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

All right. Thanks for joining. I'm really excited to have our next presenters, who recently completed their IPO. It's Allegro. From the company, we have Ravi Vig. He's President and CEO; as well as Paul Walsh. Since this is a new name to many people, I thought maybe I'd take it over to Ravi. When I do get into the questions, if you do want to send me a question, I can try to work it in my script. [Operator Instructions] But I'll turn it over to you, Ravi.

Thank you, Blayne, and thank you, Barclays, for inviting us out today. I'm really pleased to be able to present the Allegro MicroSystems story especially to those of you who don't know us. We're a company with a rich history in semiconductors. We've been in the business of power and sensing semiconductors for over 30 years. Long history, but also considerable scale, unique asset in the semiconductor space. Number one, market share in magnetic sensing. It's a $1.8 billion space, expected to grow at around 13% in the Automotive and industrial spaces, which are our key markets. Also a growing market share in our power ICs, motor drivers and regulators on motion control systems. So the sensing and power businesses tied together quite nicely in the space of motion control. We spent the last 4 years since I've come on as CEO of undergoing a transformation of the company. We've been transitioning from an IDM basically one that had wafer assets, wafer fab assets as well as multiple back-end assets, and transitioning it into a product development-focused company, an innovation company that's been now focused on becoming an fabless asset-light -- operating on a fabless asset-light model. Great impact to gross margins, over 1,000 basis points improvement over the last 4 years on gross margins as a result of these initiatives. But also great technical flexibility as we've brought on some incredible foundry partners like UMC and TSMC, specifically those that have been helping us also with our next-generation technologies that are customized to our applications. Already seeing benefits in the application of disruptive technologies. We're very well anchored into Automotive. Automotive is a key area. We like to say we were doing automotive semis before automotive was cool. It's a space that we've been -- we've got a long history in, a lot of great experience in. Great tailwinds in automotive at this point with an expectation of SAR over the next few years, growing at around an 8%. On top of that [indiscernible] continuous anchored on xEV vehicle electrification as well as autonomous driving. But in addition, we have significant industrial play in data centers as well as solar, Industry 4.0, et cetera. So as we continue our journey, the IPO was a pause, we'd likely like to say internally. We continue our journey on enhancement. So we continue down to our gross margin model of acceleration of gross margins as well as acceleration of growth rates. We continue to leverage our scale, our profitability, our rich history of profitability as well as expanding our blue-chip customer base and continuing to increase manufacturing efficiencies. So we believe we have a great story, and we welcome additional questions on this plain.

Perfect. And definitely, lots to dig into. Very unique that you have such a high exposure to auto. And yes, I agree, not always cool but definitely very hot space as electrification as well as things like ADAS layered in. Curious just overall, clearly, the global auto market, you had a software in '19 and then obviously, we had a pandemic. Can you just give us an overview? We've seen a sharp recovery kind of midyear. So just walk us through that. I think you've seen your numbers, you've recovered quite nicely. But just give us a perspective where that supply chain is? Is it still recovering? And then you talked about getting back to a growth number in the marketplace.

Yes. Great question, Blayne. So when we look at the auto market in the April, May, June, the June ending quarter, there was a lot of depression in the marketplace. The forecasts were continuing to decline. Car production for the year was expected to go drop down with a worst-case scenario, way below 70 million vehicles when a typical year was around 90 million vehicles. And so this dramatic decrease really impacted most semi companies in this space. But In August, we started seeing signs of recovery. We -- dealer lots were sitting at the low end of their targets. Car lines were starting to accelerate production. We saw some inventory overhang in August -- July, August. But starting August, we started seeing an acceleration in our order rates. And the order patterns are great. They're really extraordinarily strong. Automotive production has been constantly being upsized and upscaled as in terms of forecasting. Our job now is to try to parse out what is a supply chain rebuild versus what is true demand that's going on. But clearly, we have -- we are benefiting from extraordinarily strong auto patterns.

And then recovery aside, I think the good about autos is that -- the bad is that it's very hard to get in. The good is if you're in, you have really great visibility into your pipeline and program. So maybe you can just walk us through that. I'm sure you don't want to quantify it, but just give us a feel for how far your visibility extends out? What type of programs and trends you're excited about?

Yes. In the near term, in the near area, we typically have visibility. We're 80% to 90% booked for a quarter. So from a near-term perspective, we get great visibility out. Of course, right now, we're an inflecting market, which is continuing to show strength in demand. But we do get great visibility in the 1 to 2 quarter out. Long term, as you've stated, Blayne, auto programs are -- they really are an exercise in determination, I guess, when you're working on them. We work on them for multiple years in terms of development. The -- usually, what we work on a safety critical applications. So they go through a lot of certification, both internally in our company as well as our customers. And -- but once these programs are won, these platforms, and by platform, I don't mean a car model. I mean a steering system, for example, or a braking system. These particular -- or transmission system. These particular platforms go across multiple car models. They stay and they run for 7 to 10 years typically. And so -- and it's not the car manufacturer as well as our customers are not incentivized typically to change. It is extraordinarily difficult and expensive. So we get great visibility. We know what the programs are. We -- our 3-year forecast that we provided to the marketplace had -- is about 90% secured on one business today. So -- and we have plenty of stuff in the pipeline to achieve the forecast. So great visibility. We like to call auto an annuity in parts because once you are in a program, it generates the cash for you to invest in the next long-term investment because for a new entrant, overcoming that barrier is very difficult.

I wanted to ask about some of the trends driving content. Electrification is a big one. You had in your deck a slide, I think it was average content is maybe 50% higher on an EV vehicle versus ICE -- combustion section. Maybe you can just walk us through that a bit, talk about the types of components that you're in. And then any perspective on your share within this opportunity?

Yes. So electrification is a wonderful trend for automotive. We have seen that as the economy recovers, most of the Western governments are -- as well as China, are incentivizing electric vehicles over internal combustion. We hear from the marketplace that many car manufacturers are saying the next couple of years will be the last internal combustion -- new internal combustion engine designs that they're going to be doing. So it's really critical for a company like us to be anchored in electrification. About a decade ago, we invested very heavily in a current sensing portfolio. Magnetic sensors are -- can be configured to measure current. They provide great advantages, providing lossless current measurement. And we initially designed them for motion control, but now they're very well applicable to inverters. Main motor, for example, requires an inverter to help provide power to the various bindings. The DC-to-DC converter in the car, bringing the 600-volt battery down, the onboard chargers, the battery chargers. And then there's a whole bunch of other safety applications like leakage measurement in the charging cables, for example, the charging disconnect in case of an accident. So there's a whole bunch of other peripheral applications that go into it that are very suitable to our current sensors. We believe we have deep innovation, deep patent technology. We're on multiple. We are sitting in on a second or third generation of current sensing products, whereas our competitors are just getting into the market space. Rich history, rich IP, rich know-how. An example is -- there's a great example of a vehicle that was an SUV that was the vehicle of the year last year in the U.S. Standard model, which was an internal combustion version, had $17 of Allegro content in it. The battery electric version of the same vehicle had $25 of content. The SAM itself in the vehicle went from $37 in that particular space to $59. So we're very well anchored. Electrification also brings these peripheral applications, like when you turn a car on in an electrified vehicle, you hear nothing. And silence becomes a really big design factor, so motion control, fan drivers, cooling systems, et cetera. We are very well anchored to those. So we feel very good about this space.

I do want to ask you a similar question. ADAS is the other trend to focus on in autos. Clearly, virtually every car is going to have some flavor of it, and obviously, it ranges from park assist to fully autonomous cars. So maybe if you want a similar question, walk us through your opportunities there as well.

Yes. So we like to break ADAS out into 3 core elements. One is the sense, one is the think and one is the act. The sensing functions are the camera, the radar and the LIDAR. The thinking is the CPUs. We don't participate in that particular area. And the acting portion is the steering and braking systems. And what's not very visible to the market is that the acting systems, the steering systems, for example, the complexity of these systems is increasing quite dramatically. These systems, which were previously 100% controlled by human intervention, now have autonomous features to them. So they end up driving based on what the CPU tells them. They may turn the wheels. They may brake the car, slow the car down. So the precision of performance of these systems has gone up as well as the safety requirements has gone up. So a wonderful narrative for us is that the truck of -- the U.S. truck of the year, the 2000 model, we had there steering system semi components in there. $4 of content for Allegro. The 2020 model, $12 of content. Not every vehicle sees this kind of 3x acceleration. But the reason in this particular vehicle is that it went off to a boat launch. You press a button, launches a boat. So automatically had functions. We had a great example of a vehicle, actually a Hyundai vehicle that was in the Sonata that was in the Super Bowl ad, and we -- it was near and dear to our hearts because we're a Boston-area company, and the peak rates were in the Super Bowl. It was great. The smart park system showed the car back up automatically and park itself. And our components were in that steering system. So we're really excited about this. But more importantly, we've made a long-term play. We've invested in photonics. Photonics is an ICE photonics. This will be a long-term LIDAR play for us. We really -- we feel really good about the acquisition that we just made in Voxtel. It will help us with driving -- creating this innovative portfolio in this space.

Yes. So I do want to ask you about the competitive landscape. I think many people maybe have not focused on magnetic sensor space. And there are a number of players, but I think the list is a lot shorter in auto. So maybe you could just talk about the competitive landscape and when you win, why you win.

Yes. So we have the -- we believe we have the broadest portfolio in the marketplace. We are -- we've been doing magnetic sensing for decades. And so we have a rich history in products, both in the ordinary end, the switches and latches. This is a more conventional types of products, but also in the high innovation space. So our investments are really in the higher innovation space. We find that our products operate at a higher complexity level. They integrate a substantial amount of IP and algorithmic IP. There's great expertise in operating these devices at high temperatures, 175 degrees C, 190 degrees C kinds of applications. So all of this allows us to provide value to the customer. We provide solutions. And it's not just a component, but our components have embedded IP that solves customers' problems. And as a result of that, when we work very closely with our customers, it becomes -- solutions become quite sticky. When we look at the competitive landscape, we do have competitors, some of them that are working in the broad market space. In the consumer space, we don't tend to work in that particular space. The ASPs are much lower. The margin profile is much lower. That's not an area where we've really targeted our R&D. We tend to work in automotive and key competitors such as Melexis, Analog Devices, PI and Infineon are there in that particular space, so. But we feel like we have an extraordinarily strong portfolio, and we compete very, very well with our IP.

I do want to ask you on that differentiation. You invested in XMR technology. You have products -- maybe people probably not understand what that is, but maybe you can talk about where that's a differentiator in your portfolio?

Yes. So XMR is a technology. So GMR, TMR are really technologies that were developed with the hard disk drive market that was sensing 1s and 0s on a magnetic platter. We've taken that particular technology, and we've optimized it to sensing. Sensing requires more an analog kind of a configuration of GMR, TMR rather than the pure digital configuration that was. When we've taken it 1 step further, so we've been able to take this and deposit this GMR, TMR on top of a silicon wafer and integrated directly on top of our components. So it allows us to increase our complexity of our solutions and tries -- allows us to improve the reliability of our solutions. It empowers us, allows us to reduce the form factor of our solutions. We're 1 of 2 companies that has this particular capability today. We're shipping already. We shipped over 20 million of these units already in the market. It's a long-term play. Again, you'll notice that, that's the history of Allegro's technology investments. We invest in the long term. We're ready now. We're ready to see the market accept this broad portfolio for offering that we have.

So I want to ask you on the other end market of focus, industrial is a very broad category, I think, even data centers within that. So maybe can you walk through the opportunities on the Industrial side, too?

Yes. Industrial is great -- it's a catch all in many ways. It's a -- for us, it's a series of smaller plays. We focus our efforts in motion control. And in motion control, cooling systems for data centers has become a major challenge as the capabilities of data centers and the CPUs increased, the cooling challenges become more and more difficult. So we've invested in 3-phase sensorless motion control. So our products offer full fan control IP inside the single IC, including the power drivers, et cetera. So what we end up doing is replacing a multichip solution where competitors might use a microprocessor plus power drivers, and this creates a much larger PC board, allows our customers to reduce the form factor, be much more efficient and also lever their engineering. So we provide a plug-and-play solution, whereas in the past, they had to go develop their own IP for each fan. It's a great space. Cooling in a data center is moving from single-phase fans to 3-phase fans. Three-phase fans is what we're in. Data centers themselves, the cooling requirements are increasing as well as the conversion rates increasing. So we think it's a great growth vector. But similarly, we have Industry 4.0, great catch-all word again. But motion control is a big part of it in robotics, for example. A lot of major robotics manufacturers are using Allegro products in that particular application. So when we start looking at -- solar is another area, personal mobility is another area. So when you start looking at all of these systems, Many of them have motion control elements or power efficiency elements. These are the 2 areas that we focus our R&D on.

I do want to change. If you look at instead of by end market, by product, power is about 30% your total revenue. It's actually grown at a pretty nice clip, double-digit rate over the last 4, 5 years. You did highlight power kind of intermingle when we were talking on these end markets. I mean the question I got on IPO a lot is why is this company successful? There's lots of bigger companies in power. And I think maybe I answered some of it by just kind of -- there's some synergies with the end market. But maybe just walk us through where you differentiate with your power products? Why are you in power and why you've been successful?

Yes. So I always want to talk a little bit about the company's philosophy. So our key tagline is innovation with purpose. And we don't really intend to participate in product segments where we cannot bring in innovation and bring value into it. So when we look at power, we restructured our power portfolio about 5 to 7 years ago to move away from the commodities as well as from the ASIC strategies that we had for decades in that particular space that were dragging down the growth as well as dragging down the engineering resource optimization and usage, and we refocused the power business into value-added IP, solution set IP. So our motion control systems are outstanding. We have great motor IP. We know not -- we don't just provide the drivers for the -- for motors. We have the IP that helps the motor spin in many cases, that helps detect failures, that help protect the motors. So all of this IP and also does this -- and it's very -- much of it's targeted at the end market. So in Automotive, we're heavily targeted at this particular space. We knew electrification of subsystems, which is before the electrification of the vehicle, It's low subsystems like steering and braking started becoming electrified. We attack those segments very early in the game. So we're already there. So when we speak about our power steering applications, we have an equal amount of content of motor drivers and regulators and PMICs in those spaces as we do in sensors in those particular spaces. So our power space, the value that we provide has provided us differentiation over our competitors. The focus we have in this particular space allows us to really deeply innovate. And our customers really accept that, appreciate it, and the results are showing. The growth is grossly outperforming the market.

And then you did mention your photonics and Voxtel acquisition. Obviously, it's not a huge bet, but obviously a huge market. If you look, there's 2 public competitors through specs already with massive valuations, probably another half dozen in the works that may go public that out as well. So I'm just kind of curious, where do you see the opportunity? It's a big opportunity, but where do you see the opportunity for Allegro within this market?

Yes. So let's kind of level set what we do, what we intend to do in photonics. We are a component manufacturer. We're not going to be making LIDAR systems. But we know that there is a component challenge. It's -- the underpinnings of LIDAR systems are great components. And we know that there's a component challenge in this particular space. So when we start looking at the long-range LIDAR, one of the greatest challenges has become detecting at the 200 meters and greater sub and the ability to detect very small objects at those businesses. We acquired Voxtel. The Department of Defense had known this as a problem for the last decade. They'd invested in the whole ecosystem of smaller companies, Voxtel being one of them, to develop these technologies using exotic semis -- semi materials. In our case, Indian gallium arsenide, specifically to operate in what we call an eye-safe range. Eye-safe LIDAR is critical because you can increase the power of the laser, which allows you to detect it further. Voxtel has got a great suite of products. We're now in the process of optimizing it. Our goal is to leverage this deep innovation from Voxtel, leverage it and provide the value to a great customer base. So we are a global company. We have customers all over the world. Our global breakout is second to none, I would say, in terms of our customer base, and we intend to market it across the world to established automotive suppliers as well as the newer entrants into this particular space who are going into LIDAR. So It's a long-term play. We don't expect revenue for the next couple of years, but we do expect a level 4, level 5 LIDAR system to start coming on in the next 2 to 3 years.

Time for one more question. I want to make sure to involve Paul. Margin has been a great story. The divestitures are in the rearview mirror. Maybe just walk us quickly through what that entailed? And then the bridge to the 55-plus gross margins, you walk us through that as well.

Sure. Yes, we divested, Polar, Ravi mentioned Polar at the very beginning of this. We divested Polar at the beginning of the year. That really moved gross margin up from basically 40% towards 50%. That was significant. What we also have underway is we're consolidating the back end. So we have a factory in an assembly and test facility in Thailand and in Manila. The Thai facility consolidation is on track and is expected to be complete by the end of our fiscal year, which is March. And that will add -- that will create some -- just the elimination of fixed costs, so that will create an uplift in the coming couple of years. And then over time, we've got -- whether it's continued efficiency gains from a larger scale, a single factory, or just the growth engines of products that are newer products. And those are typically targeting much higher margin profiles and they're targeting basically foundry support. And so those are just a quick synopsis of some of the levers that can -- that will help us get towards the mid-50s over the next few years.

Well, perfect. Well, Ravi, Paul, congrats again on the IPO, and thanks for joining. Take care.

Thank you, Blayne, and thank you for your time, and thank you, everybody.

Thank you.