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Skyworks Solutions, Inc. (NASDAQ:SWKS)

Barclays Capital Global Technology, Media and Telecommunications Conference

May 22, 2012 9:00 am ET

Executives

Donald W. Palette - Chief Financial Officer, Principal Accounting Officer and Vice President

Analysts

Blayne Curtis - Barclays Capital, Research Division

Blayne Curtis - Barclays Capital, Research Division

Good morning. We're going to go ahead and get started. Welcome to the first day of Barclay's Global CMT Conference. Happy to have Skyworks with us as our first presenter. From the company, we have Don Palette, Chief Financial Officer; as well as Steve Ferranti from Investor Relations. Don's going to give a presentation. If there's room for Q&A, which as I hear is also a breakout immediately following after in Liberty One. And I'll turn it over to Don. Thanks.

Donald W. Palette

Thanks, Blayne. And I appreciate everyone showing up this morning. It's great to have you here. Opportunity to take you through why we're so excited about not only how we've performed over the past several years, but the opportunity that's before us.

And what I'm really going to try and focus on in the 25 minute presentation is I want to take you to our strategy. And the most important part of that is I want to take you through how we operationalize this strategy, basically, how we run the business day-to-day. I think that's important for you to understand, and I think that will -- that coupled with some exciting market dynamics will hopefully give you an opportunity to see where we think the company can go over the next several years.

And our ability to formulate what we believe was the right strategy and consistently execute against strategy has enabled us over the past several years to significantly outgrow the overall market growth. And the execution parts enable us to deliver best-in-class financial returns.

And I think I'll show a slide further in the presentation, but if you look at -- from 2009 to 2011, our compounded annual growth in the top line was north of 30%, and our EPS was approximately 65%. So the 30% was well above the overall market growth, so that means we were outgrowing the market and gaining share, and the 65% is extremely impressive. What that says is we were expanding product margins, as well showing tremendous leverage in the business, the 35% -- 32% topline, 65% EPS growth.

And the 3 key things that I really want you to focus on in the presentation is that we believe we're gaining share in the right markets. We're going to continue our laser-focus on execution. And by execution, it really relates to multiple areas. It's product development, it's operational, it's how we drive cost out, how we continue to be the low-cost producer, and it's execution against the overall strategy, okay? And if we do that, outgrow the market, execute, we're going to continue to deliver best-in-class financial and shareholder returns. So those are the 3 key things that I want you to take away from the presentation.

Our Safe Harbor statement.

Okay, our mission, it's really pretty straightforward. It's hinged on 3 elements. And that's we want to capitalize on high-growth market opportunities. We want to be -- we want to capture leading share position by leveraging our technology and our operational scale advantages. We don't want to be #3 or #4. We want to be #1 or #2 in all the markets that we serve. And by focusing on the right high-growth markets with the right secular trends, leveraging the technology and our operational scale, we believe that's going to position us to deliver superior returns -- company returns and shareholder returns.

So the high-growth market opportunities, where are we focused? We're going to continue to focus on the mobile Internet. And some examples of the high-growth opportunities in that would be the smartphone growth and the tablet growth. And for vertical markets, part of our high-performance analog business, we're focused on markets like smart energy, smart grid, home automation, wireless and wireline infrastructure and GPS technology. So those are some of the examples of -- and we'll continue to focus on those markets that we think are going to position us for strong growth.

We want to capture and we want to be #1 and #2, and we believe we have the broadest set of product portfolio in the space. We have a very strong RF design, history and heritage. We're doing this for a long time particularly, and a lot of our technology was developed in meeting the needs of the emerging handset market as it developed over the last 12 to 15 years. And we have a real strong IP portfolio as well. And we've got tremendous scale and volume. And the mobile Internet provides that scale for us.

We are the low-cost producer in this space. And that's really a powerful combination when you think about it. Broadest product portfolio, strong technology, low-cost producer, you combine those 2 things together, that positions you really well to meet the customer needs and to gain share. And I think that's one of the things that we've been able to do over the last several years. And our strategy is to continue to do that as we go forward. And if we do both of those things, we're going to generate again best-in-class operating results and shareholder returns.

Our goal is at the bottom. What we want to be is we want to be a company that produces diversified analog returns, but we've got an opportunity to grow like the mobile Internet space does. So translation, we're looking for 30-plus percent operating margin, and we're looking for growth rates at a minimum of 20%. Those are the goals that we have.

And then our strategy is really focused on 3 market segments. As I said earlier, what we want to be able to do is we want to be able to continue to leverage and take advantage of the high-growth at the mobile Internet space. It's going to provide us -- that's the space where we've developed most of our RF analog technology, again, over the last 12 to 15 years. And it's a space that provides a lot of volume and a lot of scale for us. It's positioned us to be the low-cost producer, which we leverage not only in products for this space, but across the catalog components and across the products for our key select vertical markets.

Then we have a linear catalog, linear components catalog business. It's an important business. What we do is we take this -- took -- have taken this technology we developed in serving the mobile Internet, and we've created a catalog business of individual components. And what's exciting about that is it has very broad market reach. We have thousands of customers. It's a lot more stable revenue stream. It gives us access to new markets. And it's also accretive to the overall return of Skyworks.

So one thing I want to point out is the mobile Internet has been about 65%, right now it's about 65% of our revenue, and our high-performance analog, which is made up of the catalog business and the vertical markets business is about 35% today. That's the split of the business.

So then we take these catalog components and what we do -- and we also take the relationships we start to develop in distributing our products to the customers, and we go in with our field applications, resources and our engineering teams, and we develop targeted solutions for customers in target vertical markets. These solutions are highly customized. They're typically sole-sourced, very long life cycles and they're highly accretive to the overall return. There's a lot of value add that is captured because we're solving a very specific solution to the customers.

Some examples of the target vertical markets are smart energy, smart grid, home automation, wireless and wireline infrastructures, some of the examples. And there are some exciting new vertical markets that we're just starting to get into. Like in the medical applications, there are some industrial applications and automotive or some examples of some of really large market opportunities that we've just scratched the surface on.

The bottom line is we want to be able to take our -- we want to serve markets where we can take our core technology. And that gives us a competitive advantage, which is going to allow us to gain share, outgrow the market and deliver best-in-class financial returns.

So about Skyworks, when we think about Skyworks today, we've got what we believe is the broadest analog component and integrated system solution product offering in the market. We've been very successful in enabling wireless connectivity across at increasing number of markets and products. We think we're uniquely positioned with our product suite to continue to take advantage of some very strong growth trends in these markets that we serve. And our goal, clearly, is to continue to gain share as we go forward in serving these markets.

Okay, what are some of the overall market business -- market drivers that are enabling some of the strong growth potential over the next 3 or 4 years in the markets that we serve? There's about 7 billion people in the world today, and there's about approaching a billion active users in the mobile Internet. So we're approaching a billion active users today. And there's no question that anytime, anywhere connectivity is a requirement for consumers today and that's not going anywhere soon. They want speed. They want performance. There's an increasing number of electronic and consumer devices that are going to have wireless capability, and they're going to need to be connected at all times and people are going to have -- there's going to be more and more applications and information that they need access to on a real-time basis, and that's all very, very good for Skyworks.

In fact, if you were to look at the broadband connections by fixed DSL and by mobile, the fixed DSL is actually shrinking. It's fixed best case but it's shrinking, and all of the broadband subscriptions going forward on mobile. And that's a very good thing for our providers like Skyworks. It gives us a great opportunity to expand our TAM.

This supports what we just -- what I was just talking about. They're predicting, from 2010 there was about 500 million broadband subscribers. That number is about a billion today. And that number is projected to go to 2.5 billion by 2014, which is a fivefold increase during that period of time. And this is a tremendous growth opportunity in new subscriptions, and again all that's very positive for Skyworks.

Another phenomenon is the cloud, as content continues to move into the cloud. Currently, right now, it's primarily a consumer event and most of the applications and data that are being used is by consumers. But enterprises are going to be using more and more -- are going to be demanding more and more access to content in the cloud. And speed and performance is going to be critical. And wireless connectivity is a critical component of having that anytime, anywhere access. And Skyworks is really well-positioned to take advantage of this growth phenomenon. And we have the RF products that we believe are going to help the company again to outgrow the overall market.

And without question, wireless today is becoming more affordable and it's ubiquitous. It's -- our wireless -- we're well-positioned to continue to take advantage of this phenomenon. It wasn't too long ago, if you think of when you thought of wireless, what you thought it was initially it was a 2G feature phone. Then it migrated to 3G -- 2G voice-only phone, migrated to 3G feature phone, smartphone, tablet, PCs, but that's dramatically changed in the last several years. You're seeing wireless content is increasing in a wide range of consumer devices. There's billions and billions of devices that are made today that have wireless connectivity requirements. And again, speed and performance is critical. And it's -- this wireless content is being embedded into an increasing number of devices. We're well-positioned to take advantage of that. Given our product portfolio and the broad set of customized solutions that we've developed in order to serve these different markets. And this is an important business content for Skyworks as we go forward, and there's some very real and significant RF dollar content in these products and it's going to increase, and we're well-positioned to take advantage of that as we move forward.

So let's talk a little bit about the TAM. We're going to first talk about what you would historically know as our core TAM, and that's in the mobile Internet. And we'll talk about some exciting things that are happening in the market that are going to allow us to, we believe, to outgrow the market on a go-forward basis.

There's no question when you look at the traditional TAM in the handset space that content and complexity in those devices is on the rise. And I think this chart does a nice job. It's got a 2G voice-only phone, entry-level smartphone and a high-end smartphone. And you can see that what's driving content is typically a band count. And with that band count, comes more complexity and there's more complex switching and other requirements in the composition of the phone that add dollar content. Complexity is very high in the high-end smartphones. And it's always -- almost always sole-sourced, which is a big change from where this space was 10 years ago when it was 2G voice-only where there was a lot of pin-for-pin compatibility, and it was easier for people to switch suppliers to meet the demands of their phone. That's not the case today. In fact, the playing field, because of this complexity that we're seeing in the high-end and even the entry-level smartphones, is the OEMs have multiple paths that they can go down as far as design. So they need to deal with RF suppliers that have the breadth of product offerings and technology that's going to allow them to pick the solution that they're most comfortable with to meet the needs of their customers. So our argument is that because of this complexity, competition is actually getting less in the market and it's going to get less as we move forward. Not everybody is going to be positioned to take advantage of that. And you can see at the bottom with competitors, 1 to 2 in the high-end smartphone, few in the entry-level smartphone, and there were a lot in the 2G voice-only phone.

And what's important here is the mix phenomena that's adding TAM as well. It's the dollar content, going from -- we sell about a billion -- there's 1.5 billion phones or handsets to 1.6 billion that are projected to ship this year. Only about 1/3 of those are smartphones right now. So again, what -- it's not only the band count in the phone, it's the mix shift from the lower-end phones to the higher-end phones that's providing the TAM opportunity. And I think this chart shows that pretty clearly.

So bottom line, the key takeaway here is we believe this is our -- what we put together based on various informations on potential handset unit growth that we get in the marketplace. This is based on about a 9% handset unit growth over to 2015. We've got ASP erosion and that's assumed about 10% year-over-year basis. And based on all that, we think there's a minimum core TAM growth opportunity in just the handset space because of this phenomena of content and complexity of about 15%. And this includes LTE as well as 3G and 2G phones, okay.

Then one of the exciting things, and I think the thing that's often overlooked by investors is the opportunity that gets layered on top of that in the handset space. That's just the course, that's the space as we know it today. That's just the transition from 2G to low-end smartphone to high-end smartphone, okay? But what's really important, what gives us a really -- what we're really excited about the opportunity to expand the TAM is that the increased content within the mobile devices, and this is over and above. What this chart depicts is if you look, the blue is the amplification of front-end module. So the band switches and the front-end module with a power amplifiers, where that's the traditional space that we would serve. That's the RF content we would traditionally have in the handset. But what's really exciting to a combination of product development and a combination of acquisitions, most notably ATI and SiGe would position ourselves to add some very significant incremental content in the handsets. And some of those examples if you look at is in some of the power management, the buck converter, LED camera, flash driver and the LCD or LED backlighting. Those are all the result of AATI. The WLAN is -- our mobile connectivity position was dramatically strengthened by SiGe. We have products in that space. We're now the market leader in that space.

So again, you've got more complex antenna switch modules that drive incremental content. All of this is a really exciting opportunity as these -- as the transition continues to occur to low-end and high-end smartphones. There's a lot of incremental content that we're really well-positioned to take advantage of.

In fact, you could see what we believe is that 15% was from the prior chart, that's the traditional handset space that we talked about. Then you layer in tablets, that's an incremental opportunity to that. And keep in mind that if a tablet is Wi-Fi as well 3G, 4G that the RF content in that is similar to that of a smartphone. So there's a lot of dollar content in that.

And then you can see the WLAN antenna switch modules, GPS, LNAs and power management, all adding incremental content. That gets you above, as I've said, the goal to be at least 20% growth. And that clearly gets us there.

And so that's basically the mobile Internet. You've got -- the takeaway is that a strong TAM opportunity in the traditional market because of the increased complexity and then also incremental dollar content, addressable content that's going to allow us to take that growth even above that 15% base.

And then finally, we have our high-performance analog business. Again, this is about 35% of our business. And if you look at the core markets that we have product offerings in today, and that would be smart energy, connectivity, cellular infrastructure and home automation, now we're selling both components into these markets as well as targeted customized solutions. And even though these are core markets today, there's a tremendous growth opportunity still in those markets. We've just scratched the surface in some of this -- for instance, smart energy, we're well-positioned but there's a tremendous opportunity in that market as we go forward, and that's the case in several of these markets. So in the home automation as well. So even though those are markets today, still a lot of growth opportunity that we haven't tapped into yet.

And then on top of that, you've got this whole list at the bottom of new vertical markets: military, automotive, medical, industrial. That, when you put these 2 together, that the overall high-performance analog, we believe is over a $6 billion TAM opportunity by 2014. It's really significant. Again, we've just scratched the surface in this market. And you can see it goes across automotive; display and lighting, where we're now well-positioned because the ATI acquisitions take advantage of that; mobile connectivity, again we're the market leader in that space; and some of these other products in markets that we believe we're well-positioned to take advantage of.

In our strategy in HPA it's really pretty straightforward. We've talked about a little earlier. And it's -- you start with the component business, that's the linear catalog business. It helps us really identify early opportunities. It gives us a very broad reach, a lot of customers with a lot of product, so it's the functioning building blocks. It's a great business. I think of it as an annuity stream. The returns are accretive, the overall returns of Skyworks.

Then what we do is we take our field apps team and our system engineering expertise teams. And then we go in -- and with these contacts we've made with the customers that are interested in our catalog products, we go in and we start designing customized solutions that are solving a specific problem for the customers. And then what we've -- as a result, what we're forming is a strategic partnership. And these customized solutions have a high-level integration, they're sole-sourced. And we're capturing a tremendous amount of value in that value stream when we do that. And the returns on this business are the highest of any of the products that we offer at Skyworks. So they're very accretive to the overall return. So that's really the strategy in HPA. And again, you apply this strategy to a $6.5 billion market TAM, and there's a lot of exciting opportunity for us in this business.

We talked about wireless, the proliferation of wireless, and we're really well-positioned post-SiGe acquisition. We're the market leader. And we believe this wireless networking, especially with the rollout in the consumer devices, that this is a billion-dollar opportunity by 2014. And again, we're the market leader, so we're well-positioned to take advantage of this growth opportunity.

And another exciting opportunity is the rollout of 802.11ac and the connected home and the -- with the rollout of it, the new technology, it's going to expand the overall RF content. And you're going to initially see that in product offerings and routers. The content is going to, in some cases, double or triple from what it's been traditionally. So this is another exciting opportunity for us.

And there's a lot of -- again, we've just scratched the surface. We've announced some wins with smart appliances with GE, but there's a lot of market opportunity. Even though we have products positioned in a lot of these different segments, the growth -- the slope on the growth opportunity is going to be significant over the next several years. And again, that's going to give us a chance, we believe we're well-positioned to outgrow the overall market opportunity.

Okay, why do we win? Why do Skyworks win? We think some of our key competitive advantages, I mentioned them earlier, our product leadership, our global sales and support and our core competency in systems level design.

Product leadership. We, again, have a really, really strong IP portfolio. We've got a strong heritage of RF design. And because of our success in the mobile Internet, being the market leader there, it's provided tremendous amount of scale that allows us to be, without question, a low-cost producer in the space. That, coupled with our hybrid manufacturing strategy where we outsource a certain percentage of our wafer supply and our assembly and test, and we in-source then we try to keep that for wafers. We try to keep that 80:20, 80% in-house, 20% outsourced; assembly and test 90:10, 90% internal, 10%. But the beauty is we can flex that depending on what happens in the marketplace and demand. The bottom line is we'll make targeted CapEx investments to keep those percentages where they need to be because what we're most interested in is for that incremental revenue to make sure that we're getting the right incremental margin and operating margin from that gives us the right return on invested capital answer.

And the one thing that gets lost on investors, we say it a lot on one-on-ones, but there's no question when you compare our gross margins and operating margins, both to our competitors, that there's a huge difference. And one of the reasons that we have a big competitive cost advantage is that we in-source our assembly and tests. Everybody else in the space does it on the outside. There's a tremendous cost advantage to be able to do it on the inside. So that positions us really well.

Now we talked about our product leadership. We think we have the broadest set of analog components as well as integrated system solutions in the space. We think that serves as very well and continue to serve us well as we go forward. And we believe we have the highest levels of integration. That allows us to capture more of the value chain.

And I think this chart just depicts that. We -- one of the key things that we've been really successful on our strategy is -- our strategy 3 years ago was to really focus on diversification. That was diversification within handset OEMs and diversification between the mobile Internet and our HPA business. So it was the combination of both, okay? And we sell in meaningful volumes to all the OEMs, and those are across the top, that provides handsets. And we also have very strong relationships with all the key baseband providers. So we believe we're the most diverse. In fact, we know we're the most diverse supplier in the space, and we think that gives us a lot of advantage. It gives us product development advantages too because you're dealing with a broader set of customers, increases your flexibility and your ability to turn those products on a more efficient manner.

And as I said, we're the leader in customized. We're one of the lead customized solutions. This allows us to capture more of the value chain. We want to be as far on the right as we can with these custom highly integrated solutions. They have the highest returns and they're going to give us the chance. It also really -- you form a very strong bond with your customers. It's very, very difficult. If you're meeting their needs on the far right, these highly integrated solutions, you're going to have a happy customer that's going to give you a lot of business for a long period of time.

And finally, our financials. You could see, as I mentioned it earlier, we had a 33% revenue growth from 2009 to 2011. Our operating margin -- our EPS went up 65%, shows the tremendous leverage that we delivered. There's a lot of leverage left in the model. We’re going to continue to expand product margins and leverage our fixed cost. The beauty in our models, we don't need to add a lot of operating expenses as we grow our revenue. And that model will continue as we move forward.

And another key thing is our operating margin went up 1,200 basis points during that time. 1,200. So that improvement was a combination of gross margin, 400, and leveraging the fixed cost. Strong cash generation, one of the things to keep in mind, this is through 2011, but if you then add in the cash we use for the ATI acquisition in early fiscal 2012, we spent a little over $500 million in cash on 3 acquisitions, all really strengthened our position in vertical markets, all instantly accretive to EPS and all are going to, if they haven't already or will in a relatively short term, give us incremental positive contribution from an operating margin standpoint as far as increasing the returns for the company. So strong earnings, we've translated that into very strong cash flow, which we've been using very effectively to pay down debt, bought some shares back and to buy key acquisitions that have strengthened our market position and our ability to outgrow the overall markets going forward.

And finally, one of key measures for us is our return on invested capital. And you could see that in 2011, we were at 23%. And our weighted average cost of capital is around 10.5% to 11%. It depends on what's going on in the debt markets. But you can see that that differential is value creation for the shareholders. So we're well above our weighted average cost of capital, and we expect that to continue as we move forward.

So bottom line for us right now, and as an investor, you have a lot of different options where to place your bets. But we think we're gaining share in the right markets. We think that's going to continue. We think we're really well-positioned to do that. The markets we're in have some really strong secular trends ahead of us. If we execute, we believe we're going to gain share. We believe we're going to outgrow those markets. We're laser-focused on execution. There's no question about that. We believe we're the -- as a management team, that's one of our strengths and will continue to be a strength. And I think the numbers speak for themselves and there's a lot of leverage left in the model, so we believe we'll continue to deliver best-in-class financial returns. So, a lot of exciting times ahead for Skyworks.

So thank you, and we're going to be heading out for the breakout session. Yes, Liberty One. So thanks.

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