Allegro MicroSystems, Inc. (ALGM) Earnings Call Transcript & Summary

Welcome to the Wells Fargo TMT Summit 2020. Your session will start momentarily. Please note, this session will be recorded.

Good morning, everybody. My name is Gary Mobley. I'm one of the semiconductor analysts at Wells Fargo Securities. I tend to focus more so on the analog and mixed-signal semiconductor group, and one of the companies I recently launched coverage on is Allegro Micro. And with us today is the management team of Allegro, including Ravi Vig, the CEO of the company; Paul Walsh, the CFO of the company; and Katie Blye, who has recently assumed Investor Relations -- Head of Investor Relations role at Allegro Micro. And I'm super excited to have the management team here today because this is the first time Allegro's management team has participated in a sell-side fireside chat like this one. And so I'm honored to be part of that. And given that you're a recent publicly traded company, I think it would be beneficial to everybody on the line and for future reference, for you to sort of walk through a background of Allegro Micro.

Thank you, Gary. Pleased to be here today. It's an exciting meeting for us. It is, as you said, the first fireside chat we've had post-IPO. We're happy to say we did have a successful IPO, and we're glad to be able to continue to share our story with you all. Allegro MicroSystems, I think has -- as many of you may know, has had a rich history in semi. It's been a company that's been one of the pioneers of power analog. Was primarily focused as an IDM and has been transitioning towards -- over the last 4 years towards a fabless asset-light strategy that's more technology-focused and pivoting towards being a product value proposition kind of supplier. And what do we have to show for it? We have the #1 share in magnetic sensing ICs. It's a $1.8 billion [indiscernible]. We are expect to grow in the spaces that we work on at about a 13% a year growth rate. Great anchor markets. When I talk about the anchor markets, xEV, ADAS in automotive, we're heavily an automotive supplier. And emerging growth vectors and data centers and smart factories. What's really been able to make ourselves successful has been a -- being a -- having a differentiated product portfolio. So our portfolio has -- is really anchored on key technology items, and we offer solution values to our customers. So we're not a -- we don't position ourselves as a commodity supplier in the space. When we look at the customer base, one of the things that we are all really proud of because of our rich history in the semi space, Allegro has been a very strong provider to the market leaders. And this market-leading customer base is global for us. We're very unique as a supplier. Our diversification, we'd like to say is 20-20-20-40. 20% North America, 20% Europe, 20% Japan and 40%, the rest of Asia, which about a little more than half is China. So this -- and between the activities that we've been working on, we really have a great growth vector and as well as a great margin expansion story. Four years ago, when I took on, we were a wholly owned subsidiary of Sanken Electric, that -- and we were following an IDM strategy. The last 4 years, we've transitioned our assets. We've divested many of our assets. We've -- and better aligned our wafer supply to higher tech. We've outsourced it all. We're now fabless, asset-light at this point. Great growth vectors as a result of that on gross margin. And we've also gone through a transformation in sales, R&D, opened up multiple design centers, increased our technical capabilities. So the company has been going to transformation. We view that the IPO has just been a stop, and our journey will continue. But we see great tailwinds, both in growth as well as the gross margin expansion.

Appreciate that overview. One of the questions I get often is people asking me to explain what a magnetic sensor is and why do automobiles need so many of them. So maybe if you can just talk briefly about, specifically what a magnetic sensor is, and the different use cases throughout an automobile.

Right. So it does sound exotic, but it is really a precision analog IC at the foundation of it. There's 2 kinds of magnetic transducers, one of which is built into the standard semi processing, typically an epitaxial-based wafer. We can architect that into a very specific magnetic-sensing config transducer. And then it's precision, low-noise, micro-volt amplification, signal processing, mixed-signal algorithmic solution solving kinds of ICs. And so what it does is it solves several use cases. The first simplest one is position. So you can detect a mechanical position digitally by having a magnet and an IC, either the magnet moving towards the IC or a metal object interrupting the field. And these kinds of position sensors are used for seat position, seatbelt buckle. Buckle, probably when you latch your buckle, it's not a mechanical switch. It's actually a magnetic-sensing IC in most cases. Power windows, you can measure how high a power window is -- and for the one touch up window systems. So multiple in-cabin uses for position sensors. But then, position-sensors advanced to analog information, too, so you can measure the position of a gas pedal, you can position the suspension height of a car, the wiper angle position, so multiple uses for linear angle. Then on top of that, you get gear speed positioning measurements. So engine crank shaft -- camshaft, transmission sensing, all of them have gears. The wheel speeds in terms of braking systems, have gears in them. So we can measure the rotation of the gear in. And finally, currently, we are most excited about our current sensing portfolio, where we've been able -- we've reconfigured the application to where you can measure the magnetic field generated by current conductor. Great applications in electric vehicles like inverters, for example, onboard chargers, DC-to-DC converters. So great growth vectors up to 80 ICs per car as a potential, depending on the fit rate of the vehicle.

Okay. I appreciate that. You guys have reported one quarter's worth of results as a public company. And from that earnings call, I think you were somewhat limited in what you can say at that time or certainly couldn't take questions. But maybe if you can just give us an update on market conditions for your 2 main end markets, Automotive and Industrial.

We see great tailwinds in automotive. We see SAR constantly improving. We see the annual car production model projections for this particular year being upgraded. When we entered COVID at the bottom, we were looking at a sub-$70 million worldwide production in car production rates. We're now in that $73 million to $74 million. It's been -- so there's been a substantial upgrading of car production. But more importantly, when you start looking at quarterly rates in car productions now in that 20 million, 21 million, 22 million vehicle kind of production rates, which is really at the low 80s and kind of a clip. Great tailwinds of wins for us basically on SAR. On top of that, we see inventories were at extraordinarily low levels. So we see the supply chain refilling. And then on top of that, content growth is accelerating. So we look at electrification trends that are being accelerated, power steering, the ADAS trends are accelerating. So we see great tailwinds in automotive. In data centers, we had wonderful take rates. The take rates are expanding. We see a little bit of a pullback coming up over the next couple of quarters as data centers take a pause, but we don't -- we see that mainly as the pullback in the market before it reaccelerates. And the same -- so we're seeing broad strength, no matter -- whether it's in the Automotive business or whether it's on the Industrial business.

Okay. In the last couple of days, we've started to see some of the sales stats in various geographies around the world for the month of November. And I guess, it's not a big surprise that North America and Western Europe are showing double-digit percent year-over-year decline. And I think just like deteriorating environment in terms of sales out of those regions for the month of November, given the COVID lockdowns and whatnot. But we're seeing strength as well, offsetting that out of China, India, South Korea, Japan. And so maybe you could share with us whether or not you've seen a sort of pause in the bookings trends on the automotive side or how -- to what degree you have geographic diversification into some of the faster-growing regions.

Yes. So we are extraordinarily diversified, as I stated earlier, given our 20-20-20-40 kind of a global profile that we spoke about. But we don't see a pullback in the bookings. And to the contrary, we see continued -- I would almost say, exuberance at this point in our bookings rate. So our challenge now is to manage the supply chain, to make sure that we're not -- we're guiding our customers towards -- not guiding them towards inventory builds, I guess, is the biggest place that we're concerned about. But we see strength. We really do see our ability to be -- to achieve our projections that we provided to the market.

Okay, that's helpful. I wanted to switch gears and talk about -- talk just a little bit about the algorithm of growth as you think about the automotive end market. It's been -- it's certainly heavily influenced by a low single-digit percent light vehicle production growth, but above and beyond that, what is the algorithm for growth to drive share of automotive-related revenue?

Yes. So in the next couple of years, we see automotive SAR actually tending to try to recover from the low 70s million vehicles at this point to the high 80s million in the 2 years out. So we see a great tailwind in SAR itself. On top of SAR, we have 2 basic elements -- or 3 basic elements in terms of dollar content growth. So we see our internal combustion, a piece of it, staying relatively flat given the downward pressure in internal combustion engines. But on the other hand, the content and take rate of sensing, it continues to increase even in internal combustion as efficiency trends continue to accelerate. In comfort and convenience, we see growth -- continued growth in that particular space as the in-cabin becomes -- it continues to become an area of focus for car manufacturers. But more importantly, we see our ADAS business continuing to accelerate. It's a great growth vector as our ADAS systems, whether it's the steering or braking systems, continue to have increased feature-rich content from a -- both from a performance and from a safety perspective. And finally, electrification's a great growth vector. So we see automotive moving forward from a 4% to 6% or above SAR kind of a historical model that we have to a 6% to 8% -- 6% to 10% kind of above the -- above SAR in upcoming years, just basically driven by electrification and autonomous vehicles. We do see our Industrial business continuing to grow strength in the high single digits. So we see, as a company, long term -- in the near term, mid-single-digits growth -- year-over-year growth is certainly achievable. Long term, low single digits is our model.

Okay. One of the common questions that I get as it relates to Allegro is the content opportunities or challenges as the industry transitions to -- from internal combustion engines, or ICE powertrains, to full battery electric vehicle powertrains. Can you share with us the dollar content opportunity that you compete for in a just traditional ICE powertrain versus a pure battery electric vehicle and maybe even extending the conversation to include hybrid powertrains as well?

Yes. So we -- the way we look at it is that our internal combustion SAM, if you want to call it, is about $37 for Allegro. It increases to $59 between both our power and sensing products for xEV. And that is excluding any photonics, LiDAR-related business that we speak about. So we see electrification as a really good thing. We've got proof points in electrification with customers such as Toyota, Tesla, Volkswagen, BYD, all market leaders in electrification that have selected Allegro to be a large part of their ecosystem, so we're already shipping to them. So we see that as a really wonderful movement in the direction of benefits. So while we may lose cam and crank sensor in terms of full battery, we gained 6 to 12 inverter current sensors. So we do see that there is a content growth for the company.

Okay. And the same axiom, I think, stands up in ADAS and autonomous vehicle-type functions. And if I'm not mistaken, this -- as it relates to ADAS and maybe a redundancy issue that drives your content growth, could you explain that in a little more detail?

Yes. So we like to separate ADAS into 3 basic categories: sense, think and act. And so when people think of ADAS, they typically think of cameras, RADAR and LiDAR, but there is also the thinking piece of it which takes the process of that data and figures out what to do. And then there's the acting piece, which is the steering and braking systems that actually do what the CPU wants it to do, what the brains wanted to do. And we are strong suppliers in the acting piece at this point. So as you look at steering systems, as steering systems get autonomous functions added to them, as vehicles get autonomous functions added to them, like the self-park, self -- the trailer launch for a pickup truck, for example, et cetera, we start seeing that ADAS systems greatly accelerate in their -- both in their complexity for performance, but also for safety and redundancy. Because these systems, when you're actually physically moving the vehicle, these systems cannot fail. It would be a disaster if they were to fail. So for example, we have a great case study, where we took a major -- the #1 selling pickup truck in North America. We looked at -- we have their sensing and power content in the steering system, both in the 2017 model and the 2020 model, we go from a $4 content to a $12 content, some of that is based on increased redundancy requirements, and some of it is related to higher precision and greater performance requirements.

Okay. You hit on this a little bit earlier, but I was hoping you could share with us what sort of efforts you have going on the LiDAR front following your acquisition of Voxtel and what are some of the hurdles you have to clear before you can declare success in that market.

Yes. So we're really extraordinarily excited about LiDAR. This is an area that we have invested in. We think it is extremely complementary to our rich history in sensing as well as our rich history in automotive. And the area that we focused on in LiDAR is in eye-safe LiDAR, 1550-nanometer LiDAR, which we believe is going to be the technology of choice for long-range LiDAR. And the primary reason for that is long-range LiDAR has -- requires high-energy laser emissions. In the 900-nanometer range, which is the visible band range, which is the silicon performance, you cannot emit enough power without damaging the eyes. And so there are significant restrictions that limit the range of such vehicles. We purchased Voxtel because DoD, Department of Defense, the U.S. Department of Defense, had figured this out a decade ago and they had been investing in various companies, including Voxtel, in developing this 1550-nanometer ecosystem. So Voxtel has the makings of a portfolio of 1550-nanometer single-pixel 1D arrays and 2D arrays. Our challenge is going to be to industrialize it to the level that automotive expects in the safety-critical applications. We will be, in the next 6 months, releasing our product portfolio -- the beginnings of our product portfolio. And we expect this to be accretive in fiscal '24.

Okay. One of the other common questions that I get regarding Allegro Micro is how Allegro differentiates from competition. And one of the things I often cite is that your advantage in your relationship with UMC and increasingly TSMC. And so what sort of technology from a process advantage do you have in having this fabless business model? And how does that translate into different types of production-proven intellectual property?

So one of the benefits of having this rich history as an IDM, even though we've transitioned out of -- as an IDM, we've had, in our DNA is process development. So we have an ecosystem where we are able to architect and develop wafer technologies. And that's critical for magnetic sensing, the -- to get high-performance magnetic sensors as well as high-performance power devices. Foundry processes typically are not set up or optimized around it. So with UMC, we've developed our current generation, which is a 180-nanometer BCD process. It's a 100-volt BCD process, very well anchored towards automotive, also towards a 48-volt system trends, both in data centers and automotive. It's a great basis for us to drive future growth. In addition, we've been able to install, through our partnerships with our foundries, specific wafer technologies related to xMR. Now xMR, it's GMR, TMR, these are advanced magnetic sensing technologies, and they are technologies that greatly advance the state of the art in the ability to sense magnetic fields. The precision that they provide is several orders of magnitude better than hall effect, which we currently have an established leadership position in. Our partners believe in us, and they have dedicated fab space to us. We have our own proprietary tools located in their foundries, and so it is a successful partnership. We don't view UMC or TSMC as a transactional partner. We view them as strategic. And we hope that they also view us in the same -- with the same lens that we're -- that this is a strategic relationship here that drives intellectual property. We've been able to use the intellectual property of these foundries to advance our wafer technologies and -- which is so -- and we bring the high-voltage magnetic sensing piece to it, so it's -- and the automotive piece to it. So it's been extraordinarily successful for us.

Okay. Maybe if I can bring Paul into the conversation and talk about some of the margin-related drivers. And on the previous topic, can you share with us the cost advantage that you get from wafer supply from UMC, TSMC versus your prior fab, which is Polar, based in Minnesota?

Yes. So there's a meaningful cost benefit to being -- sourcing from UMC and TSMC compared to Polar. That is -- that provides a long-term tailwind for us, for the company. As new -- about 20% of the company's revenue comes from new products, so over time, virtually all new products are being released to UMC and TSMC. So it creates a long-term mix benefit by having a much more competitive wafer price, and it's a meaningful difference in terms of wafer pricing. Other tail -- other margin drivers, Gary, to your -- to the beginning of your question, include -- we have -- today, we currently have 2 back-end facilities internally, one in Thailand, one in Philippines. We are well down the path. We were about 70%, 75% complete through the second quarter, September quarter, of closing Thailand. We're basically consolidating everything into the Manila facility, which will give us a benefit in the next year -- in the next couple of years, certainly, of having reduced fixed costs. We should get some efficiency benefits as well by having all of that production under 1 roof instead of 2. And so we'll be complete with that by the end of our fiscal year, the March quarter. And that -- in fiscal '22 and '23, that should provide us a benefit of 200 to 250 basis points, just that infrastructure change. Longer term, we've got process improvements internally that will also create more uplift towards the margin. And couple that with my first comment about just more and more product being sourced from the foundries gets us into that long-term -- into our model of mid-50s.

Yes. Just to package that under -- those factors underpin gross margin expansion from roughly 50% to the long-term target of 55%. Ahead of the IPO, you guys divested your fab and moved to a fabless business model. That fab was called Polar. And as part of that divestiture, you have a purchase commitment then. Could you run through how much that purchase commitment is and how long to expiration of that purchase commitment?

I'll take that Paul? Or do you want to?

Sure. Yes, thank you.

So as part of the IPO, we created a purchase commitment with Polar. It's on a 3-year rolling forecast. We're just obligated to purchase what we commit -- what they commit to supply for the next 3 years, so there is a benefit. We're not really intending to do a rapid divestiture of our wafers -- or transition of our wafers. It is not a useful use of our resources, especially in a market like automotive, which is risk-averse. So -- but there is this natural erosion that's going to occur in terms of the volume. As Paul stated earlier, that 20% of our revenue comes from new products. And so as new products ramp and replace the older ones, we will see our volume declining. The benefit is that we've secured the supply to -- at Polar through our contracts. And yes, I mean, it's -- but on the other hand, we have the 3-year flexibility. So every year, we can come off and provide a new forecast for the third year.

Okay. I want to conclude with a question that you probably didn't get asked during your IPO roadshow, and that is what gives you confidence that you have the right management team and processes in place to take Allegro from slightly more than $0.5 billion in revenue to $1 billion plus?

Thanks, Gary. I mean, that is a great question. That's one that we were not asked in the -- in our prior meetings. But yes -- so I would say that the first thing is that we have a rich history. We have, as a company, technology and innovation in our DNA. And if we -- that is essential for a company our size to continue to grow and continue to thrive in the marketplace. I would say that the next thing is that we have a great blend in our management team between external expertise, people that have brought in public company experience, but others that have a rich internal history, too, so -- but are not averse to change. I think our history and our track record over the last 4 years of transformation would probably support that statement. And finally, I would say that our Board has been architected specifically to help us drive both improved performance for the company, but also -- they are also like-minded that inorganic growth is a good thing and they have the ability to help guide us towards that. So we look at all 3 legs of the stool, all 3 legs that, we believe, are extraordinarily strong.

Okay, I appreciate that. I think we're up against our time limit. And again, I was honored to be part of your first fireside chat as a public company, and I wish you guys the best. Enjoy your holidays, and enjoy the rest of your time at the Wells Fargo TMT Summit. Thanks, everybody.

Thank you, Gary.