
Thank you, Ron. It's good to join you today for the call. And now down to business. For any of you who missed the release, you can find it and any relevant non GAAP reconciliation on our website at ti.com/ir. This call is being broadcast live over the web and can be accessed through TI's website.
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 Safe Harbor statement contained in the earnings release published today as well as TI's most recent SEC filings for a more complete description. The 2nd quarter was another solid quarter. Our core businesses of analog and embedded processing grew strongly with combined revenue up 14% from a year ago.
We continue to benefit from our investments in industrial and automotive as these important markets continue to grow as a percentage of our revenue. Revenue of $3,290,000,000 came in slightly higher than the middle of the expected range we communicated to you in April. Earnings per share of $0.62 were near the top of our expected range as profitability was stronger in the quarter. Free cash flow of $3,200,000,000 or 25 percent of revenue for the trailing 12 month period was right in line with the 20% to 30% range in which we expect to operate over time. Also over the past 12 months, we returned $4,200,000,000 of cash to investors through a combination of dividends and stock repurchases.
As a reminder, our model for cash returns to shareholders is to return all of our free cash flow, less the net debt amount that is retired, plus any proceeds we receive from exercises of equity compensation. This model demonstrates our confidence in TI's business and our commitment to return excess cash to our shareholders. In the Q2, TI revenue grew 8% from a year ago with double digit growth in both analog and embedded processing. Analog revenue grew 14% from a year ago, primarily driven by power management. High performance analog, high volume analog and logic and Silicon Valley analog also grew.
Embedded processing revenue grew 14% from a year ago, primarily due to processors and microcontrollers, both of which grew about the same amount. Connectivity grew at a faster rate, although it was coming from a much smaller base. Embedded processing delivered its 7th quarter in a row of year over year growth as our investments over the past few years in strategic areas are yielding favorable results. In our other segment, revenue declined $90,000,000 or 13% from a year ago due to legacy wireless, which is essentially gone. Turning to distribution.
Resales increased 15% from a year ago, while distributors inventories were about even. Weeks of the inventory fell by several days to just over 4.5 weeks. This reduction was driven by a higher a higher percentage of resales being supported by TI's consignment inventory programs. From an end market perspective, most growth from the year ago came Equipment followed by Automotive and Industrial. Enterprise Systems was also up, while revenue in personal electronics declined due to mobile phones and tablets areas that use legacy wireless products from TI.
Now Kevin will review profitability, capital management and our outlook.
Thanks, Dave and good afternoon everyone. Gross profit in the quarter was $1,880,000,000 or 57.1 percent of revenue. Gross profit increased 20% from the year ago quarter and gross margin hit another new record. When compared with record in the Q3 of 2013, revenue was $48,000,000 higher and gross profit was $102,000,000 higher. This reflects an improved product portfolio focus on analog and embedded processing as well as increased efficiency in our manufacturing operations.
Moving to operating expenses. Combined R and D and SG and A expense of $821,000,000 was down $39,000,000 from a year ago. The decline primarily reflects the reductions in legacy wireless as well as continued cost discipline across TI. Acquisition charges were $82,000,000 almost all of which were the ongoing amortization of intangibles, a non cash expense. Restructuring and other charges were a $4,000,000 benefit.
As a reminder, the year ago quarter included a gain of $315,000,000 associated with the transfer of wireless connectivity technology to a customer. Operating profit was $982,000,000 or 29.8 percent of revenue. Operating profit was up 8% from the year ago quarter. Net income in second quarter was $683,000,000 or $0.62 per share. Let me comment on our capital management starting with our cash generation.
Cash flow from operations was $775,000,000 in the quarter. Inventory days were with our model of 105 to 115 days. Capital expenditures were $80,000,000 in the quarter. On a trailing 12 months basis, cash flow from operations was $3,590,000,000 up 8% from the same period a year ago. Trailing 12 months capital expenditures were $388,000,000 or 3% of revenue even lower than our long term expectation of 4%.
Although, we've been able to keep capital expenditures at this low level, we continue to invest to expand both our capabilities and our capacity. As examples, capital expenditures in 2nd quarter included the cost to prepare the site and install the first tools into our new assembly and test facility in Chengdu, China. We completed manufacturing our first units there for qualification purposes. In addition, we brought on additional tools to expand capacity in our 300 millimeter facility in Richardson, Texas. We are able to make these investments and keep our capital spending at low levels because of our strategy to invest in capacity opportunistically and ahead of demand.
Free cash flow for the past 12 months was $3,201,000,000 or 25 percent of revenue in the middle of our expected 20% to 30% Free cash flow was 10% higher than a year ago. Depreciation expense for the past 12 months was 856,000,000 Depreciation exceeded our capital expenditures by $468,000,000 or 3.7 percent of revenue. We continue to expect to hold capital spending at low levels or at about 4% of revenue. As a result, the depreciation will decline to the rate of capital spending our gross margins will directly benefit. As we've said, we believe strong cash flow growth, particularly free cash flow growth is most important to maximizing shareholder value in the long term and will be valued only if it's returned to shareholders or productively reinvested in the business.
To that end in the Q2, TI paid $323,000,000 in dividends and repurchased $743,000,000 of our stock for a total return of $1,070,000,000 The shareholder return part of our capital management strategy is to return all of our free cash flow minus debt retirement plus any proceeds that we receive from exercises of equity compensation. Total cash return in the past 12 months was $4,200,000,000 which was 18% higher than a year ago. Dividends were up 32% and stock repurchases were up 13%. Fundamental for our cash return strategy are our cash management and tax practices. We ended the 2nd quarter with 2.8 $1,000,000,000 of cash and short term investments, down from $4,030,000,000 at the beginning of the quarter.
The decline mostly reflects the use of $1,000,000,000 to retire debt in the quarter. TI's U. S. Entities own 82% of our cash. Because our cash is largely onshore, it is readily available for a variety of uses including paying dividends and repurchasing our stock.
TI orders in the quarter were $3,330,000,000 up 7% from a year ago and our book to bill ratio was 1.01, which would have been higher, but was impacted by the conversion of consignment of some products that are sold through distribution. Turning to our outlook. We expect TI revenue in the range of $3,310,000,000 to $3,590,000,000 in the 3rd quarter. At the middle of this range, revenue would increase 6% from a year ago. If you exclude the $57,000,000 of legacy wireless revenue from the year ago quarter, revenue would increase 8%.
We expect 3rd quarter earnings per share to be in the range of $0.66 to $0.76 Restructuring charges will continue to be essentially nil. Acquisition charges, which are non cash amortization charges, will remain about even and hold at this level for the next 5 years. Our expectation for our effective tax rate in 2014 remains about 28%. This is the tax rate you should use for the 3rd In summary, the Q2 demonstrates the strength of TI's business model focused on analog and embedded processing, which we believe are the best opportunities inside semiconductor market. We continue to invest in areas that offer sustainable growth, solid profitability and good cash flow from operations.
The percentage of our business from industrial and automotive markets continues to grow as customers increasingly embrace technology that makes end product smarter and more connected. At the same time, we continue to invest in our manufacturing capabilities and our strategy to opportunistically acquire manufacturing assets means that we can deliver strong free cash flows. We continue to demonstrate as we did again in the Q2, our commitment to provide strong returns to our shareholders in the form of dividends and share repurchases. With that, let me turn it back to Dave.
Thanks, Kevin. Operator, you can now open the lines up questions.
Thank you.
In order to provide as many people as possible the opportunity to ask a question, please limit yourself to a single question. After a response, we'll provide you an opportunity for an additional follow-up. Go ahead,
Renee. And we'll now take our first question from Jon Pitzer with Credit Suisse. Please go ahead.
Yes, good afternoon. Congratulation on the strong results. Kevin, I guess my first question is on OpEx. I think for the June quarter going into June you kind of guided that OpEx would be flattish Q on Q and you did better than that. I'm kind of curious is that a pull in of the $130,000,000 of annualized savings you expected from the restructuring?
Or is that just a bigger number than $130,000,000 And how do we think about OpEx trending in September and the back half of the year?
Yes, John. The you're right. The OpEx we had expected to be roughly even from Q1 and the 2nd quarter and that came in a bit lower than we'd expected. And part of that was some pull in with the restructuring actions that we announced in the Q1 for both embedded processing and resizing of our operation in Japan. And part of it was just continued discipline on the part of all the business units in TI when it came to spending.
As you look into 3Q, we continue to expect the second half to see the primary benefit of the cost savings that we talked about for those restructuring actions. Call that we expect about $130,000,000 of annualized savings with about 85 percent of that in OpEx and the balance in cost of revenue. So as we go into Q3, we'll see about half of that amount come into our results in OpEx with the balance in 4th quarter. So by the time we leave the year, we should be at an annualized $130,000,000 cost savings in that action.
Do you have a follow-up, Connor?
Yes, that's helpful, Kevin. As a follow-up, I know this is somewhat of an unfair question. But if you look at the proceeds from equity compensation, last year it was almost about a 3rd of the cash returns to investors. And I know that's been a volatile number and probably a number that's impossible to predict. But I'm kind of curious how do you how should you think we should think about that number going forward from here?
How do we try to model that number in the future?
John, we talked in during the update to our capital management strategy that going forward we would expect the proceeds from stock option stock option exercises to reduce considerably. We saw gosh, I guess it was probably 2 to 3 times our normal rate of stock option exercises and cash proceeds in 2013 than we've seen in prior years. So we talked about that going forward that would probably come back down to a more normalized level. And I would suspect that what we saw last quarter, what we saw this quarter probably is more reflective of what you should model going forward. Figure about I think we saw about 4% or 5% stock options exercised last year and that'll probably drop back to 1.5%, 2% on a level.
Okay. Thank you, John. Next caller please.
Thank you. We'll go next to Jim Covello with Goldman Sachs.
Great, guys. Thanks so much for taking the question. I appreciate it. Could you just give us some perspective on kind of the broader cyclical environment? Would you say there's anything at all going on other than normal and maybe break that down by subcategory a little bit?
And I'll leave that as both questions and pass from there. Thanks. Okay, Jim. I think that we don't have any unique insight into what's going on from a cyclical standpoint. I think that the quarter that we just delivered, we feel good about.
If you look at the middle of our range into 3rd quarter, 8% if you're excluding legacy wireless is another good quarter on a year on year basis. If you look at a lot of the signals that one would pay attention to such as inventory inside of the channel, We took several days out of inventory in the quarter as we had a higher percentage of revenue supported by our consignment programs inside of distribution. And if you look at cancellations, they continue to remain at very, very low levels. We think inventory at customers remains in check as well. So and then if you look at our lead times, they continue to remain stable.
We'll always have some pockets where they may move out temporarily. But with our capacity and position of our inventory, we feel really good to be able to continue to support that. So you have a follow-up question? The sub the verticals, any differences by vertical? No.
I think that from a year on year standpoint, we had if you look at industrial, we had growth in nearly all the sectors, so very broad based from that standpoint, led by areas like factory automation. Automotive, we had double digit growth in all of our Spectors led by ADAS or Advanced Driver Assist Systems. Personal Electronics was down, but it would have been up had it not been for growth driven by projectors and servers and comms equipment was up due to wireless infrastructure. So really broad based growth on that, Sam. Okay.
Thanks. We'll go to the next caller.
Thank you. We'll take Stacy Rasgon with Sandler Bernstein.
Hi, guys. Thanks for taking my questions. First, I want to dig into your I guess your margin trajectory. Your incremental operating margins for analog and embedded processor both exceeded 100% sequentially in the quarter. Your analog business also has about 100% incremental operating margins year over year.
I guess the strong performance particularly in analog surprises me a little
bit. I thought most of the
cuts you did were in embedded processing. So I wonder if you could give us some sort of view on what's driving that strong incremental margins? How much of that is sort of gross margin expansion within the businesses versus OpEx? And what do you sort of see as sort of sustainable levels of incremental operating margin going forward as the revenues and the businesses continue to grow?
Yes. Stacy, the fall through is very good both on a quarter over quarter and a year over year basis, certainly at the company level and at the segment levels. I mentioned, I guess, on the first call from John that from an OpEx standpoint, spending remained disciplined across the company. So while the restructuring action that you referred to will disproportionately benefit embedded processing versus other areas of the company, some of that will benefit other areas of the company as well. For example, we mentioned resizing our sales team in Japan.
And that's not just the sales team in support of the embedded processing, but also those in support of some of the other business units. So you get a little bit of benefit there. But then you really got just discipline spending across the company as frankly people are spending only what they need to support the growth of the business. On a go forward basis, again, we expect OpEx to be down a little bit sequentially primarily for the benefit of embedded processing. That will be true for both the 3rd Q4.
Beyond that, I don't know that I'd give you any more specific forecasts on OpEx other than by the time we reach the end of the year, we will enter next year with OpEx about total cost savings we restructured about $130,000,000 about 85% of that coming up OpEx.
Got it. That's helpful. Yes, for my follow on, I want to dig into gross margins just a little bit. So if I take that half of the $130,000,000 kind of hitting you or 85% of hitting you by next quarter, It sounds to me like you're guiding OpEx down about 2%, which will give me an implied gross margin guidance at the corporate level, call it into the upper 57%, so maybe 500 basis points maybe even a little more from Q2. So I think you could give us just some view of what's driving that gross margin expansion?
Is this just further efficiencies manufacturing efficiencies? Is this just depreciation coming down? Is this something else to do with mix or pricing or just overall revenue leverage as revenues grow?
I think it's a little bit of all of that to be quite frank Stacy. If you take a look at as we go forward on gross margin, there's multiple drivers inside the portfolio, not the least of which is being able to load or fill up our very cost effective factories. We also get improved product mix, especially as we see industrial and automotive becoming a larger portion of our total revenue mix. And finally, we get the benefit from depreciation as it begins to roll off being that the CapEx has run substantially below depreciation now for quite some time. Again, just as a reminder, depreciation was about 7% of revenue over the last 12 months and CapEx is expected to be around 4%.
So we got some closure that will start happening over the next couple of years. Depreciation this year is expected to be down a bit versus last year, but it will start to climb more rapidly next year. So you got a number of different things going on not just next quarter that will move gross margins up again as you indicated, but should also continue to benefit us as we look out into the balance of the year and going into 2015.
Great. Thank you, Stacy.
Operator, we can
go to the next caller please.
Thank you. We'll go to Blayne Curtis with Barclays. Thanks.
Hey, good afternoon. Thanks for taking my question. I was wondering what your utilization was in the quarter and where you expect that to go? And then the second part of my question, as you look into December typically seasonally softer period things seem fairly normal. I was wondering your thoughts on just seasonality into December.
I'll mention I'll talk the utilization and Dave will talk the seasonality there for but, Blayne, we look at utilization 2Q to 3Q. We don't expect that to really change all that much as we have our wafer starts not too far off from what we saw in the Q1 and what we start excuse me, the Q2 and what we started in the Q2 will come out of the factory in the Q3. So overall utilization unlikely to change all that much as we look into the near term.
And from a seasonality standpoint, Blaine, essentially we're going to let you determine what you believe seasonality is. And just a few things to consider as you go through that. Obviously, calculator revenue is usually strongest in 2nd quarter and third quarter with the back to school buying period and you saw that in our results this quarter. And our semiconductor growth is typically relatively stronger in the second and third quarters compared with the first and 4th. So outside of that, we don't put much credence on a specific sequential growth number just because the numbers around that have been so unpredictable.
And we're just going to step back from trying to provide any appearance of doing math on it, because it will appear that we're endorsing one number over another. So you have a follow on Blayne?
Just wondering maybe in the September quarter a similar question whether outside of calculators there is
any areas of particular strength or weakness.
You had mentioned weakness? You had mentioned comm had been a strong point. Is that sustaining? And then it seems like autos as well have held in there better usually a seasonally weaker second half, but seems strong. Just curious any comment on that?
Sure. Yes. Other than the comp level guidance, we don't really get into strength or weakness by sector. If there's something very unusual going on like with our legacy wireless, of course, we've given visibility into those types of things in the past. So with that, we'll move to the next caller.
Thank you. We'll move to Doug Friedman with RBC Capital Markets.
Hi, guys. Thanks for taking my question. And before I begin my question, Ron, it's been great working with you and best of luck in retirement before I forget to say that. So going into the numbers, if you could talk a little bit maybe about your strategy to maybe increase free cash flow. When we look at sort of what's going on with your balance sheet, you're getting pretty close to getting a debt level that might be good to carry that debt and stop retiring it or maybe just start rolling it forward.
Can you maybe talk a little bit Kevin about your strategy there?
Well, the strategy is less about debt and more about the actual product portfolio in the markets that we're going after Doug. It's really about being sure that we're thoughtful on how we spend our research and development dollars and that we spend them on products that we expect to have very long revenue life streams off of them. And then in correlation with that is to continue to be opportunistic and to expand our manufacturing capacity at times when you may at least expect us to do that because we can get it for cost that are very low. Those are our 2 biggest levers for expanding cash flow. As it relates to debt going forward, as you observe, we just paid off a net of $500,000,000 this year.
We raised $500,000,000 in the Q1 and repaid $1,000,000,000 in the 2nd quarter, so a net reduction of $500,000,000 We still have on the balance sheet total debt of about $4,625,000,000 And those actually have lives that extend all the way out to 2023. So I don't see a balance vanishing from our debt vanishing from our balance sheet anytime soon. On a go forward basis, of course, our buyback, I think that was one of the things you were asking about on the free cash flow, is really a function of what our calculation of net present value of the company is. And so long as we see that the intrinsic value of the company exceeds the market value, we'll continue to be buyers of the stock.
Okay. And Doug,
do you
have a follow-up?
Yes. What role will M and A possibly play in? And when do you think is there an opportunity to reenter the M and A market that you guys really have not been active since the National Semi deal has closed?
When it comes to M and A, again, it's about product strategy. Our bias is likely to be should we find an opportunity that would be attractive to us, our bias would probably be in the analog space as opposed to embedded processing. And frankly, aside from the technology that we acquire or the product opportunity that we acquire being attractive meaning long revenue streams, we would also have to work for us mathematically meaning that the price at which we could acquire it would have to be such that we could get a return on our invested capital inside a 3 to 4 year period. And we're pretty disciplined about that. Some of the opportunities that some have speculated on here in recent months are such if you do the math it's very difficult to overcome that hurdle of making sure it's ROIC accretive.
And we
think that's very important if we're going to actually generate excess cash flow and free cash flow off of any acquisition in the future. Okay.
Thank you, Doug. Operator, next caller please.
Thank you. We'll take Joe Moore with Morgan Stanley.
Great. Thank you. I wonder
if you could touch
on the strength that you had alluded to in communications equipment in Q2. Is that macro base stations? Or is there some other element of that?
Yes. The majority of that is would be macro base stations. If you look at investments that we're making longer term that will include small cell, but we really don't have measurable revenue on products like that at this point.
Okay. Thanks. And as part of the embedded restructuring that you had done, it sounded like you were pulling back on some
of the investing in that category.
Does that change your trajectory at all? Or does that mean you participate less in base stations over time?
No. I think if you look at those investments and those product cycles, they tend to have they tend to be very long in nature. So the areas that we've pulled back tend to be areas that we now believe are either mature or in the process of maturing and yet we continue to invest in areas that will drive growth in the future such as small cells as I indicated before. So thank you, Joe. And we'll go to the next caller please.
Thank you. We'll move to Ambrish Srivastava with BMO.
Hi. Thank you. A question on CapEx Kevin. Your capital intensity has been fairly below the 4% that you said that you would be. What should we be modeling for the remainder of the year?
And more importantly, what would cause it to defect to move in effect upwards?
Yes. Ambrish, the again, I think for purposes of your models, I would just assume about a 4% of revenue kind of planning is going to get you pretty close to probably the right answer over time. In any one quarter, I'm sure it's going to be off, but it will be okay on a rough annual period. Anything that might cause us to go above that could possibly be if we had a sudden opportunity present itself where we could add capacity at a significant cost savings. We wouldn't let that 4% artificially restrain us from taking advantage of very inexpensive manufacturing capacity, which would benefit our future free cash flow.
But right now, I don't see that on the horizon. So again, for your model, I'd probably just use 4%.
Okay. And my quick follow-up, Dave, you mentioned that consignment as a percent of sales has changed. Where has it gone back up? And I think I remember it used to be in the mid-40s before?
Yes. If you look overall, our consignment as a percent of revenues has moved up a little bit from about 45% to about 50%, if you look inside of our distribution channel. So about 55 percent
of our
revenues go through distribution and about 55% of those revenues are supported by consignment. So that's really the part that's beginning to drive that higher and our inventories that's owned by distributors lower. So thanks, Ambrish.
And we
can go to the next caller please.
Thank you. We'll take our next question from Christopher Rolland with FBR Capital Markets.
Hey, guys. So your extra capacity at the bottom of the cycle may have been a bit of a burden, but can be very valuable as the cycle heats heats up here. So do you think we're at the point in the cycle where you guys are benefiting from that extra capacity either front end or back end? Do you think that some of your competitors might have a lack of capacity there and might be switching to your product?
Yes, Christopher, clearly, we've had this strategy in place now for a number of years where we're acquiring as inexpensively as we can manage to in advance of our needs. The most recent example was the acquisition of an assembly test operation in Chengdu, China that I commented on earlier in the call that we're now bringing online. And so that has certainly been a benefit to us to allow us to have very stable lead times on behalf of our customers and to be able to meet any short term spikes or inside lead time requests that customers have had. Broadly speaking across the industry, it does strike us many people perhaps have chosen not to invest in as much capacity as they might have in the past. It's unclear to us just what that may mean going forward.
But at least from our standpoint for our customers, they can have confidence now we have ample capacity to meet their need.
Yes. And Chris, I'll add also, we've taken other actions that utilize that capacity different points of demand. And so one thing that we've done and you can see it on the balance sheet is that in periods of weaker demand, we'll actually build finished goods inventory as well as staging wafers to support future demand on low volume product. And so it may take 20 minutes, 30 minutes to set up a piece of assembly test equipment. And you may run only 10,000 units on that part.
And that may take you a half hour or an hour. It doesn't take much longer to build either 6 months of demand or a full year of demand or a year and a half of demand and put that on the shelf. So when demand actually gets stronger, we've got the capacity open and available to support that stronger demand. So we feel good to be able to support really any demand environment that we see in the future. Do you have a follow on Chris?
Sure. The other segment it was above the street also above seasonality. Is that just calculators? Or is there something else there?
Yes. That's really just calculator. It's seasonally strong in the 2nd and third quarter for the back to school selling season and then it's typically weaker in the 4th and first quarter as kids are already in school and have the calculators.
Thank you, Chris. And we'll go to the next caller please.
Thank you. We'll take our next question from Vivek Arya with Bank of America.
Thanks for taking my question and good luck to both Dave and to Ron. For my first question, I'm curious what are underutilization charges running at right now? And what at what level of utilization can they go to 0?
Yes. In fact, they were about $56,000,000 last quarter. That's down from the prior quarter, which is about $105,000,000 And that's bit of a theoretical question as to what revenue would take to get to 0 because clearly the mix of products flowing across the various manufacturing flows are going to have a direct bearing on that. So we had much higher demand, but it was on a flow where we didn't have a lot of excess capacity wouldn't help much on the underutilization. So our job on that is to make sure that all of our flows maintain open capacity.
And I'll remind everybody again that the underutilization we don't let that distract us. It's an accounting adjustment that affects nothing happened to free cash flow. We are completely focused on free cash flow as the
way to return value to our shareholders. And Vivek, I'll also mention that that charge is less than half of it is actual cash. So or about half of it is non cash. So it really doesn't impact our free cash flow by having that open capacity. Do you have a follow-up?
Yes. So I guess so that means the open capacity you have is more source of keeping CapEx low and free cash flow rather than being a big source of expanding gross margins per se. But maybe on to my second question. On the demand environment, can you give us a sense I think you mentioned end markets, but what about the geographies? Are there certain geos that are better or worse than what you thought 3 months ago?
Thank you.
Okay. So and so let me follow-up on the last one just to make a clarifying point. So as Kevin talked about, there's certain factories that and you've seen some competitors, some of the manufacturers in Taiwan run above 100% capacity. So when we've got factories or flows that run above 100% or above the theoretical level that we've got from a utilization standpoint, we'll continue to get a benefit and we still may have a 100 utilization charge. So don't think that that all you have left is revenue growth that small number that's an under utilization charge.
So just wanted to make that clear. So from a regional standpoint, year over year, Vivek, we saw Asia, Europe and Japan were up. The U. S, we saw it was roughly even from a year ago standpoint.
So with
that, we'll go to the next caller.
Thank you. We'll take our next question from C. J. Muse with ISI Group. J.
Muse:] Yeah.
Good afternoon. Thank you for taking my question. I guess first question, once OpEx normalizes exiting calendar 2014, how should we think about growth in OpEx relative to top line into 2015 and beyond?
Well, C. J, that's a long range plan you're doing there here for a semiconductor analyst. From an OpEx standpoint, I think that it will probably grow at least with the change in paying benefits that you'd expect on a year over year basis. So you certainly start there. And then to the extent that we see additional opportunities that we may want to invest in from an R and D standpoint or additional sales opportunities we may want to expand that may grow a bit beyond that.
But typically you're going to see I think this last year paying benefits increased increased average around 3% maybe 4% depending upon the average from around the world. So that's what I'd probably use for planning.
Okay. Helpful. And I guess as a follow-up, question on the cycle. It looks like your guide for Q3 year over year is slowing a bit And would love to hear your thoughts on where we are here. Were we rebuilding inventory downstream and now we're normalizing and now tracking more with GDP?
And or are there any signs of reacceleration in GDP or in demand in any parts geographically or product wise etcetera?
Yes. C. J, I think on that front, we really don't spend a lot of time looking at the cycle. And our strongest indicator demand of course is the view that we get from orders and the forecast that we get from our consignment customers as they'll give us forecast. Those forecasts of course can change.
And we just turned in good growth year on year. If you look at the year on year growth at 6%, 8% without legacy wireless continues to be strong. At the midpoint of the guidance range, yes. And so that's what that's what we believe all those indicators are showing us. As I talked about before, things like where we build in demand in the channel or downstream, we actually took inventory out of the channel as more of our distributors move to consignment and as the products that were on consignment actually grew faster than the other products.
So we really it's the 4 a little over 4.5 weeks of inventory that's in the channel, we consider that to be lean, but probably we'll be running in what is the more of a new normal range. So those changes in inventory downstream because of the consignment that we've got, we're going to have less of an impact on our revenues as what they've had in the past. So with that, I'll go the next caller please.
Thank you. We'll move to David Wong with Wells Fargo.
Thank you very much. Could you give us some idea of how your policy of returning the bulk of your cash to shareholders affects future acquisition policy? Do you have an expectation your active acquisition activity will be relatively low or that you'll be working primarily in stock purchases?
Yes. David, I think the way to think about it and it relates to it kind of goes back a bit to a question that was asked earlier about, I believe, by Doug on debt on the balance sheet. From an acquisition standpoint, again, we'll look at first the strategic fit to make sure it makes sense and then second to make sure the numbers actually work from return on the investment that's the capital that we put into it. Beyond that the way we'd pay for it is probably very similar to what we did this last time. When we bought National Semiconductor, we used some cash on hand, but we actually released the strength of the balance sheet and went out to the bond markets and issued quite a bit of debt, which supported that acquisition.
As we slowly retire debt as we had been and continue to over the next foreseeable future that just opens the balance sheet back up and makes it available again to take on debt if there's an attractive ROIC accretive acquisition out there. So that's where I would that's how I would think about the strategy going forward. I don't see any of our cash management strategy having any interference whatsoever with our ability to continue to acquire when it makes sense.
Great. Thanks.
Thank you. We'll take our next question from William Stein with SunTrust.
Great. Thanks for taking my question and congratulations on the good quarter and guide. I'm hoping you might comment on the margin progression in the Embedded segment. It seems to have progressed a bit better. And it looks to us as though perhaps the restructuring benefits that you're targeting are coming in a bit earlier than you previously expected?
Yes. Wendy, you're exactly right on that. They have started to come in a bit earlier than we planned, but we still have a long way to go. We will see additional benefit as we move into 2nd and third quarter as we talked about earlier excuse me, 3rd and 4th quarters as we talked about earlier as we see more of the cost beginning to come out of there. But frankly, while that is certainly helpful in moving the profit performance of that segment forward, it is not going to be done when that's over with.
There's a lot more work to be done there and the work is really on the revenue growth side. The operating profit clearly is below what we think the potential for that segment is and that management team is very focused on driving results to get that profit up to where it should be. And really after the restructuring actions that are complete by the end of this year, it's really going to be all about revenue growth. It actually has been a lot about revenue growth as evidenced by the fact that that business has successfully grown for 7 quarters in a row on a year over year basis. And we expect to
see more of that as
we go forward, so that business can grow its way into the cost structure it will have remaining.
Kevin that's helpful. If I can follow-up just a bit in that. I think there's one area of that business where you're kind of under hitting relative to your weight in the industry and that's microcontrollers. I know that you've invested in this area in the
last year or 2.
Terms of products end markets features that might lead to accelerating share gain in that category?
Yes. Maybe I'll make a comment if you'd like to add in Kevin. Yes. Well as you know that's an area that we decided to step up investments going back several years ago now back 2010, 2011 in that period. And the expansion of investments included both development teams to produce more products and begin to broaden the portfolio.
And second is in application support, basically supporting customers and design in. So we feel really good about the progress that we've got. We've had several years that we have gained share inside of microcontrollers. I think that we still I think we're some industry analysts will have us at like a number 6 position inside of the market. So we've got plenty of room to grow.
And those are the types of markets that take a while to begin to get traction. And it's somewhat like a flywheel that you keep investing, keep making progress and that progress begins to snowball. From a product standpoint, we're really building out a broad portfolio. We're focused on catalog products, primarily going into industrial applications. You'll know inside of embedded processing, we also have connectivity products.
So there we support about a dozen different wireless standards. So we're getting very good traction and you can go to our website today and be able to find reference designs with microcontrollers ranging from $0.25 up to a couple of dollars using all of those different combinations of the connectivity products. So we feel really good about the progress. As I said in the opening remarks, embedded processing has had 7 quarters of year on year growth and a big part of that is driven from microcontrollers.
Thank you.
Okay. Thank you very much Will. We can go to the next caller please.
Thank you. We'll move to Ross Seymore with Deutsche Bank.
Hi, guys. Before my questions, I also wanted to just pass on the congrats to Ron and to Dave on the promotion. Best of luck to both of you. I guess, Kevin, one clarification for you that I wanted to get from you, if I could. What was the starting point off of which that $130,000,000 in savings exiting this year was going to be achieved?
Ross, we announced that action with our Q1 results and we took the excuse me, the Q4 and Q1 results as I recall. Q4, we took a charge in Q1 for embedded processing. So that's the start there. In the Q2 we took the charge for the Japan restructuring. So it's a bit of a mixed start if you will.
So a little hard for you to do a direct correlation. But again the math you should be using is $130,000,000 annualized savings by the time we end the year with 85% of it come out of OpEx.
Great. And I guess as my follow-up in the past and I don't know if you guys are going to do this anymore that now that you've started to split out the revenues in a different way. But in the past in the middle of the year you say what the revenues by end market did mid year. Is that something that you can give us now? Yes, Ross.
We're really just plan on giving those numbers on an annualized basis. As I answered Jim's question earlier, we'll provide revenue on a quarterly basis just color on what's happened in each of the markets. And that's what we've decided to move to. So with that, we can move to our next caller please.
Thank you. Our next question comes from Tore Svanberg with Stifel.
Yes. Thank you, Ron, and best wishes in your retirement. First question, you talked a lot about strength being broad based, but are there any segments or markets in Q3 that are relatively weak, whether that's seasonal or even secular?
From an end market standpoint, Tory, the only market that we saw decline was in personal electronics and that was I'm sorry, was it Q3 or Q2?
Q3 guidance.
I'm sorry. Yes. Again, I somewhat addressed that. We're really not trying to get into the color by end market or product segments or that we're really just focused on the top line number overall. Did you have a follow on for it?
Yes. That's fair. My follow-up is, did you have a change in your distribution strategy at all in the quarter? Or are you planning it? I'm thinking are you going to go to certain customers more of a direct business or?
No. We haven't had any change in the quarter. I can say that we've had changes to our business arrangements with distributors on a periodic basis over the years. And for example, if we just go back a few years ago as an example, we implemented the consignment program with distribution. So now we've got more than half of our overall revenues supported by distribution.
So they're going to continue to be a very important part of our business. We're focused on growing our revenues overall, which will mean growing our revenues with them. As we've invested in catalog products and in industrial markets, we want to work with the distributors to be able to broaden our reach with customers. So we will do things that will optimize both our resources and theirs. But any specifics of details that we've got going on with changes we just won't get into.
Okay. With that, we'll go to the next caller please.
Thank you. We'll take our next question from Srini Pajjuri with CLSA Research.
Thank you. Dave, just looking at the end market breakdown one more time, I apologize, I know that this question has been asked several times. You gave us the year on year trends. Can you also talk about sequential trends from Q1 to Q2?
Sure.
Yes. I think aside from the increase in calculators, in personal electronics led by a strong quarter in PC and notebooks. We did see Industrial, Enterprise Systems and Automotive all contribute to the growth sequentially. So if you look underneath that in Industrial as an example, we had we've got over a dozen sectors inside of industrial. So with that we saw areas like factory automation and control, smart grid, motor drives drive that.
In automotive, on a sequential basis, we had growth in all sectors overall and that was led by ADAS. So those are the things that drove the drug revenue in the quarter sequentially. Okay.
Great. Thank you. And then on the connectivity front, Dave, I think you mentioned you a number of different standards. If I recall correctly, you sold the smartphone business a while back. My question is, is there anything preventing you from participating in the wearables market, if you think about the watches, etcetera?
No. And in fact, you'll I actually wear some of those products to track my steps and it has quite a bit of TI contact both from power management standpoint and other analog products as well as connectivity. So the beauty of having a catalog portfolio is that the incremental cost to engage a customer, the tools and the support are all in place. So we can very readily and very easily support markets like that overall. So thanks Srini.
We'll go to the next caller please.
And the next question comes from Ian Ng with MKM Partners.
Yes, thanks. Just a clarification on being opportunistic in acquisition of manufacturing assets. Are you is it for taking a long view on increasing capacity? Or are you removing bottlenecks in the manufacturing flow? It looks like Richardson analog is still a lot of headroom here.
Yeah. Ian, it can be a little bit of both. If we see bottlenecks popping up someplace and we're able to go ahead and pick up equipment inexpensively or if we anticipate that a flow is going to become a bigger more important revenue source in the future, we can go ahead and pick up for that or just outright new factories for example. And that's what we did when we bought the assembly test site in Chengdu, China. That was an entire factory that we bought in that case.
So we'll play we'll take advantage of whatever opportunity presents itself, especially if the finances are compelling.
Great. And this commentary on connectivity growing faster within embedded, I'm assuming we're talking about Internet of Things and wearables. Do these sockets have good attach with microcontrollers and power management? And do you have a sense of IoT mix? How much of it is more like industrial military first responder type of applications with long cycles?
Yes. If you look at our the product portfolio, we actually support a dozen or so different wireless technologies. So whether you need Bluetooth low energy or Wi Fi, we've got GPS, We have multiple sub gigahertz standards including things like ZigBee. So, whether you whatever label that you want to put on to that, essentially if things are getting smarter and more connected, we've got a broad range of catalog products in which to show to customers and we can be fairly agnostic on how to solve their problem and bring really the best bit of the technology to whatever market they're trying to enter. And oftentimes, we'll find manufacturers that have never had any wireless experience.
So they'll want to go to the web. They'll want to contact our local apps people and get support for that product and they really don't have to become RF experts and so they can focus their time on other things. And that's a combination that's working real well. Okay. With that, we can go to the next caller please.
And the next question comes from Chris Caso with Susquehanna Financial Group.
Yes. Thank you. I wonder if I could go back to Wondering if I could go back to some of your earlier comments with regard to the consignment revenue. I guess just to clarify that, I guess what you're saying is the higher percentage 3rd quarter is what's pulling down the book to bill. And I think in the past you've talked about your book to bill for the non consignment portion of your business.
Could you tell us what that is? And perhaps that's a better indicator of the end market booking trends? Yes. On the what I talked about Chris was that we've had a conversion of more products into consignment going through distribution. And so that suppressed the book to bill a little bit that we just came out of the quarter with.
If you keep in mind that oh, gosh, how much of our revenue is going through consignment now? Probably 50%. 50% for the total company is going through consignment. So what that really means is that book to bill for that consignment revenue is by definition 1. And so the book to bill that we report to company really just applies to the other half of the revenue.
So that 1.01 that we just reported in very simple terms would be 1.02 because it really applies to the non consignment portion of the business. And again that was suppressed somewhat as a result of a conversion from a previously direct sale to a consigned arrangement.
Yes. And Chris, I'll just add in 2nd quarter, we delivered a 10% sequential growth and our book to bill was 1.03. If you look at orders, they were up 9% sequentially. So that book to bill number is just one number. And Kevin said, it's got some noise in it.
So it's one consideration that we look at as we put together the demand forecast. Do you have a follow
on Chris? Yes, sure. For my follow on, I guess, I'll ask a little bit of a bigger picture question. TI over the years has always been a cyclical company just a function of the industry. But as you guys are operating the business a little bit differently now, your focus is on some different end markets.
Just interested in your view of going forward, what does that do to the cyclicality of TI as we go over the next couple of years? Yes. I think you're spot on, Chris. As you look at the mix of what's going on inside our portfolio, in years past as you observe, we had some big verticals, certain end markets you might be able to take a look at and our business would cycle with that end market in addition to any so called semiconductor cycle itself. Now as we have industrial and automotive becoming a larger and larger percentage of our total revenue and the markets to which our products are being shipped into, arguably we would see likely see less impact as a result of big vertical fluctuations and begin to see a little bit more correlation between TI's growth going forward and the global GDP as a whole.
So we'll probably track more to the economy as opposed to a particular single end market. That's not to say that we escaped the semi cycle if there still is one. It's simply to say that our fortunes are tied much more broadly than they have than ever in the past. And therefore, it'll be much more reflective of how does the overall global GDP tend to expand over time.
Okay. And with that, operator, we have time for one last caller.
Thank you. Our final question from Timothy Arcuri with Cowen and Company.
Thanks so much. Guys, if based on your current schedule of CapEx? Is this a 2016 event or is this sometime beyond that? Thanks.
Yes. Tim, it's unlikely that we would see CapEx and depreciation converge prior to 2016. So that's probably a good starting point for you to build your models with.
Follow on Tim?
Okay, great. Okay, great. And then a question about gross margin drop
through. The number has been
a little bit above 75%
the last couple of quarters.
But is that still the right number to think about going forward for the gross margin drop through? I know people were talking about operating margin drop through, but I'm wondering about gross margin drop through. Thanks.
Well, certainly we're operating at a higher level now Tim than we have in years past. And we talked a number of years ago about over a long term a long window of time that that fall through during the course of the business cycle historically has been a pretty good indicator to follow. But in any one time period, it's always been a number that doesn't really apply very well. More importantly, going forward, we're operating at a much higher level of gross profit than we have ever in our and I would expect that to continue to drop through quite richly and importantly drop through as free cash flow that we can continue to return to our shareholders in the form of dividends and stock buyback.
Okay, great. And with that, I will turn it over to Ron to make some final remarks. Okay.
As we wrap this up, let me just close by saying the past 32 years working at TI really has been a good actually a great ride. For Dave and Kevin, let me simply pass on the request and words of advice that have been passed down through generations of CI managers and that please don't screw it up. Thank you all for joining us. A replay of the call is available on our website. Good evening.
That does conclude today's presentation. We thank you for your participation.