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Texas Instruments Inc. (NASDAQ:TXN)

Conference to Discuss Capital Management Strategy

February 22, 2013 11:00 am ET

Executives

David Pahl

Kevin P. March - Chief Financial Officer, Chief Accounting Officer and Senior Vice President

Analysts

Ambrish Srivastava - BMO Capital Markets U.S.

Glen Yeung - Citigroup Inc, Research Division

Vivek Arya - BofA Merrill Lynch, Research Division

John W. Pitzer - Crédit Suisse AG, Research Division

Kenneth Lee

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division

Craig A. Ellis - B. Riley & Co., LLC, Research Division

William Stein - SunTrust Robinson Humphrey, Inc., Research Division

David Schwartzman

Operator

Good day, and welcome to the Texas Instruments Conference Call. At this time, I would like to turn the conference over to Dave Pahl. Please go ahead, sir.

David Pahl

Thank you, Mara. Good morning, and thank you for joining our conference call and allowing us to share our capital management strategy with you. Kevin March, TI's CFO, is with me today to provide details and to answer your questions. For any of you who missed yesterday's release announcing our latest dividend increase, you can find it on our website at ti.com/ir.

This call is being broadcast live over the web and can be accessed through TI's website. From the website, you'll be able to see our presentation, or if you wish, you can download it from there as well. 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 press release published yesterday, as well as TI's most recent SEC filings for a more complete description.

Over the past few years, TI has undergone a strategic transformation. The consistent direction of that transformation was a focus on better opportunities and markets, namely Analog and Embedded Processing. These continue to be some of the best opportunities inside of semiconductors, offering compelling financial characteristics, growth, diversity and stability. They also offer the best exposure to the growing opportunities inside of the industrial and automotive markets. At this point, our most difficult strategic actions are complete, and we now have a company with more than 70% of our revenue coming from Analog and Embedded Processing. As a result, our business model consistently generates cash, and the sustainability of this business model gives us confidence in our ability to return more of that cash to shareholders in the form of higher dividends and additional share buybacks.

Consistent with this belief, we announced last night that we're increasing our dividend to an annualized rate of $1.12 or a dividend yield of 3.4% as of yesterday's close. This 33% in our dividend follows a 24% increase announced last September and marks our 10th consecutive year of increases.

As well, we announced that our Board has authorized us to repurchase an additional $5 billion of shares, bringing the total outstanding authorization to $8.4 billion. Our share repurchases have resulted in a 36% decrease in our shares outstanding since the end of 2004. Our track record of increasing dividends and our continual share repurchases demonstrate a foundation and consistency of returns to our shareholders.

Further, the combination of generating and returning sustainable cash to our shareholders puts TI in a unique class of companies, especially when compared to other technology companies.

We appreciate your time today to allow us to provide you a full look at our capital management strategy. With that as a backdrop, let me turn it over to Kevin and he can share the details.

Kevin P. March

Thank you, Dave, and good morning, everybody. Let me just begin by mentioning that we are pleased that after many years of very hard work, TI's transition to an Analog and Embedded Processing company is essentially complete. And as Dave mentioned, more than 70% of our revenues last year came from Analog and Embedded Processing. And with the legacy Wireless products nearing their wind down on the near-term horizon, the growth of our Analog and Embedded Processing portfolios will soon be able to shine through, benefiting both our top and bottom lines.

The transition to Analog and Embedded Processing, we believe, puts TI into a uniquely strong class of growing companies that generate and return cash to their shareholders. This business model enables TI to consistently convert 20% to 25% of our revenue to free cash flow. And importantly, we are employing a capital management strategy designed to return 100% of our free cash flow less dividend -- less debt repayments to our shareholders in the form of dividends and share buybacks. We believe that TI's capital management strategy will continue to enhance our competitiveness and maximize our shareholder returns.

Let me just take a moment to take a look at a few of the key advantages that TI enjoys that allow us to deliver on this capital management strategy. Right on the top of the list, quite frankly, is a very high margin portfolio that we enjoy as a result of our focus on Analog and Embedded Processing semiconductor technologies. Second on the list is that we employ a tax strategy that repatriates cash back to the U.S. rather than leaving it stranded overseas. The result is we have ample cash to use for our U.S. operations, and importantly, to return to our shareholders. Because we have a strong balance sheet and we maintain certain obligations as fully funded, such as our pension obligations, we maximize our access to low-cost debt. This results in the ability to leverage our balance sheet when economics makes sense or when strategic opportunities present themselves.

And finally, as a result of our focus on Analog and Embedded Processing technologies, we enjoy the benefit of very long-lived manufacturing assets further enhanced by active use purchase -- used equipment purchase from over the last few years, which translates into our expectation for low capital expenditures for quite a few years to come.

The combination of these advantages results in a couple of very important outcomes and enables our capital management strategy. First and foremost for the company, it allows us to convert 20% to 25% of our revenue into free cash flow. And importantly for investors, it allows us to commit to 100% of our free cash flow, less debt repayment, to be returned to our shareholders in the form of dividends and stock buybacks.

I think it's instructive to note where our advantages place us in the S&P 500, and this chart illustrates it quite clearly. Arguably, we're in pretty good company in that we're in the 80th percentile, or put it another way, the top 20% of free cash flow generators in the S&P 500. Other names that are in our neighborhood are pretty respectable companies also, Capital One, Bristol-Myers, Pfizer and Apple, just to name a few. And we expect the business model that we now have put in place to keep us low ranked in the S&P 500 for many years to come.

Our capital management strategy, and I think it's most nicely summed up by this particular graphic. To put it quite simply, we have a great business model because of our focus on Analog and Embedded Processing semiconductors. We employ an effective tax strategy, which brings our cash home to the U.S., making our cash available. That results in a strong balance sheet that allows us to keep our pension funds well-funded, and thereby, maximizes our access to debt when the economics makes sense.

This in turn allows us to deploy this cash to continue to invest for our competitive advantage over time, which includes investments in our technology capabilities, our manufacturing capacity, our working capital and acquisitions. And because we will be generating more cash than we need, it also allows us to return cash in the form of dividends and buybacks and periodic debt repayment.

There are several elements to a comprehensive capital management strategy, and I'll use the next few slides to discuss what our ideas are on these. First and foremost is cash availability. To put it quite simply, where your cash is has a meaningful impact on what you can do with it. We believe the most responsible thing to do is to repatriate our cash, albeit at the lowest possible tax rates, so they can be reinvested in our businesses and returned to our shareholders. As we look out into the future and anticipate future tax rates, we assume the continuation of the current tax laws. And when you do that, off of our current 22% tax rate, we're estimating that when our revenues reach about $15 billion, we'll probably experience about 25% tax rate. And when our revenues reach $18 billion, we'll probably experience something like a 28% tax rate.

After making your cash available, then the question is how much cash do you hold. Obviously, this is a somewhat subjective calculation and reasonable people can arrive at different conclusions. But that being said, we employ policies whereby we expect to maintain sufficient cash on hand to meet our operational needs and pay our expected dividends and debt. This policy is designed to allow us to manage through a wide range of scenarios and be able to fulfill our commitments on dividends and debt obligations. Because of the design of our global footprint, we expect that we can keep more than 80% of our cash onshore, though our model is to average over time about 10% of our trailing 12 month revenue plus our next 12 months dividends and expected debt repayments. Our status at the end of 2012 was that 83% of our cash was onshore, and our total cash on hand was consistent with our model.

Turning to our pension strategy, we watch this closely because globally, it's a large commitment for us and it has a direct bearing on our debt capacity. So our strategy quite simply put is to maintain our pension plans fully funded on a tax sufficient U.S. GAAP basis to minimize any risk of overfunding, and to the extent that we do invest cash into those trust funds, to invest the assets in those trust funds on an asset and liability matching principle. Our status at the year-end 2012 was that globally, our pension plans were 95% funded. So our expectation for future cash requirements are minimal for this obligation.

Turning to our debt strategy, I'll remind you that our current debt is about $5.6 billion payable through 2019. The coupons on those debt issues range from 0.45% to 2.375% for TI-issued debt, and 3.95% to 6.6% for the debt we assumed for the National acquisition. We expect long-term debt will continue to be a part of our capital structure when borrowing economics makes sense. I'll note that we believe our high rating of A1A+ provides comfort to our debt and equity owners as to our ability and commitment to fulfill our payment obligations. So in light of that, we do not expect our debt balances to negatively impact our credit ratings. We'll consider rolling over our debt when interest rates are less than the expected inflation rate or dividend yield. Also, we expect that if we do roll over, maturities in any 1 year would not exceed $1 billion in order to minimize any future rollover risk.

To facilitate our access to debt, we intend to maintain a current shelf registration, which is helpful because it enables a short lead time if you choose to raise capital and includes the debt markets. In addition, we also intend to keep our long-term credit lines and diverse set of high-quality banks. Our status, again, as of the end of the year, is our current debt is at already capacity, our shelf registration is current and we presently have a 5-year $2 billion credit revolver with a very high quality set of banks.

Turning to investments to maintain our competitive advantage, our strategy here is really quite simple. And that is to extend the competitive lead that we already have with our differentiated Analog processes and our 300-millimeter in-house manufacturing capability. Our capital expenditures for technology development will be focused on differentiated Analog process flows and specialized packaging techniques, as well as differentiated embedded memory flows down to 90 nanometers.

Our capital expenditures for manufacturing capacity, in this case, our model is to maintain our wafer fab capacity at a tooled basis, a minimum of 3 years ahead of what we expect demand to be, and clean room for up to 5 years ahead, with a special focus on opportunistically equipping our 300-millimeter Analog fab, especially where distressed pricing opportunities materialize.

On the assembly test side, we expect to remain tools capacity at least 18 months ahead of demand with open space in our assembly test sites at least 3 years ahead of demand. And we expect to continue to use foundries for all of our CMOS production below -- for 49 nanometer and below, and on selected analog and packaging overflow demands.

Our capital expenditure journey has actually been a long one, dropping from levels exceeding 20% of revenue coming out of the '90s to the low double digits by the middle of this last decade, where we now expect to operate in the 4% range through $18 billion and a 47% range thereafter. And unlike in the past, where our capital expenditures occurred much closer to when we needed the capacity, which subjected us to full-priced equipment, we now acquire our capital well before we need it, opportunistically capturing far lower prices, thereby further lowering our cash needed for capacity expansion in the future.

Turning to working capital, it's really quite simple here, it is to stage inventory to maintain very high levels of customer service. Obviously, that's starting to be competitive with our peers. In addition to this we continue to be very disciplined with how we manage our accounts receivable and our accounts payable. Our inventory model is to have between 105 and 115 days of inventory. As of the end of fourth quarter, we had 103 days. You might note, if you look over the past year, our peers have operated in the 90- to 130-day range. So this model puts us right in the center of where our peer group operates.

Finally, on acquisitions, it will continue to be biased towards Analog and smaller acquisitions that bring us attractive products and/or talented engineers or improve our position in attractive growth markets. As has been the case for a while, the financial test for acquisitions for us is that the return on invested capital from the acquisition must be accretive to our -- with the average cost to capital within 4 years in order to be affordable.

Returning cash to our shareholders is nothing new for us, we've actually been doing it for many, many years now. In fact, over the past 5 years, we have generated and return, 100% of our free cash flow to our shareholders or about $12.5 billion. What is new is voicing our commitment to continue to return 100% of our free cash flow less debt repayment. And we can do this because we are now at a point where our business model not only strengthens our ability to achieve that kind of commitment, but to sustain this commitment over time.

Over the last 8 or 9 years, we have actually reduced our total shares outstanding by 36% through a disciplined practice of steady stock repurchases. Going forward, you can expect more of the same, that is repurchasing steadily on our discounted cash flow value of the company, exceeds the market stock price for our shares. Our target allocation for stock buyback is total free cash flow less the amount that we use for dividends and debt repayment. As of yesterday's authorization of $5 billion, that brings our total authorization today that's available for future buybacks to $8.4 billion, as Dave mentioned. Over that same 9 years, we have also consistently increased our dividends, as you can see from this chart. With yesterday's announcement, our new dividends annualized rate is $1.12, which represents about 43% of what our 2012 free cash flow was. At yesterday's stock price, that's a yield of about 3.4%. Our formula for dividend is to target about 50% of our trailing 4 years average free cash flow to be used for dividends. With yesterday's announcement, TI has increased its dividend in each of the last 10 years now.

Again, looking at how we are persistent in the S&P 500 with our dividend yield, we're already well positioned in the 69th percentile previous to this increase. But with the new increase, it puts us in the 84th percentile, actually quite consistent with where we rank on a free cash flow basis.

So really just to summarize, our transition to an Analog and Embedded Processing company is -- quite simply results in a much stronger free cash flow business model. The combination of a higher-margin portfolio and a sensible tax strategy means that we have cash available for strategic uses and to return to our shareholders. Our access to low-cost debt in the upkeep of obligations mean that we have a balance sheet that's not only strong, but easily available to be leveraged when the opportunity presents itself. The long-lived assets and long-staged equipment purchases that our model enables means that our capital expenditures going forward will remain to be low as we've seen in the past year. We believe this puts us in a unique class of strong generators and returners of cash. To reiterate, we believe that we will be able to convert 20% to 25% of our revenue into free cash flow as a result of a product portfolio that has been and will continue to grow. You can expect that 100% of our free cash flow, less debt repayment, will be returned to shareholders. And I will just close by saying that the increases in the dividends and the share buybacks that were announced yesterday reflect management's confidence in our business model, and importantly, our commitment to shareholder returns. So with that, let me turn it back over to Dave.

David Pahl

Thanks, Kevin. Operator, you can now open the lines up for questions. [Operator Instructions]

Question-and-Answer Session

Operator

[Operator Instructions] We go to our first caller, Ambrish Srivastava with BMO Capital Markets.

Ambrish Srivastava - BMO Capital Markets U.S.

That was very detailed and comprehensive. One question, and then I have a follow-up as well, please. When we -- Kevin, you mentioned that -- you were talking about the business model has transitioned, and you look forward to the Embedded and the Analog now shining through. So the first part, we know that the transition has happened. What gives you the confidence about the shining through part? Is it based on the organic TI business getting design wins or National doing better? So just please help us understand that part, and I had a quick follow-up.

Kevin P. March

Sure. I think it's the combination of the 2. Organically, we have been growing and gaining market share now for a number of years. And that's quite apparent when you just look at the market available data. In addition, we have the additional leverage from the Silicon Valley Analog or the National acquisition. Recall that when we talked about the acquisition, we expected during the first year that they would -- that, that business unit would probably continue to lose share as it had been doing prior to when we acquired them. During the second year, which we're now into, they would stabilize from a share standpoint. And then by the third year, we'd expect it to start gaining share, consistent with the other Analog divisions that we operate. And so combined, we look at that and expect that's going to continue to gain share for us going forward, which means even if the market growth rate is unpredictable, our ability to grow inside that market is fully in our control. Similar in Embedded Processing, you may recall that we stepped up our investments in Embedded Processing, especially on engineering and our sales on field staffing about 2 years ago now. And it takes several years for those types of step-up in investments to begin to yield results, and we would expect to see that business begin to -- it has been growing nicely and gaining share, but we expect to see it continue to grow quite nicely and gain shares and move forward.

David Pahl

Do you have a follow-up, Ambrish?

Ambrish Srivastava - BMO Capital Markets U.S.

Yes, Dave. My follow-up on the buyback, should we be thinking about the level that you guys have been doing the last 2 years? And then also what kind of stock level do you feel your stock is undervalued?

Kevin P. March

Well, let me start with the first one. We, obviously, have been actively buying our shares for a long time now. I mean as you saw from that chart, we reduced our share count by 36% since 2004. The amount that we will allocate to stock buyback is really, the formula is clearly pretty straightforward. We take a look at our prior 4 years free cash flow, the average free cash flow. We will allocate half of that free cash flow for dividends. We'll use the balance for paying down debt as it comes due and buying back shares. So I think that the kind of stock buyback activity you've seen us do here recently is probably pretty reflective of what we can expect going forward. As to the valuation question, I would simply say that we believe that the valuation opportunity for TI is substantially above what it currently is as our strategy unfolds in the next few years.

Operator

And we move now to Glen Yeung with Citi.

Glen Yeung - Citigroup Inc, Research Division

Kevin, just following up on your last statement. Can you provide us the parameters you use in calculating the DCF that you talked about on Slide 14?

Kevin P. March

Glen, it's pretty classic business school calculation in that we look at the current value of the company as it relates to our asset base and our free cash flow generation capability over time, and we discount that back at our weighted average cost to capital.

Glen Yeung - Citigroup Inc, Research Division

Okay. Nothing unique there then. The other question I had, Kevin, was you talked about, in the CMOS process, you're going to outsource below 45-nanometer, but Analog, and I obviously recognize that Analog is not at that node, but do you anticipate Analog will eventually get below 45? And if it does, is that something you intend to do in-house? And then related to that, you also mentioned that you want to have a certain amount of tools installed ahead of demand. Is that dependent on the availability of cheap tools? You've always been very good at buying tools from bankrupt companies. Or are you willing to buy new tools if you need to?

Kevin P. March

On the tool question, I'll answer that one. I'll let Dave take a poke at the -- on the other part of your question. On the tool question, Glen, we're looking there -- quite frankly, when you buy it before you need it, you actually don't have to pay full price, whether that's a relatively new tool or a used tool. And that's quite simply the essence of the strategy here, is to purchase it when you don't need it, and you can wait until the price is attractive. Clearly, we'd prefer to buy the tools when they're distressed, when certain competitors in the industry find it necessary to get rid of those tools, that's the most attractive pricing opportunity. But again, our strategy is to buy well before we need it so we're not subjected to, if you will, the catalog price at the time we do need it. Dave, do you want to comment on the [indiscernible] question?

David Pahl

Yes, Glen, if you look, our total number or percentage of wafers that are outsourced today is around 20%. And again, that's 45 nanometers and below that's 100% outsourced for advanced CMOS. And as our Wireless business unwinds, obviously, that percentage will decrease and the percentage that we build in-house will increase since essentially, all of the Wireless is built outside. And if you look at where Analog is today, there's actually a small portion of the wafers built at 180 nanometers. We have some newer process technologies at 130 nanometers. But most everything in Analog is 250 or above. And you just -- for most technologies and most applications, you just -- it's not a Moore's Law gain, and hence, one of the reasons why we can purchase more mature manufacturing assets and keep them employed for decades. So thanks, Glen, and we'll go to the next caller.

Operator

And we now take a next question from Vivek Arya with Bank of America Merrill Lynch.

Vivek Arya - BofA Merrill Lynch, Research Division

I realize, Kevin, you have a mid-quarter update coming up soon, but can you give us your sense of what the state of the industry is right now? I think many of your peers have called for a bottom. But what I've seen is that over the last 2 years, it's been a relatively easy call to call a bottom in December, but then the visibility has tended to be limited after that. So I understand you want to be TI-specific, but how do you see the state of the industry? Do you see visibility improving, anything improving, or is it still very short-term focused right now?

Kevin P. March

We'll give more color in a couple weeks on our mid-quarter update as to what our current thinking is certainly in the near term, which I think is always on people's minds. But do recall that we had given a range that expected our revenue would probably decline slightly in the fourth -- first quarter versus the fourth quarter. And then seasonally, if you look, we typically see the industry, and TI included, seeing sequential growth in the second quarter. Right now, I don't see anything that I could comment on that would cause us to expect anything different than what history has taught us to expect, and we'll give more color on that a bit later when we get closer to that time.

David Pahl

Yes. And our mid-quarter update is scheduled for March 7, Vivek. So do you have a follow-up?

Vivek Arya - BofA Merrill Lynch, Research Division

Yes. Second, I think you mentioned that you are largely done with your restructuring actions. One question we hear very frequently from investors is what is TI's baseline earnings model, i.e., what is your target business model for growth and operating margins? So now that you're done with all the restructuring actions, how should we think about those particular metrics so we can start forming a long-term earnings model for TI?

Kevin P. March

Yes, I think the thing -- the way to think about this, Vivek, is consistent with our capital management strategy that we just articulated, and that is that we're focused on not just growing the top line, but generating and returning cash to our shareholders. So while our gross and operating margins by themselves are important metrics, they don't necessarily prove an enterprise's ability to actually generate free cash flow that can give return to shareholders. And other important factors that need to be considered also are the company's tax policy and the company's capital expenditure needs. And that being said, our mix continues to improve because Analog and Embedded Processing continue to become a bigger part of our revenues as Wireless declines. Combined, that should support all of these metrics improving and giving us better ability to generate cash for our shareholders. So again, I think the value that shareholders will find is not only the potential appreciation value of the stock price itself, if you will, but also the fact that we will continue to return our cash in the form of dividends and stock buybacks. I will just remind you that historically, we are in a growth phase, our incremental margins tend to fall through about 75% over the course of the cycle. So if that's -- hopefully, that's helpful to your question. Okay, we'll go to the next caller, please.

Operator

We take our next question from John Pitzer of Credit Suisse.

John W. Pitzer - Crédit Suisse AG, Research Division

Kevin, a lot of what you said was straightforward. If you look at your historic buyback and sort of the return on that buyback, it would appear that the core business generates a significantly higher return than the buyback. So I'm just kind of curious, why not have a greater focus on top line growth through M&A, especially given over the last 5 years, that core business has kind of had a negative CAGR. And I know it's been a hard industry, a difficult industry environment, but just can you help me understand why not more emphasis on top line growth?

Kevin P. March

Yes, John. I think we've got plenty of emphasis on top line growth, and I -- I take some issue with the core business having negative CAGR because, in fact, if you say total TI, that would be true when you work in the effect of the wind down of the Wireless business over the last 5 years. In fact, the organic areas that we've been investing in, those, in fact, have been growing quite nicely for multiple years now. To support that growth, you asked the question about acquisitions. Well, in fact, as you're all well aware, we just did a very large acquisition about 1.5 years ago. And frankly, those for us come along probably once every decade or so. To the extent that we will use acquisitions to continue to support our objectives in the future, I'd expect those are going to be pretty small acquisitions, certainly for the foreseeable future.

John W. Pitzer - Crédit Suisse AG, Research Division

And this is my follow-up, just the mix between buyback and dividend, especially a dividend of 50% over the last 4 years average free cash flow, anything magical about that target or what was the sort of the rationale behind that target?

Kevin P. March

Quite frankly, we think that it's a strong signal to our investors that you can expect a constant stream of income from TI in the form of dividends, and that at a 50% average free cash flow level over the last 4 years, that gives us ample headroom, if you will, to ensure that, that dividend would be uninterrupted. Because certainly, the other side of that program, it can be flexed if it needs to be.

David Pahl

Okay, thank you, John. And we'll go to the next caller, please.

Operator

We'll move now to Tim Arcuri with Cowen and Company.

Kenneth Lee

This is Ken Lee for Tim. Question on the capacity. You guys had talked about opportunistically acquiring capacity. Can you help me understand the rationale between at up to $18 billion in revenue, when you guys would acquire capacity and kind of just the rationale behind that? And I have a follow-up.

David Pahl

Yes, thanks, Ken. We've talked about before that we've got current installed capacity end-to-end, so both wafer fab capacity and assembly test capacity to support revenues up to $18 billion. And as you saw last year, we were able to put that capacity in place and yet, last year, spend less than 4% of our revenue line on CapEx. So as we look forward, and especially in areas like 300-millimeter tools, there are some of those tools that become available on the market fairly infrequently. So if the opportunity presents itself to acquire that equipment for pennies on the dollar like we have in the past, we want to take advantage of that opportunity and begin to extend that $18 billion from where it is today. And we expect to be able to do that, and actually, have made some acquisitions even here more recently and still do that inside of our current CapEx guidance, and therefore, continue to run at that 4% range for the foreseeable future. So do you have a follow-up?

Kenneth Lee

Yes. On the share repurchase, is there an expiration on that? And also, how do we think about the run rate in terms of repurchase? I know you guys had talked about in the near term, you guys are going to kind of be at the pace that you guys have been the last couple of quarters. What are the primers on whether you guys would accelerate that or decelerate that?

Kevin P. March

Yes, Ken, there is no time expiration on the repurchase. It's a budget that the Board allocates to management to deploy for these purposes. And so our present budget available is $8.4 billion. And as you noted, we have talked the share repurchase activity you've seen in the past few quarters. It's probably pretty representative of what you can expect going forward. So I think I'd probably just leave it at that. I don't expect a significant change one way or the other in the size of share repurchases for the foreseeable future.

Operator

Our next question comes from Stacy Rasgon with Sanford Bernstein.

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

I know you're talking about returning 100% of free cash flow less debt repayment, but it really does sound like you are prioritizing cash flow over that debt repayment. You've got about $1.5 billion in debt that's maturing in May. You have about $1 billion maturing every year kind of going forward. What is your thinking around, in particular that sort of short-term tranches coming due in a few months in terms of paying them? Should we expect that to be refinanced?

Kevin P. March

Yes. Stacy, certainly, at today's interest rates, it remains very attractive to be looking at rolling over the debt. You may recall that we initially took out the debt to acquire National Semiconductor. We had intended to pay the -- we paid the debt as it came due. And in fact, as we came into the middle of last year, we were seeing interest rates continue to be at historically low levels, and we decided that it made economic sense for us to go ahead and simply take on debt to capture those levels. And that's really a function of what we're talking about here. When it makes economic sense, we'll go ahead and roll over that debt to take advantage of these kinds of interest rates. And really the metric we're using is if we can capture interest rates that are even below expected inflation or below our dividend yield, then it seems like that's an attractive and accretive decision on behalf of our shareholders, and a safe decision on behalf of our bond holders, because we're quite capable of repaying it. So as long as we continue to see very attractive interest rates, you can probably expect that we will make some allocation to rollovers.

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

Got it, that's helpful. And for my follow-up, just a question on the tax strategy. I just want to make sure I have the math right. So you're showing your sort of -- I guess this is your blended tax rate as a function of revenue. Is it just making the assumption that as revenues grow, you're repatriating more cash at 35%, and so the tax rate on this goes up? Are you doing something else around the tax strategy to minimize taxes?

Kevin P. March

No. There's a couple of elements that affect the tax strategy. For example, we enjoy a advance pricing agreement with the IRS that helps us to have a more predictable expectation as to intercompany pricing, and that's very important to your tax strategy and tax rate. And we just negotiated a 6-year deal with them recently. What that model really just assumes is that the incremental profit is taxed at the current statutory rate of 35%. And the current tax law remains in effect. Quite simply, I don't know how to forecast a change in the tax law. And so if you just tax each incremental dollar of profit at 35%, you fall through with those kinds of rates that you see in the sample model I gave.

David Pahl

Okay, thanks Stacy. And we'll go to the next caller, please.

Operator

And the next question is from Tore Svanberg with Stifel.

Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division

So this capital management process has been going on for a while, I mean the Analog business model has been obviously improving your cash flow every year. So I'm just wondering why now, why sort of communicate all this now? I mean is there more confidence in the business model? Is it because you're exiting OMAP? Just trying to understand the timing.

Kevin P. March

Well, it's a combination of those things, Tore. It's the fact that the Wireless is winding down and the cash call on that technology is going away. And it's the fact that we're now at more than 70% of our revenue's coming from Analog and Embedded Processing, which are much more stable and reliable generators of cash. And so we have reached that point in the transition of the company where we think it makes sense to go ahead and clearly articulate to our stockholders what our capital management strategy is, and the fact that they can count on us returning 100% of our free cash flow minus any debt repayment that we engage in going forward.

Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division

That's very fair. And as a follow-up, when we talk about working capital and the inventory model being 105 to 115 days, I'm wondering if that will change once you move even more of your business to consignment or should we still assume that 105 to 115 days range?

Kevin P. March

Yes, Tore. That comprehends that move to consignment. Let me give a little bit more background on that. We ended last quarter at 103 days. Keep in mind, we're still winding down the legacy Wireless products, so obviously, we don't want any more inventory on those products that we absolutely need. We're also in the process of on our SVA product lines, as a result of bringing that division on to our IT systems in the fourth quarter, we've begun the process of migrating their products, their distribution-related inventory to our consignment model. So that 105 to 115 days comprehends this full transition, if you will. Over time, we would expect to probably be closer to that as we go into the future.

Operator

We go now to Craig Ellis with B.Riley, Caris Investment Bank.

Craig A. Ellis - B. Riley & Co., LLC, Research Division

Question was asked and answered, but I appreciate the unique, helpful presentation.

David Pahl

Okay, thank you, Tore. And next caller, please.

Operator

And the next caller is William Stein with SunTrust.

William Stein - SunTrust Robinson Humphrey, Inc., Research Division

The one question that I have remaining is regarding your capital structure and the leverage. You have a little bit of debt outstanding. I think the consistency of your cash flow could, in fact, support a more levered balance sheet, and that would clearly be good for equity. I wonder what management's thoughts are on that?

Kevin P. March

Yes, it's a good question. It's a fine balance that we have here. Obviously, a company's ability to -- or their capacity for debt is somewhat a function of their credit rating. In our case, we have a credit rating of A1A+, which is a very strong credit rating. And we actually think that, that credit rating provides 2 very important care abouts to investors. That is it shows that we're a strong company that is committed to, and able to, pay its obligations. And those obligations would be interest and debt repayment to debt holders and dividend obligations to our stockholders. So while theoretically, it is possible to leverage the balance sheet more, it would be at the expense of lowering our credit rating. And we happen to think that with a company of our size and our global ambitions, this is the right balance and the right mix to be at this credit rating and to manage our debt inside that rate of capacity and not exceed that capacity. That's just simply the plan that we put together, and that's how we intend to operate.

Operator

And the next caller is David Schwartzman with Seix Investment Advisors.

David Schwartzman

I think you just answered my question. Earlier in the call, you had mentioned that you like paying your debt down because you then had the ability to flex your balance sheet. And I was going to ask was that all within the current ratings. And I think your answer was yes, but...

Kevin P. March

That's correct.

David Pahl

Okay. Well, we'll go ahead and conclude our call today. Thank you for joining us. A replay of this call is available from our website. Good day.

Operator

Ladies and gentlemen, that does conclude today's conference. Once again, we thank everyone for joining us.

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