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

Good afternoon. Why don't we go ahead and get started with this session? It's my pleasure this morning to introduce the management team of Allegro MicroSystems. We've got both Ravi Vig, who's the Chief Executive Officer and President; and we have Paul Walsh, who's the Chief Financial Officer. As many of you know, Allegro is a little bit over a month removed from their initial public offering. It's been a tremendous success. The stock's up almost about 100% from where it was priced. And we've got the opportunity today to spend about the next 30 minutes in this forum to talk to both Ravi and Paul about the company. Again, if you have any direct questions, because we are virtual this year, please feel free to e-mail them directly to me and I'll sort of work them into my prepared questions.

But with that, I first want to thank Ravi and Paul for joining us today. And Ravi, I always try to make the first question in this setting somewhat open-ended to kind of help you set the stage around the value proposition you see Allegro offering the investment community. So maybe you could spend the first couple of minutes talking about the core IP of the company, the markets you exploit that IP into and kind of what's the overarching strategy here.

Thank you, John, and thank you, everyone, for spending the time with us and listening to our story. As a company, Allegro has had a rich history in semis. Allegro was founded in 1965 and has been in the business of semis ever since. A company with that history started out as an IDM, focusing on power and then on magnetic sensing devices. Over time, once I came on, we did the transformation of the company to go to shed our IDM legacy and move more towards a fabless asset-light model and with one that's really focused on key technologies. Technologies and innovation is what makes us successful. We like to use a tagline and call it "innovation with purpose." And that innovation has been very well-received in the marketplace. We are the #1 supplier of magnetic sensing ICs in -- with specific focus into automotive. Our automotive markets that we focus in are ADAS, xEV, which are key drivers for our future growth. But in addition, we've architected a really nice play in motion control, where we've also developed -- progressed our power portfolio into the motion control space. Our motor drivers have significant IP embedded in them, the mixed-signal devices. They are capable of fault detection. They're capable of driving and controlling motors, all with embedded logic, things -- moving towards a trend of 3-phase precious motor control, which is a tremendous trend for -- both from an efficiency standpoint and a control standpoint. And finally, we've just invested in a portfolio of photonics, which we intend to use to target long-range LiDAR in the IC 1550-nanometer range. So all of these set us up really well. The transformation of the company has also included an enhancement or investments into our R&D organization, increasing our design centers, increasing our analog design capabilities. It's also included a restructuring of a manufacturing operations to become fabless asset-light along the way. We've brought in some great manufacturing partners like UMC and TSMC, that both collaborate with us on manufacturing capacity, but also collaborate with us on technology. So we feel really good about our positioning, the tailwinds in automotive. Our main markets are great. Automotive SARs is projected to grow. And in addition to that, our content is expected to grow above SARs. So we're feeling pretty good about our operating model.

Ravi, that's a really good sort of entry summary. Paul, maybe you can pick up on that and just talk about some of the financial implications of some of the actions and repositionings that you've done that Ravi mentioned in his prepared comments?

Sure. The company has been through a lot of manufacturing trends, a lot of business and manufacturing transformation. We divested a fab last -- at the start of this year. That helped improve gross margin by 1,000 basis points. We're in the process of consolidating our back end into 1 facility from 2. We don't really need 2. That process will be complete by the end of March. That will add about 200 to 250 basis points of gross margin over the next couple of years. And that's significant, and really, it allows us to -- this transformation helps position us to drive a higher level of gross margin certainly and which helps feed the top line in terms of fueling continued investments.

That's helpful. Ravi, I would like to use these fireside chats sometimes to maybe tackle some of the potential misperceptions out there in the marketplace. And I think in part because most of the exposure investors have had to the "sensing market" has been through handsets or through MEMS. There's a view out there that it's a somewhat commoditized market. I'm wondering if you could address specifically kind of the barriers and the moats you have in magnetic sensing. Holistically, you have slightly less than 20% share, which I know on the surface doesn't seem like a lot, but I think people underappreciate just how strong your position is in your served addressable market and also the fact that you're not just bringing components to bear, you're bringing really system-level solutions to bear. Maybe you can spend a few minutes kind of addressing that.

Thanks, John. Yes. So as a company, we've really focused on technology, focused on providing system-level solutions to the customers, providing things that, in many cases, become plug-and-play answers. We like to say that, for many engineers, electromagnetic fields was the most hated class in college, and they all hoped to let go of it. And our job is not to make them relearn that, but to be able to use our products in a very simple manner. And which -- what that means is embed an extraordinary amount of value in them. We operate at a higher ASP level than the broad market in general. It's a reflection of the embedded IP that we have, both in the circuit design, but also in the packaging. And between the circuit design and packaging, our goal is to make customers view these components as plug-and-play. We, for example, in our current sensing portfolio, we have great IP. We've -- in our overall company, we have over 1,000 worldwide patents. I mean for a company the size of -- in our size, that's an extraordinary accomplishment in our opinion. So this patent portfolio is what differentiates us. It allows us to operate with this deep IP, with this deep knowledge in the various application spaces that we operate in. We don't believe that our objective, either in sensing or in power, is to operate in the commodity space. We believe that there are much larger competitors that could do that, particularly attack those spaces much more efficiently. We provide value, IP, technology to our customers.

Sorry. I had myself on mute. That was a great answer, Ravi. I kind of want to go back to business now by the end markets you addressed. And clearly, I think what's most unique about your company is just how much of your revenue exposure today is in the auto market. It's significantly larger than the next largest exposed company in the space, and it's multiples of what sort of the average semi company has as far as exposure to auto. And so I wanted to dive a little bit deeper into that end market. You talked about the potential for content growth. Can you help us understand the drivers of that? And I know there's, in our mind, kind of 2 drivers. There's a mix driver as ICE moves to sort of hybrid and EV. But there's also drivers from ICE-to-ICE, hybrid-to-hybrid and EV-to-EV, and maybe you can touch upon that.

Sure. Great question. So when we look at the market drivers that we have, for one, the magnetic sensing ICEs, and one clarification I would like to provide is that even in the sensing ecosystem, the word is all-encompassing. Sensors could mean mechanical configurations, wires, connectors, et cetera. We do not provide that. We're an IC play. We provide the semis with perhaps customized, miniaturized packaging, very typically using semi processes -- well, always using semi processes too, and these parts look very normal in terms of products. So these particular products are -- have been very well-optimized into, for example, in xEV. So a great growth area in xEV is the current measurement, magnetic sensing measures the magnetic fields generated by current conductors. And what that gives you is a very extraordinarily low-loss version of measuring current and power. It also gives you very high levels of isolation that you can maintain. So for example, the main inverter in a car for the main motor could use anywhere from 6 to 9 current sensors in that particular application. The DC-to-DC converter that comes from the 600-volt battery down to the 48-volt or 12-volt rail, depending on the customer's architecture, could also have a bunch of current sensors. The wall charger could have current sensors. This is an example of the proliferation of this technology. It's just at the beginnings of the inflection point. But this is an example of the proliferations of the technology in an electric vehicle, knowing that EVs are still at a very low basis, but there's significant momentum there in terms of electrification. But ADAS is a similar area. So we see content growth in ADAS, especially in the drive portion of ADAS, where steering systems are being enhanced, braking systems are being enhanced. We are well embedded in motion control in the steering systems, for example, and we see content growth in there. And so you've got these inflection points that are driving growth. But it's a great question to talk about what's happening at ICE because I -- this is the first time someone's asked me that. And what I would tell you is that for ICE vehicles to continue to operate, they have to still continue to improve the fuel efficiency. There are still standards that continue that make these -- that require those engines to continue to operate in a more fuel-efficient manner. And so there's a bunch of systems that get added on, like turbochargers, for example, that get added on, and more precise cam measurement, et cetera, higher speed transmission. So all of these lend themselves towards increased content, even in ICE. And so we feel -- we see that ICE for us will be -- will continue to be a significant presence for us. And we'll continue to -- despite the long-term decline of the market in the near to midterm, we don't see ICE as being -- we see ICE as being a significant business for us moving forward. Go ahead.

No. Go ahead, Ravi. I'm sorry. I didn't mean to interrupt.

No, and when you start looking at these growth vectors in automotive, comfort and convenience, we are very well-architected with wafer technology in terms of these very high-temperature processes, so 170 degrees C BCD to 190 degrees C survivability of our technologies and packaging. All of this leads itself to being able to operate and power under -- in what we call "under the hood." These are applications that may self-heat or operate in a high-temperature environment. And it's kind of ring-fenced because most foundries, et cetera, do not have these standard processes. We develop them and co-develop them with foundries. We have our own PDKs, our own memory circuits, et cetera, all of these optimized for automotive, for the long life, the low failure rates, et cetera. And so our power products also have great tailwinds in these kinds of applications.

Ravi, you and I talked about this through the IPO process. It's oftentimes challenging for you to sort of bucket where all your sensors are going within the auto market. I would be kind of curious, and I got this question from the audience, what percent of the business today do you think is ADAS and EV each? And how does that trend over time?

Yes. So ADAS and xEV together would probably be in that 25% level of our automotive business, 20% to 25% of our automotive business. And xEV is an emerging -- I mean EV is an emerging business. It's a much -- it's a smaller portion of this overall, but it's seen rapid growth. I think we spoke about this in our earnings call, that our current sensing business has shown great growth year-over-year. And we don't expect that kind of trajectory to continue, but we do expect great tailwinds. But it's coming off a low base because electrification a year ago was much lower in volume than it is today, but it's still not a significant portion of the automotive industry.

Well, Ravi, talking about just the overall business trends, we're clearly on the right side of the cyclical on the auto recovery. Clearly, COVID had a negative impact on production. Earlier this year, we're starting to see significant sequential growth. As we look out to next year and 2022, I think the Street's modeling your auto business to be up kind of low double digits, low teens year-over-year, each year. And I want to push on that a little bit because it's not hard to kind of envision a cyclical recovery in autos next year for units alone that could be a mid-teens year-over-year growth number given the base in calendar year '20. I layer on top of that, content and mix shift. It seems like you guys could do better than that. And then even as you look out to 2022, to get back to prior sort of peak levels of autos by the end of '22, you still need to see kind of high single-digit growth rate in overall units. Again, layering on your content, layering on mix, it seems like there's opportunity for upside. How would you answer that question?

Well, we've got great tailwinds. I think -- and I would agree with the premise that we have good tailwinds. I think what's important for investors to realize is that there is some cloudiness still in the future. We are still trying to figure out what the impact of the recent resurgence of COVID is, what it's going to do to the next calendar year. Supply chains are reacting nicely. At this point, we are seeing that auto production is recovering nicely. So we feel good about the model that we've provided. But at this point, it's just a little too soon for us to talk about restating our assumptions. But I think it's important to keep in mind that it is still murky. I think that we haven't reached a stable level of a crystal ball yet. It's -- things are changing still quite rapidly.

Well, Ravi, that brings up a good point because on the last -- on your first quarterly conference call, you did talk about there perhaps being a little bit more inventory, June into September, than you thought. Any update you can kind of give there? And where do you think the inventory levels are as we go into December and early next year?

So inventory levels are back down. I mean they are -- we had some overhang. I think we had some overhang in June, July because in the March, April time frame, customers were COVID-paranoid about factories shutting down. Some of them did stock up, but then their own production facilities got impaired, and so they ended up with some amount of inventory. And that inventory was bled off in our -- in the early part of the last quarter. But right now, we look at our distribution inventories down at the low end of our range. We look at customer inventories, we see no real -- we don't have great transparency from customers on their inventory, but their intelligence says that there is no great movement in their inventory levels at this point. They're sitting low.

Ravi, apologize for that technical difficulty. At least, it proved to the audience that we're doing this live and not taped.

That's right. That's right, John.

I wanted to take your answer on...

It's happened to all of us, John, so...

I wanted to take your answer on the auto side and segue to Paul for a second because I think, to me, one of the powerful things about your business model, notwithstanding some of the uncertainty that global pandemics can cause, is that you guys are in end markets that have design cycles that are kind of 3-plus years in length. And once you get designed in, you're pretty much sole-sourced and you've got revenue streams for multiple years to come. And so Paul, I'm going to put some pressure on you. This should be a business model that has a lot of visibility, if not on a quarter-to-quarter basis, over a longer period of time. How do you think about kind of the visibility of the model as we and the investment community try to forecast revenue and earnings in out-quarters?

Well, in the near term, we typically -- given that what you're just describing, given the nature of the end customer, John, in the near term, we typically enter a quarter with a considerable amount of backlog in place. So it gives us good visibility into what the top line will be. And then I think from a long-term perspective, we know the variability, I would say, is less than in, say, other end markets because, to your point, many of these customers are -- they're designed in. They've been with us for forever. And we know the new applications. We know the design wins coming in for this year and for the next year. And then it just becomes a matter of understanding how does that play up against the macro side of it, what the production metrics are. So I do think, compared to other industries that have maybe steeper ramps or -- but also steeper declines, I think this provides a lot more long-term visibility into the customer base.

That's helpful. And then, Ravi, kind of switching gears more to the industrial side of the business. And I oftentimes joke that industrial is what semi companies call things when they're not quite sure where they're going. And I don't say that in a bad way. I mean I think it's great that you've got diversification of application, diversification of end market, diversification of customers inside of industrial. But when you think about kind of the core drivers as you try to unpack industrial, what would you point to? And specifically, I would love to hear you talk a little bit about some of the opportunities you have in data center.

Yes. I mean it's a great characterization of industrial. It is -- it's a bunch of meaningful segments and not a single segment or a single killer app. And so when we look at data centers, data centers is a great example of an application of our technologies. Data centers are transforming. They're increasing in power. And as a result, they're increasing in thermal load. We operate in the, in this particular space, in the cooling space of data centers. There's a transition going on today. If you want to improve the cooling of a data center, you just -- you increase the number of fans, you increase the air flow. The single-phase fans that they use today are noisy audibly as well as electrically noisy as well as they make -- they're very inefficient from a power standpoint. And so a lot of these data centers now moving down the green trend are moving towards 3-phase fans. Our solutions and data centers have a full integration of fan-controlled technology, including communication back to the CPU, with all the necessary fault detection, cooling the ramps, et cetera, speed ramps, slowdowns, et cetera. So all the smarts are built into a single IC. Very well-accepted in the marketplace, we supply to most of the data center guys through leading fan manufacturers in the world. So -- and we're really happy with that. This is a trend that we see will give us continuous tailwinds in the data center space. But we do have other great little segments in industrial. Person mobility is one of them. The solar is another area that we participate in. It lines up very well with our green energy trial activities with current sensing, et cetera. So industrial for us is a great space. We've put some -- we've increased our efforts in this particular space, and it's showing up as results now.

And Ravi, I often joke that Wall Street's core IP is to oversimplify things, to try to get a better understanding of things. And I know you guys have struggled a little bit with how to characterize the "Other" bucket of revenue that you have because "Other" seems like a throwaway name. But as you and I have talked about, there's actually a lot of good businesses in there that are long-duration and actually margin-neutral to accretive to the overall business. So I would kind of be curious, if you could spend a moment or 2 just on that "Other" bucket and kind of the drivers there and how you feel about that business.

Yes. And John, thank you because we did talk about this. And we look at it in hindsight, and we maybe should have given it a sexier name. But our "Other" business is basically business that we generate from products that we target, that we have developed specifically for automotive or industrial. And so there's a bunch of different applications. It's leveraging our distribution organization. Our distribution organization services over 10,000 customers, many of them, maybe 10,000 units, 50,000 units, 100,000 units kinds of customers. And they could be anywhere from IoT applications that we can look at those and say, well, IoT in its own is, I would call, an "other" kind of an application, but it's a bunch of small things, thermostats, smart receptacles, et cetera. Sprinklers, smart sprinkler systems, for example, use our products. So there's a bunch of stuff in that particular bucket, but also white goods. White goods is a stable, long-term, secure kind of business. It's seeing a little bit of energy right now because of, again, the construction environment in the U.S. and the -- so we are seeing benefits from that. But also -- but then there's a bunch of, I don't want to categorize it as random, but it is like the application of the period. It might be selfie sticks, for example. Or there's a bunch of stuff like that, that comes up, that we have, and we have a robust organization that addresses these opportunities. These opportunities cycle through every -- they may have a 12- to 18-month cycle, but new stuff comes in, in that particular space because there's always a reason for use of our power products and our current sensing products, our linear angle sensing products, et cetera. So there's a bunch of applications out there. Wherever you have motion control in these other categories, we have products that are suitable.

Paul, during the roadshow, I know you guys had some out-year targets for EBITDA margin. I'm wondering if you can kind of remind us of what those targets were. More importantly, what's the revenue number you think you need to achieve them? What are the big drivers of incremental growth in EBITDA margin? And I guess I'm going to put you on the spot again. We talked about, in our initiation report, that when you look at the quality of the IP that you bring to bear and the gross margins you're able to generate, we look at kind of your multiyear EBITDA margins as still having potential upside over a longer period of time. And so are those targets kind of ceilings? Or are they sort of a breakpoint to higher levels later on in your life cycle?

So those targets that we talked about, John, are more over the medium term, over the next couple of years, to drive through some of the transformations to drive gross margin up into the mid-50s, to leverage OpEx as the business grows. We talked about what some of the top line targets are in that time period as well. And so what I think is when the company goes through those -- through that next phase over the next couple of years, we continue to -- it's not like we're going to be satisfied with that. I mean we continue to assess what other opportunities we -- other means or opportunities that we can to continue to expand. And I do think that once the company -- once the volume of the company pushes upwards significantly, there are -- those opportunities certainly have more legs.

Ravi, you mentioned earlier, in your first answer to one of my questions, some of the work you've been doing in LiDAR with the Voxtel acquisition. I'm kind of curious, so that's a business right now that's in investment mode. It's sort of consuming more OpEx than it's generating revenue. What's the path to sort of revenue growth there? And to the extent that there's a lot of investors on the line that have had hit-or-miss experiences with LiDAR, what's your strategy and why do you think it's differentiated?

Yes. So when I -- when -- just to, kind of, to digress a little bit, the philosophy of the company today is -- or it has been for a long time, that we invest in the long term. Our investments are not for the new. There is, of course, a normal product development, but there's always a portion of an R&D budget that's focused on the long term. So we could use our current sensing as an example, where we invested in current sensing over a decade ago, and today, it's put us in great positioning for our -- for xEVs and inverters. When we look at our xMR investment, the GMR investment that we've done, it is now starting to produce products that are putting us in great position for expansion of that particular segment. And when we look at LiDAR, we look at it as being the same -- in the same particular model, that right now, our goal is to be able to satisfy the long-range LiDAR requirements of the marketplace. Our long-rate LiDAR requires very high energy lasers to get the range. Today, the silicon bandwidth lasers in the 950, 980 kind of a nanometer range are all limited in terms of by -- for regulatory purposes because they damage the eye. And so they do not -- they cannot -- or it's very difficult for them to provide sufficient range to operate cars at high speed. There is another technology that the DoD has invested in, the U.S. Department of Defense had invested in over the years. And Voxtel participated with -- in that particular development. They've worked on something called 1550-nanometer LiDAR. The purpose of that is to be able to -- you can put a lot more power from your laser. You can sense a lot more range. It is a more expensive technology than silicon, but on the other hand, it provides performance for the safety critical. I mean it's essential for -- to be able to sense beyond the 200 meters, 250 meters, for cars to truly become -- move down the autonomous path. So Voxtel brings us that particular portfolio that we are in the process of optimizing for automotive grade. We don't anticipate significant revenue for the next 3 years or so. We do it, but we do anticipate that it starts becoming accretive at that point. In the meantime, our goal is to invest in it, industrialize it, see the market and get customers to embrace this technology space.

Well, Ravi, that's probably a good sort of stepping stone to talk about M&A potential overall. And I'm going to ask you from both sides of the ledger. How do you think about M&A going forward as a way to augment kind of what you're doing organically? But more importantly, it strikes me that given the quality of your IP, that Allegro itself could be an M&A target. I'm wondering if you could talk about kind of your aspirations on that front. And maybe it's a little bit unfair question because with One Equity Partners and Sanken being dominant shareholders, they probably need to be part of the discussion. But one of the questions that I get often is how do I think about the ownership of One Equity and Sanken over time. And so maybe as you address the M&A question, you can also talk about that ownership dynamic.

Yes. I mean our job as a management team is to continue to make the best company we can, okay? It's a shareholder's job and then the Board to guide us down the path for maximization of shareholder value. But at the end of the day, the true intrinsic value of the company comes down to what we can create in terms of execution, product road maps, et cetera, and operation -- operating footprints. So I will actually leave the whether we are a target or not to that particular statement. It comes down to the leading shareholders and whatever their philosophy is. They will help guide the -- and work with the Board to guide it down that path. But I would tell you that Allegro is also -- we're not averse in terms of acquisitions. We just want to be very introspective on that particular topic. We would like to continue down the path of making sure that our gross margins continue to improve. We have great organic tailwinds at this point. And so M&A would want to be accretive. It would want to be at least giving us line of sight that it could be gross margin-neutral for us so that we can continue down the road -- the story. We're a power and sensing company, and we don't plan to stray very far from that particular footprint.

Great answer to an awkwardly ordered question. With that, even adjusting for the technical snafu, we have come to the end of the fireside chat session. I really wanted to thank Ravi and Paul and especially everyone joining today for participating in this fireside. And Ravi, Paul, I wanted to pass along all of our wishes at Crédit Suisse that you, your immediate family and importantly, the larger Allegro family kind of stay safe and healthy in what's been a very challenging and trying 2020. I think I speak for all of us when I say we can't get a vaccine fast enough and get a return to normalcy in '21 quickly enough. But thank you very much.

Thanks, John. And the same likewise to the Crédit Suisse family and to everybody that's listening. It is a scary, strange time, but we hope we can make our way through this now safely. Thank you all.

Thank you.