Good day, welcome to the Texas Instruments fourth quarter and 2013 year-end earnings conference call. At this time, I would like to turn the conference over to Ron Slaymaker. Please go ahead, sir.
Good afternoon, thank you for joining our fourth quarter and year-end earnings conference call. As usual, Kevin March, TI's CFO, is with me today. For any of you who missed the release, you can find it and relevant non-GAAP reconciliations 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 fourth quarter was a good one and wraps up a good year.
We're entering the first quarter of 2014 feeling better than we did entering the first quarter of 2013. Before I review the quarter, let me provide some information that is important to your calendars. Starting this quarter, we will not be providing a mid-quarter update to our outlook. Our business is now sufficiently diverse across markets and customers that we believe a mid-quarter update is no longer necessary. The diversity in our business means that TI's results should mostly reflect broader industry trends, as opposed to TI-specific considerations, such as adjustments in demand from a large customer. In fact, in our last eight updates, we've narrowed to the middle of the range six times on a revenue basis. We do plan to hold a call on March 13th to update you on our capital management strategy.
This will be a follow-on to the call we did a year ago on this topic. In this call, Kevin March will provide insight into our strategy and also answer some of the most frequent questions that we are asked about this strategy. More details will be forthcoming. Revenue in the fourth quarter was in the upper half of our range of expectations. Once again, cash generation and returns remained strong. Free cash flow was $3 billion, or 24% of revenue for the trailing 12-month period, or in this case, the full year of 2013. Over that same period, we returned over $4 billion of cash to investors through a combination of dividends and stock repurchases. This return was 136% of free cash flow for the year. Again, our strategy is to return all of our free cash flow to our shareholders, except what is needed to repay debt.
EPS was at the midpoint of our range. However, it also included $0.03 of charges for a restructuring action that was not previously included in our guidance. Overall, a good quarter. The restructuring that is underway is a result of our ongoing assessment of our investments and the market opportunities that we are addressing with those investments. First, we are reducing costs in certain Embedded Processing product lines that either have matured or do not offer the return opportunities we are looking for. These changes will accelerate the profit margin improvement in the embedded business while still maintaining its pace of growth. I'll note that we are not exiting any markets or discontinuing any existing products, but are aligning resources consistent with our updated views of the market opportunities.
We are also lowering costs in Japan by reducing resources in that country to levels that are appropriate to the opportunity. Combined, these actions are expected to result in annualized savings of about $130 million by the end of 2014. As a result of these actions, we will eliminate about 1,100 jobs. Total charges are estimated to be about $80 million, with $49 million included in the fourth quarter results and the remaining charges of about $30 million to be included in the first quarter. These charges are recognized in the other segment. In the fourth quarter results, TI revenue grew 2% from a year ago. Excluding Legacy Wireless, revenue grew 10%, with double-digit growth in both Analog and Embedded Processing. Sequentially, revenue declined 7%, with half of the decline due to seasonally lower calculator revenue. Analog revenue grew 12% from a year ago and declined 3% sequentially.
From a year ago, all four major product lines were up, with power management leading the growth. Sequentially, all major product lines were down, with High-Performance Analog declining the most. Embedded Processing revenue grew 11% from a year ago and declined 10% sequentially. From a year ago, the growth was due to strength in microcontrollers. Connectivity revenue grew a single-digit percentage rate, and processors were about even. Sequentially, all areas were down, with the biggest decline in processors. In our other segment, revenue declined $209 million, or 27% from a year ago. The decline was due to Legacy Wireless dropping $216 million. Sequentially, other revenue was down $90 million due to the seasonal decline in calculators. Legacy Wireless revenue was $54 million in the fourth quarter, and we expect it to be essentially gone in the first quarter.
Turning to distribution, resales declined 3% sequentially, trending about the same as our semiconductor product revenue. Distributors' inventory levels were about even with the prior quarter. Let me make a couple of observations about the year overall. For 2013, Analog and Embedded Processing revenue grew a combined 4%, with Analog up 3% and Embedded up 9%. These two key areas were 79% of TI revenue for the year, up from 72% in 2012. Operating margin for Analog was 25.8%, and it exceeded 30% during the second half. Operating margin for Embedded Processing was 7.6%, a level that should increase as we continue to grow and as we execute our restructuring plan to better align resources with the opportunities that we are pursuing. Finally, we are refining descriptions of our end market mix to more closely match our perspective of our markets and investments.
Traditionally, we and many other companies have described the markets as communications, computing, industrial, consumer, automotive, and education. The real world didn't always align so cleanly, and some of the categorizations became blurred. For example, consumer smartphones were included with infrastructure equipment in the communications market, and consumer tablets were included with servers in the computing market. In both of these examples, high-volume consumer products were grouped together with enterprise equipment that have very different life cycles and market characteristics. We believe our revised segmentation is more descriptive and reflective of the markets we sell into, and therefore, more helpful for our understanding of our business.
Starting now, we will provide an annual snapshot of our product mix along the following market descriptions: industrial, which was 24% of revenue in 2013; automotive, which was 13% of revenue; personal electronics, which was 37% of revenue and includes subsets which we call sectors, such as notebooks, tablets, mobile phones, and consumer products; communications equipment, which was 16% of revenue; enterprise systems, which includes sectors such as servers and projectors, was 6% of revenue; and calculators, which was 4% of revenue. We have mapped our product revenue into these markets as well as the sectors, and even end equipment levels below that. We find this especially beneficial for the industrial market, where the market definition has historically not been very clear and where we have a strong strategic focus.
We now have a reasonably precise profile of where our revenue is shifting that is more accurate than we've had in the past. We've included on our website this 2013 product revenue breakout by market, along with the 2011 and 2012 historical breakouts. We've also identified the sectors below the markets to provide you a clear understanding of how we're mapping the revenue. We will not be disclosing our revenue breakout below the market level. We plan to update this for you annually. Kevin will review profitability and our outlooks.
Thanks, Ron, good afternoon, everyone. Gross profit in the quarter was $1.64 billion, or 54.2% of revenue. Gross profit declined 8% sequentially, about the same as the 7% decline in revenue. Gross margin held up very well, slipping only 60 basis points from last quarter's record high. From a year ago, gross profit was up 13%, well above the 2% increase in revenue. The result was a 570-basis point expansion in gross margin. There are a couple of major reasons for gross profit expanding significantly faster than revenue. First, the quality of our portfolio has improved as a higher proportion of our revenue is from Analog and Embedded Processing products. Second, our factory utilization has improved as we have increased loadings in our most advanced factories, and we have shut down older, less efficient manufacturing assets, such as our Houston and Hiji six-inch factories.
Moving to operating expenses, combined R&D and SG&A expense of $807 million was down $26 million sequentially and down $48 million from a year ago. The sequential decline is mostly due to seasonality, as employees typically take more vacation and holiday time in the fourth quarter. The decline from a year ago was due to the wind down of our Legacy Wireless products. Acquisition charges were $84 million, almost all of which is the ongoing amortization of intangibles, a non-cash expense. Restructuring and other charges were $62 million. This included a $49 million charge for the restructuring action that Ron discussed. This was not included in our prior guidance and negatively impacted earnings by $0.03 per share. Operating profit was $687 million, or 22.7% of revenue. Our tax rate in the quarter was 25%, a point above the 24% that we had guided.
The effective tax rate remained at 24%. We had several small discrete items that pulled the rate up in the quarter. Net income in the fourth quarter was $511 million, or $0.46 per share. Let me now comment on our capital management, starting with our cash generation. Cash flow from operations was $1.20 billion in the quarter. We increased our inventory by $5 million compared with the prior quarter. Inventories days increased by six days to 112 days, consistent with our model of 105 to 115 days. Capital Expenditures were $107 million in the quarter. I should note this includes our purchase of a 358,000 sq ft assembly and test facility in Chengdu, China, that is adjacent to our existing wafer fab. We expect to have this facility equipped and in production by the fourth quarter of this year.
On a trailing 12 months basis, cash flow from operations was $3.38 billion. Trailing 12 months Capital Expenditures were $412 million or 3% of revenue. As a result, free cash flow was $2.97 billion or 24% of revenue. This is within our expected range of 20%-25% of revenue. I'll note that depreciation expense for the full year was $879 million. Depreciation exceeded our Capital Expenditures by $467 million or 3.8% of revenue. Over the next few years, as we continue to hold capital spending to low levels, depreciation will decline to the rate of capital spending, and our gross margin will directly benefit. As we've said, strong cash flow, particularly free cash flow, means that we can continue to provide significant cash returns to our shareholders.
In the fourth quarter, TI paid $326 million in dividends and repurchased $734 million of our stock for a total return of $1.06 billion. Our capital management strategy is to return all of our free cash flow to shareholders, except for what we need to repay debt. In the full year 2013, free cash flow was $2.97 billion, and we reduced our debt level by $500 million. We returned a total of $4.04 billion to shareholders, or 136% of free cash flow. This return was 54% higher than in 2012. We returned more than our full free cash flow in the year because proceeds from exercises of employee stock options totaling $1.31 billion in the year have also been an additional source of cash for the company, all of which was used to repurchase stock.
There was an abnormally high level of exercises in the year due to the stock price performance. Although the exercises were somewhat of a headwind for the share count reduction, we more than offset this with stock repurchases. In the end, we reduced our shares outstanding by 25 million shares, or 2.3% in 2013, similar to the last couple of years. In total, we have reduced our share count by 37% since the beginning of 2005 with our repurchases. Fundamental to our cash return strategy are our cash management and tax practices. We ended the fourth quarter with $3.83 billion of cash and short-term investments, with 82% of that amount owned by TI's U.S. entities. Because our cash is largely on shore, it is readily available for a variety of uses, including paying dividends and repurchasing our stock. TI's orders declined 10% sequentially, and our book-to-bill ratio was 0.94.
Turning to our outlook, we expect TI revenue in the range of $2.83 billion-$3.07 billion in the first quarter. At the middle of this range, revenue would decline 3% sequentially, with most of the decline coming from the final step down in Legacy Wireless revenue, which is now essentially gone and should not be a factor in sequential trends after the first quarter. Therefore, if you exclude the Legacy Wireless revenue from the fourth quarter of 2013, revenue at the middle of this range will be almost even sequentially. If you exclude it from the first quarter of 2013, growth will be 10%. We expect first quarter earnings per share to be in the range of $0.36-$0.44, which includes a $0.02 EPS impact from the $30 million of restructuring charges discussed earlier.
We expect our effective tax rate in 2014 to increase to 27%, and this is the rate you should use in your models for the first quarter. This is about three percentage points higher than our 2013 effective tax rate, negatively impacting earnings per share by $0.02 in the first quarter. This rate is higher due to the expiration of the R&D tax credit at the end of 2013 and our forecast for higher profits in the year. Historically, the R&D tax credit has expired and was later reinstated retroactively to its expiration date. In summary, we're encouraged that a lot of hard work at TI over the past few years is producing results. Today, we're a company firmly rooted in Analog and Embedded Processing, areas that have strong potential for growth and good profits that require low capital investments and therefore can generate a lot of cash.
Although much of the heavy lifting associated with the structural improvement of TI is now behind us, our work is not done. The restructuring action we discussed today is a result of an ongoing process at TI of review and continuous improvement. This process helps ensure that we focus our investments on opportunities that have the best potential for sustainable growth and returns. With that, I'll turn it back to Ron.
Thanks, Kevin. Operator, you can now open the lines up for questions. In order to provide as many of you as possible an opportunity to ask your questions, please limit yourself to a single question. After our response, we will provide you an opportunity for an additional follow-up. Operator?
Thank you. If anyone would like to ask a question, you may do so by pressing star followed by the number 1 on your telephone keypad, and please make sure that your mute function is turned off to avoid your signal to reach our equipment. We will take our first question from John Pitzer of Credit Suisse.
Yeah, good afternoon, Ron, Kevin. Congratulations on the good results. I guess, Ron, can you help me understand, when you talk about these realignment actions, how big of a revenue pie did these costs kind of cover? What was sort of the growth hurdle or the gross margin hurdle that you guys used to try to determine this sort of realignment of costs?
Well, I don't know that I can get into all of that detail, John. Clearly, the Embedded Processing overall runs, I think last year was just about 20% of our revenue. The processor piece of that, I think, we've probably communicated, I can update it even for 2013, was 50% of our revenue last year. Again, that's where I would say most of the actions in Embedded Processing are taking place. Again, it's primarily in processors. I would say secondarily, we're taking some action inside of microcontrollers as well. Processors was about half the revenue. Of course, not all of processors is being affected, but certain product lines within that. Then, separately, the action in Japan.
Last year, Japan was about 9% of our total revenue. Again, this is just more or less an action to, on the one hand, we'll be consolidating some of the business activity that was previously in Japan, just to other regions of the world where we can do it more efficiently. Also, we'll be affecting some of the sales and marketing activities in Japan, kind of to align those resources with that opportunity that we see in Japan going forward. Do you have a follow-on, John?
Yeah, guys. Just relative to the new segmentation with personal electronics being 37%, I'm just kind of curious, should that be an area where we see future realignment, or do you feel given your cost structure, you can still go after the growth in that market at that sort of acceptable returns? How do I think about that 37% over time as a % of the mix?
John, I would say to you that if you take a look at that on the website, you'll see that it's down a little bit year-over-year. Really, what's going on there is the wind down of Legacy Wireless. That's really the handset and the tablet spaces coming down. We will continue to be engaged in personal electronics, make no mistake about it. The biggest difference is that we'll be driving a lot more aggressively with our catalog products as opposed to custom products. On the historical basis, the catalog products tend to have a much longer life to them and a much better margin profile to them than custom products do. There won't be any overt change to our approach to personal electronics. It'll just wind down on its own because of the wind down of Legacy Wireless as the biggest driver of that.
Okay. Thank you, John. Let's move to the next caller, please.
We will go next to Doug Freedman of RBC Capital Markets.
Hi, guys. Thanks for taking my question. Can you take a look or give us some insight into how far all of your acquisitions have been integrated? What you're talking about now on your restructuring front, it sounds like really end market related. Are there more efficiencies to be gained through further synergies that you might identify?
Doug, we haven't made an acquisition in a couple of years of any meaningful size, and we've pretty much wound up the, if you will, the synergistic opportunities of that consolidation about a year ago now. There's not really much in the way of synergy as it relates to acquisitions going forward. What we're doing on this restructuring is just part of an ongoing exercise that we've actually done for a long time. They're usually of a smaller level, in this case, a little bit larger. That's really looking at where we're spending our research dollars and looking at the market opportunity that those products from that research spend would go into. In this case, we've got some of the markets have matured or are about to mature, which means we don't need to have as many teams designing new parts for it.
In other cases, we may have invested in certain markets where we had anticipated better growth and return opportunities, but those initial expectations have since been changed for a variety of reasons. There's really no acquisition synergies that I can think of to suggest to you. This is just really an ongoing process of dealing with the reality of market changes over time.
Do you have a follow-on, Doug?
Yeah. As my follow-up, there's been some concern in the industry as far as unit growth and the ability to grow revenue sort of above global GDP levels. We saw some interesting data out of the SIA recently showing some pretty steep declines in Analog ASPs. Can you comment if you're seeing any change in the way either you or your competitors are approaching the business?
I don't know about competitors. I can say that at TI, we have not reset our expectations downward as you might be suggesting there from a growth standpoint. I think over the last few years, global GDP has been certainly below a normalized run rate, and that certainly has affected our industry as well. Our view is that the markets that we serve being Analog and Embedded Processing, will likely grow on a unit basis, and frankly from a revenue basis, about 2X global GDP. We've believed that for some time. Again, we're looking at longer-term trends, not what happened over the last three years or even five years. Again, our view on that is unchanged. Okay, Doug, thank you for your questions. Let's move to our next caller, please.
We will go next to Christopher Danely of J.P. Morgan.
Hey, guys. Just a question on the restructuring. How much of the cost savings will go into COGS versus OpEx? What do you think is going to be the revenue headwind by the end of the year in terms of taking these products out?
Chris, on the cost savings, we anticipate by the end of the year, we'll be at about $130 million annualized cost savings as we exit the year. About 65% of that will probably be in R&D, about 20% in SG&A, and about 15% in cost of revenue. As it relates to revenue, there should be no impact on revenue. We're not eliminating products. We're not discontinuing products. These are products that have very long lives. What we're really dealing with here is that the rate of change in those markets have matured now, in most cases, and it no longer makes sense to continue to invest or invest as heavily as we have because there's just not the growth window there.
Chris, in many of these markets that we view are maturing, frankly, you could double, you could triple the investment and not affect the revenue level, not affect the growth rate, just because the nature of what the market trend overall is doing. Again, let me just reiterate, we said it in prepared remarks, and Kevin just said it, there are no products being discontinued, and we're not exiting any markets with this action. Do you have a follow-on, Chris?
Yeah. Can you guys just maybe give us kind of a status update on your end markets and what you expect to grow maybe the most versus the least for this year?
Okay. I can do part of that, which is the historical view. I don't think we want to try to extrapolate into a forecast for 2014. Let me just start with fourth quarter 2013. Again, this information really is coming out of the database that I described we've put together for our new market framing. Again, fourth quarter, most end markets were down sequentially. The biggest driver of our revenue decline, though, was the seasonal decline in calculators. I think as we said before, that was half of the sequential dollar decline in fourth quarter. Outside of that, personal electronics declined the most, followed by enterprise systems and industrial, all three of those areas declined at single-digit % rates. Automotive and communications equipment were each about even sequentially. Just a little more color on some of those areas.
Industrial, we saw strength in appliances and industrial displays, that strength was more than offset, actually, by broad-based declines elsewhere. In enterprise systems, really, we saw weakness or declines there due to servers. In personal electronics, we saw declines in TVs, gaming, and printers, we saw strength sequentially in tablets. Moving to the full year 2013, industrial for TI, this is based for our revenue, was up 7%. That was driven by factory automation, building automation, appliances, medical, and motor drive. Automotive was up 14% for TI in the year, driven by infotainment systems as well as advanced driver assist systems and safety. Personal electronics revenue was down 18% due to mobile phones and tablets as we wound down our Legacy Wireless business, followed by much smaller declines in other areas of personal electronics.
Communications infrastructure for the year was up 4%, driven by both wireless infrastructure and enterprise switching. Enterprise systems for the year was down 8%, driven by servers and projectors, calculators declined 3% for the year. Okay, Chris, thanks for your questions, we'll move to the next caller.
We will go next to Blayne Curtis of Barclays.
Good afternoon. Thanks for the question. I apologize if you answered this already. The decline in Embedded Processing, you had expected decline in processors. Was that greater than you were expecting? Where do you see the trajectory this year for that business?
Blayne, let me first of all get some data in front of me. Are you talking about the sequential trend in fourth quarter there?
Sequential decline into the December quarter. It was down double digits.
To be honest, I don't have the data here on our forecast. I can say that was, I again reiterate, it was down double digits, as was connectivity. Microcontrollers was down also, but to a much lesser degree. I don't have the forecast data on processors to be able to say what it did versus our expectations. Do you have a follow-on, Blayne?
Yes. I think someone asked this already, but just looking at the March quarter sequentially, do you see any of your segments growing? If so, which ones? Would you point out any segments that are outside of calculators that are down a significant amount?
Calculators will be typically flattish in the fourth to first transition. That's their typical seasonal pattern anyway. The only area that we really said we expect an additional decline is in Legacy Wireless, where it will go from $54 million in the fourth quarter to be essentially gone in the first quarter. I think we described that already. Outside of those two areas, we don't really have comments in terms of in-market trends that we expect to evidence in first quarter. Okay, Blayne, thank you for your questions. Let's move to the next caller.
We will go next to Stephen Chin of UBS.
Hi, thanks for taking my questions. First question is on the automotive segment. Based off of the strong 14% growth that you just mentioned for last year, I was wondering if you had any color from downstream customers on the inventory levels in supply chain, especially given the, I think some of the comments from AutoNation last week about relatively high automotive inventories in the U.S. Any comments about momentum there in the first half this year?
Stephen, I probably don't have anything more that we would have that would be a unique perspective that TI provides. When you have somebody talk, like AutoNation talking about inventory of automobiles, you have that data. We don't have any unique perspective. That's several layers below where we're selling into that supply chain. I'll speak more broadly that we believe inventory seems to be pretty well managed currently, if not lean. You heard my comments on distribution. Distribution inventories remain below five and a half weeks, which again, are lean. Anything in terms of a particular supply chain like automotive, we really don't have that granularity. Again, our general sense is inventory is not at all an issue more broadly into the markets that we're serving. Do you have a follow-on, Stephen?
Yes. My follow-up is on gross margins and sort of relative to where your inventory levels are currently. If I'm not mistaken, in prior quarters, you were able to build a little bit of strategic inventory in some of your longer shelf life products. Just given where the inventory levels are currently, would it be safe to say that you would not continue to build any more strategic inventory? Thanks.
Stephen, on the inventory, we just closed the quarter at about 112 days of inventory, which is consistent with the model that we have for ourselves of carrying between 105 and 115 days. Specifically, if you look at our balance sheet, you'll notice that during the fourth quarter, we drained our work in process, and our finished goods increased somewhat. That's just reloading the factories to meet the lower outlook that we had in the fourth quarter. We do expect in the first quarter to begin to reload the factories as we go forward. Inside that 112 days is the strategic inventory that you were talking about, which is parts that have long shelf lives. We've been building that up for a couple of years now, and we'll continue to manage that at about its current levels.
Okay, Stephen, thank you for your questions. We'll move to the next caller.
We will go next to Timothy Arcuri of Cowen and Company.
Thanks a lot. Ron, can you talk, given the savings on the OpEx, can you talk a little bit about how OpEx is going to work its way through the year? Is there sort of anything out of the ordinary other than just how the $130 million gets ratably impacts the P&L through the year? Thanks.
Tim, let me go ahead and comment on that for Ron. The first thing to remember about OpEx is it will seasonally go up in the first quarter. If you looked over the last three or four years and just compute an average, you can see that on average, it probably goes up about 4% fourth quarter to first quarter. You can expect an increase again in this first quarter as we start out 2014. As we flow through the year, the cost savings that we talked about as a result of the restructuring actions will begin to show up in the second half of the year. By the time we leave the year, we'll be at about $130 million annualized savings rate at that breakout that I mentioned earlier across R&D, SG&A, and cost of revenue.
Okay, Tim, do you have a follow-on?
I do, yeah. If I look at Analog share, you've been talking about SVA gaining share this year, and if you just take seasonal December for the SIA, it looks like you're sharing Analog basically was flat in 2013 versus 2012. Is there something that maybe might start to kick in in 2014 that is going to cause Analog to gain share year-over-year? Thanks.
Well, we'll see how 2014 rolls out. I guess, for starters, based on the WSTS data that's been released through November, we believe we actually gained a small amount of share in Analog. By the way, I should note, if we just look over the last few years, I guess I have data since 2009 in front of me. On average, we've gained Analog share at probably 30-40 basis points on average per year. We've gained in every one of those years. The range has been pretty broad. There are some years where we may be, I'll say, 10 basis points of gain, and other years during that time period, where we've gained over 100 basis points.
I would say it's not necessarily a smooth curve in terms of market share gains, but at least it's consistent from the standpoint of, we believe we've gained share every year, and it's our expectation and our intention to continue doing that, including 2014. By the way, everything I think I just said there, I could also apply to Embedded Processing. Although, I would also say that Embedded Processing, probably in 2013, our share stepped up a little more strongly in Embedded Processing than it did in Analog last year. Again, market share is important to us. Everything I've also described about our market share gains was on an organic basis, so it's not comprehending acquisitions and the impact of National or anything like that. Again, we've been gaining share consistently, and we expect to continue that. I guess that was your follow on, Tim.
Let's move to next caller, please.
We will go next to Jim Covello of Goldman Sachs.
Great. Guys, thanks so much for taking the question. Recognizing it's a relatively small part of the business, are you managing the 8% year-over-year declines in servers as if that's a secular issue driven by server virtualization that some of the other companies have also highlighted weakness in that area? Do you think that was more of a cyclical issue in the server market, and you expect to bounce back in that area? Thanks.
Jim, I'll comment on that. I can't say specifically that we're managing servers by itself. We are looking at the entire compute space, notably hard disk drives, for example, and noting what's been going on in total demand for hard disk drives and managing accordingly, to what looks to be a secular decline, as you pointed out, Jim, in that space. We've been adjusting our investment levels in that technology development and our staffing levels and so on to meet what we believe is a smaller market going forward than what we've seen in recent years.
Okay.
Yeah, thanks. In terms of the M&A outlook, I know you had just mentioned that you hadn't done a deal in a couple of years, and obviously you guys have been so good about doing these deals over the years, and then you integrate it and potentially over time you've looked at others. If you do not do a deal in the next couple of years, do you think it would be because you really don't find one that's for sale that makes sense, or do you just really not think that incremental deals make sense regardless of whether they're available from here? Thanks.
Jim, I'd say it's more the first, not the latter. That is, when we take a look at potential acquisitions, we look real hard at the numbers, and we've got to be able to make sense of the numbers. Namely, we've got to be able to get a return on that investment that exceeds our weighted average cost of capital in a reasonable timeframe, which we define as three to four years. If we can't get past the numbers, then we just simply step aside and wait for an opportunity to come at a later date. Really a numbers-driven analysis as we look at M&A.
Okay, thank you, Jim. Let's go to the next caller, please.
We will go next to Ambrish Srivastava of BMO Capital Markets.
Hi, thank you. Guys, a question on the divergence. I know that every quarter, both the businesses will not track up around the same levels, but Embedded was down a lot more on a quarter-over-quarter basis versus Analog. What was driving that?
Ambrish, I think it's very similar to what you said. I don't know that it's just the markets that Embedded sells into. In this case, we noted that the processor area was down more than other areas. Obviously, you're going to have different customers, you're going to have different markets, but they're both very diverse businesses. They're not uniformly consistent in terms of the customers, the markets that they're selling into. Beyond that, we don't have a specific color for you. Do you have a follow on, Ambrish?
Yes, I did, Ron. Going back to the comments you made earlier on at the top of the call, you mentioned that you're feeling a little more, and I don't want to paraphrase the word, but the message was you're feeling better about 2014 than you did heading into 2013. Is that just to do with the new rationalized product portfolio, or is that a comment based on what you're seeing from the end markets? Thank you.
I think it's both, to be honest. I'll make some comments, and Kevin probably has some things as to how he's feeling as well. I'd say, first of all, the strength and position of where we are today in Analog and Embedded is a big factor. Having those two product lines now making up 82% of our revenue going out of the year in the fourth quarter, frankly, is a great feeling, and positions us, you know as well as any, Ambrish, how long the wind down of that wireless revenue was, having that wind down behind us such that the top-line growth for the company can reflect a lot of the good things that we're doing, a lot of the potential that Analog and Embedded have embedded in them is just great.
I think also, more specifically, the overall environment in terms of the markets that we're selling those products into. Frankly, just areas of strategic focus, such as we've said, industrial is really important to us. Automotive is really important to us. The strength of those markets and frankly, our position in those markets, not that our position is so strong that it's saturated. We like the fact that we have lots of headroom for growth and market share gains, but we also like the design position we have there. Then maybe just a little more tactically, coming out of fourth quarter, our book-to-bill was stronger exiting the year than it was a year ago, and we also have good backlog coverage coming into first quarter as well. Those are the kinds of things that I know we look at.
Kevin, do you have anything else you would add?
Yeah, Ambrish. I'd probably just say on a macro level, looking at the total economy, the U.S. economy clearly seems to be stepping up its growth. Europe appears to have stopped declining, and it appears that China has stabilized, and those are three big economic regions of the world. You've got to feel better about that at this stage starting 2014 than we did 12 months ago starting 2013, with the uncertainty we're all staring at in those three economies. Then again, a bit more tactically to what Ron was talking about. If you look back a year ago, the sum of Analog and Embedded Processing was 74% of TI. Today, it's 82%. A year ago, Analog and Embedded Processing were down quarter-over-quarter, 9% on revenue in fourth quarter, and flat year-over-year.
You fast-forward to this year, not only is Analog and Embedded Processing bigger in percent, it's also bigger in dollar terms. It was only down 5% quarter-over-quarter, and it's up 12% year-over-year. We've got real momentum going as we move into 2014. You take the macro look, you take it TI specific as the portfolio is finishing its restructuring, and you got to feel pretty good about how we're going to start 2014 and what the year may hold for us.
Okay, Ambrish. Thank you for those questions. We'll move to the next caller.
We will take our next question from Tore Svanberg of Stifel Nicolaus .
Yes, thank you. I first had a capital management question. Last year was pretty unusual, $4 billion, and $1.3 billion, I think you said, came from stock option exercises. I know obviously you don't have a crystal ball on this, but could you just give us a rough sense as we look into 2014, what we can expect as far as free cash flow generation and especially maybe handicapping the stock options exercises?
Yeah. Tore, I do wish I had a crystal ball to help out with that particular question, but like you, I'm lacking in that right now. I would say that we would expect that the exercises are going to be lower next year than they were this past year. I would also just put aside any concern about that because frankly, we just use the cash proceeds from those exercises to buy back shares. It doesn't really impact what we've been able to do to share count for our stockholders. I believe in early March, as Ron mentioned, we're going to have a capital management strategy update, and that'll be a really good time to ask some of these questions. I'll take you a little deeper into some of what we're thinking on where we're going with capital management at that time.
Follow on, Tore.
That was very helpful. Also, do you have any CapEx and R&D estimates for the year? I know in the past, sometimes you've at least given the R&D guidance for the year. Just wondering if you're going to do that again this year.
I'd say going forward, you're not going to be getting that from us anymore, Tore. The CapEx guidance that we'll give you is simply the band that we talk about around our revenue, meaning that our target is 4%-7% of revenue on any one year, and we expect that given the size of our manufacturing footprint today, we don't expect to be pushing above the lower end of that range. In other words, probably more around the 4% of that range of revenue until we hit about $18 billion of revenue. From a CapEx guidance, that's how I'd suggest you'll hear the modeling from us going forward, not a specific number.
On R&D, frankly, we're reaching a point now where it's pretty stable, and it should probably just kind of grow with pay and benefit increases over time, and with the top-line revenue growth over time. Based upon that, we're not going to be providing R&D guidance going forward. You'll be able to just take a look at our results, and it'll be pretty straightforward for you to model that going forward.
Tore, the other one I would comment on is we've also historically given annual guidance for depreciation. Given that depreciation is so GAAP these days from CapEx, and frankly, it's a multi-year lagging indicator versus our CapEx trend, it just doesn't seem to us to be an especially useful number from a guidance standpoint. Clearly, you guys can go off and make some assumptions on what that may be, just given what our capital spending trends have been. Okay, Tore, thank you for those questions, and we'll move to the next caller.
We will take our next question from Vivek Arya of Bank of America.
Thank you for taking my question. Actually, both my questions are about different end markets. First on the wireless infrastructure market, if you could give us a sense for whether some of the restructuring you're doing on the processor side, does that impact the ability to benefit from all these 4G LTE deployments, or am I just reading too much into that and there isn't any connection? In that case, what are the trends that you are seeing in that market?
Okay. Vivek, I would say that first of all, we don't believe anything that we are doing here is going to impact our ability to benefit from LTE deployments. That does not mean that the base station area is not an area where we're seeing some resource reductions. It is. Just in general, LTE, we are already very well-positioned across those various customers. Our system-on-a-chip products have been out in the market for some time, we have a great position as LTE continues to deploy. As to the comment, let me just talk maybe more broadly, I'll start at the Embedded Processing level and then drill down into some of your comps infrastructure question. Let me say, again, you heard us give the numbers, Embedded Processing has really delivered strong growth this year.
That came out of areas like catalog microcontrollers, specifically product lines like the MSP430, the C2000. It came out of areas like connectivity, processors for automotive markets, processors for industrial markets. Those areas that have been driving and producing growth, we will continue to invest as aggressively as we have in the past. The reductions that we're making are, as I said before, primarily processors, and then secondarily, in some of the product areas in MCU. Within processors, I would identify areas like IP cameras, and certain areas of communications infrastructure, where frankly, the future growth just doesn't merit our current levels of investment.
Now to specifically, kind of your question about LTE and base stations more broadly, I guess I don't want to go into a lot of specifics there except to say, again, comms infrastructure is an area that will receive fewer resources, and it's based on our view that parts of the macro base station market are maturing. On the flip side, small cell is an emerging opportunity for us, and we'll continue to invest accordingly there. Even in the maturing areas of base station, as I started off here, we believe our revenue will continue for a very long time given the breadth of our position and the long lives of the equipment that we're already engaged with there. Hopefully that provides you some color as to what we're doing in comms infrastructure. Do you have a follow-on, Vivek?
Yeah, Ron, actually, I had thought about asking about the PC market, but instead, what I'll ask you is, in the market, it's always about what have you done for me lately. Last year, the TI story was about the benefits you got from exiting wireless, the really strong capital returns. Now, I think for this year, what we're hearing is sort of the same. What is really the next catalyst that can help you either outgrow the market or provide much superior returns than what we are seeing from the peer group? Really, what is the value proposition for outsize investor over-weighting TI this year?
Well, Vivek, I think that there's a number of opportunities in front of us that we've got going on here. You've seen some pretty strong growth rates that we just talked about in the areas we've been focusing our attention on for a number of years now, Analog and Embedded Processing. We talk about the fact that we're returning 100% of our free cash flow, that's what we use for debt. We also have plenty of room to grow with very little need to spend that much more to grow, and I'm talking specifically about our manufacturing footprint. If you take a look at the very cost-effective factories that we've put into play over the last couple of years, and the low level of CapEx it takes for us now to keep those factories going, the incremental margin and free cash flow opportunity from those factories is extremely attractive.
In addition to that, we've just got the overall growing space in industrial and automotive, which tend to be not only quite long-lived revenue profiles, but also quite attractive margin profiles. Again, those products run across those inexpensive factories and just help generate ample amounts of cash. I think from an investor standpoint, there are quite a few things to continue to look forward to, which is really our ability to continue to grow at the kind of rates that we're doing now inside Analog and Embedded Processing, and leveraging the very inexpensive factories we put in place to generate a lot of cash. Vivek, let me make a couple other comments. I think a lot of our long-term oriented investors clearly looked through the wireless transition, frankly, even over the last two years, into what TI was becoming, and that was the value proposition for them.
A company focused on very diverse markets of Analog and Embedded Processing that didn't require a lot of capital, that generated a lot of cash. Then, as you pointed out, they liked management's commitments to return that cash to them. I would kind of take a different view from what you described with some of the other investors, because a lot of investors I talked to last year, the year before, the year before, the response was, "We like what you're doing in wireless, give me a call when you're out of it," and that no longer represents a headwind for your growth. For investors that have been sitting on the sideline because of the concern that wireless represented such a significant headwind to growth, I think the value proposition for them is clear. It's no longer there.
The growth that we've been producing in Analog and Embedded is no longer going to be an obstacle for top-line growth. For a lot of those investors that frankly, our growth hasn't screened very well in the past, that's not going to be an issue going forward. Just my two cents worth on that topic. Okay, let's move to the next caller, operator. I believe this likely will be our last caller.
Very good. We will go next to Ross Seymore of Deutsche Bank.
Hey, Ron. Thanks for squeezing me in. Two quick ones. What would you say your new targets are, if they've changed at all, for the growth rate in Embedded, as well as your operating margin goal in Embedded, given the restructuring actions?
Okay. I would just say, first of all, in terms of growth rate target, absolutely no change. Again, I think Embedded did a good job on growth last year. Frankly, we would've liked to have seen that growth come through at a higher level of profitability overall for the business, growth has not been an issue. To the extent that we've tried to describe for you, our investments in the areas that are growing in Embedded will continue unabated. Our expectations for growth in Embedded are absolutely unchanged, and I think you'll continue to see good results there. In terms of profitability and margin objectives, I guess what I would say, Ross, is I know we've provided some numbers in the past, but in fact, I'll say what we've said in the past because I'm sure you have them in your notes there.
I think in a September 2012 investor meeting, our manager there described that his growth margin targets were 55%-60%, operating margin target was about 30%. What I would say is, in general, a well-run company focused on the Embedded Processing market opportunity we think has potential for a financial profile consistent with those types of numbers. That being said, what we're going to do with this segment is very similar to what we've done for Analog and not be communicating specific growth margin and operating margin targets and progress going forward. Again, clearly our objectives are much higher than where that business ran last year and ran fourth quarter. Do you have a follow on, Ross?
I do. I can't let Kevin get away with the whole conference call without somebody asking about the gross margin. Kevin, any help on the puts and takes for the first quarter as we look at the gross margin? It seems to imply at the midpoints of everything that it's down a little bit, just wanted to double check on that. Thanks.
Yeah, Ross, you're right. I won't give you specific guidance, but I'll give you some high-level things to think about. Clearly, as we came through the fourth quarter, we were taking our factory starts down through the quarter. We go into first quarter, we're taking our factory starts up. That's on the expectation of a normally stronger second quarter for us. The result of that is going to be that while starts will be higher in the first quarter than they were in the fourth quarter, the average utilization won't really change that much. Just based upon that and the timing of moving the wafers through the factories and through the assembly test sites, we would probably see a little bit of gross margin headwind as we bring those factories back up, but not a large amount.
Okay. With that, my clock shows it is 5:30, we are going to wrap up at this point. I'd like to thank you for joining us. A replay of this call is available on our website. Good evening.
This does conclude today's conference call. Thank you again for your participation, and have a wonderful day.