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

Good afternoon, everyone. Before we get started, if you are a member of the press or media, please disconnect at this time. This is a restricted line. Any unauthorized party in this meeting or any unauthorized use of the information communicated in this meeting is subject to prosecution to the fullest extent of the law. Any unauthorized person, including the media that is on the line at this time, please disconnect. Please note, today's call is being recorded.

Good morning, everybody. My name is Gary Mobley. I'm one of the semiconductor analysts here at Wells Fargo Securities. I appreciate everybody joining us for our Fifth Annual TMT Summit. With us today, we have the management team from Allegro Micro including CEO, Ravi Vig; CFO, Paul Walsh; and Head of Investor Relations, Katie Blye. And I appreciate everybody joining us today. And I wanted -- since Allegro Micro has been a public company for just over a year, perhaps it makes sense for you guys to give us an overview of the company in terms of product portfolio, market focus and any direction you want to take us to start out with?

Thank you, Gary. I'm Ravi Vig. Thank you all for joining us. And perhaps what Paul and I can do is give a little bit of an overview of the company and our journey so far. So Katie? So Allegro has been in the -- has been in the semiconductor business for over 50 years and basically working on sensing and power devices. Allegro is what we are a fabless asset-light company with over 3,700 employees. The majority of them, almost 3,000 of them being located in the Philippines in a facility, which is an assembly test facility. Over 10,000 customers worldwide. As Gary mentioned, we were NASDAQ listed October last year, and we've gone through a 1-year journey. What makes us special is that we have 2 really well-focused positions, one in magnetic sensing, magnetic sensing is a $2 billion business space, where we are the #1 supplier in this particular space. We have approximately an 18% market share focused on the higher value in spaces that we hear. In magnetic sensing, what you do is you can provide speed, current angle positions of mechanical objects, current promotion controlled, inverters, et cetera. So you can configure magnetic sensors for a variety of electrification and motion control applications. Power devices, we focused our power portfolio very heavily on embedded power really, again, focused on 3-phase motors, motion control. We believe we're very good at it. We have great expertise in how to drive motors, how to keep them efficient, which is a major issue for the marketplace and for the customer base today, audible noise, et cetera. So -- and we believe in providing a solution-based product to the customer as opposed to less sophisticated drivers that the customer has to deal with. So -- and then we have the key markets we're targeting, xEV and ADAS in automotive. These are -- we are very large automotive players. About 2/3 of our business is automotive, 1/3 of our business is industrial and other. In automotive, great growth vectors in xEV and ADAS. We have another focus area in industrial, which really syncs up with our automotive business very well, electrification and motion control. And in industrial, we are focused on Industry 4.0, which is basically robotics, et cetera. We are focused on solar power, which is again electrification, wall chargers, the whole electrification systems for vehicle charging infrastructure, et cetera. And also when we start looking at data centers for cooling systems, the motion control systems required in data centers for cooling. So these are also very strong growth areas for the company. $591 million revenue in fiscal '21 with last quarter's revenue of approximately $194 million. Great year-over-year growth and over 10 years of operating profit. So gross margins have been improving. We are in the high -- in the -- we crossed 53.6% on a non-GAAP basis, well on our way to our 55% intermediate target. And moving forward, we expect to -- that 55% is just a stop in our journey to improve. So technology is key to what we do. BCD, our own proprietary BCD processes give us some advantages. We have xMR, which is a new magnetic sensing technology that we have released on top of our BCD wafers doing really well. And our -- both our magnetic sensing business and Power IC service pretty large TAMs that are growing at decent CAGRs. So a quick summary for the company, and we'll just open it up to Gary.

I appreciate the overview, Ravi. Maybe if I can switch gears and go to a topic that I'm universally asking my companies participating in our TMT conference, and that is the supply chain constraints that not only are characterizing the current industry conditions, but I think perhaps more so are constraining the growth potential or the revenue potential for automotive-focused semiconductor companies, which certainly includes Allegro Micro. And so maybe if you can just expand a little bit on some of the supply side constraints that you're dealing with, not only on the power side, but as well on the magnetic sensor side?

Yes. So we are -- we do embedded power. We do high-voltage things, well, from high voltage, I mean 12 volts to about 100 volts kind of power supplies. Runoff car batteries from the -- between the 12-volt battery and the 48-volt rail that's being introduced at this point. So these embedded power, embedded smart sensing that runs off these battery voltages requires fairly robust BCD processes. And these BCD processes run in 200-millimeter wafers, 180-nanometer alignment. Having said that, the 200-millimeter capacity is really not being expanded today. So there are challenges. The explosion in semis, basically all across both industrial as well as in automotive has really driven up demand. So we're all challenged. We see the challenges all the way through 2022, probably in entering 2023 at this point. Our benefit has been is that we've been on a long-term plan. So we've been working with our suppliers, UMC and TSMC over the past multiple years. And UMC is well in stride and shipping to us. TSMC is ramping as we speak, on previously contracted wafer ramp. So before this exuberance in the market. And so we've got capacity to support our mid-double-digit projections for the next fiscal year.

Okay. And so your December quarter guidance, which is your third fiscal quarter, your -- I believe, constrained and that's perhaps what's driving your expectation that revenue declines mid-single digit percent sequentially. But correct me if I'm wrong, you expect to make that up perhaps during the March quarter, is that the correct way to think about it as we wrap up the second half of the fiscal year?

Yes. So the December quarter was affected by a onetime event in Malaysia. Malaysia is a major source for assembly of IC packages and they are also a source for us. COVID greatly impacted Malaysia. There were hard lockdowns in factories, et cetera. We lost production due to COVID in the -- during the month of September, and which has affected available supply for this particular quarter. Malaysia has done -- as a country has done a really good job of bringing up the vaccination rates. These factories are now fully vaccinated or as fully as you can expect. And so we don't see -- and they're running back at normal rates. So this is a speed bump at this point, COVID-related speed bump. We expect a next quarter, which is our March ending quarter to be back at the normal growth trajectory that we were on. We don't see any road blocks to that today, okay?

All right. Well, one thing we continuously hear about is transitory inflation, well, arguably, it's transitory, maybe even permanent inflationary pressures on the semiconductor supply chain. So my question to you is have you been able to pass along these price increases? And can you give us some sense of the magnitude of the price increases that may be acting as a tailwind for your revenue in calendar year 2022?

Do you want to take that, Paul?

Sure. So we've been able -- there have been cost increases -- input cost increases throughout calendar '21. They -- many of them were not as publicized as TSMC's wafer price increase for calendar '22. But we've been able to pass on these cost increases to our customers where it makes sense and with the intention of keeping this at a margin neutral at a minimum. So -- and with the visibility we have into the cost road map over the next 18 months, that's all been comprehended into that process. We have not explicitly stated what any price increases would be than not blanket price increases. They are very -- they vary based on the nature of the customer.

Okay. Appreciate that, Paul. How long until you might be in a position to restock your distribution inventory. I know it's been below your historical target ranges. But when would you expect that supply situation to perhaps eventually catch up with demand?

Paul?

Sure. where we are in distribution is well below our desired levels for inventory. I imagine that's the case for many of our peers too. I don't really foresee any improvement in inventory positioning or, i.e., the inventory will stay lean in the channel and stay lean on our books as well for the foreseeable future because essentially any supply we get, we will service demand with that. So -- and that's what we've seen over the past couple of quarters as well.

Okay. Well, as it relates to supply, I know that historically, you've sourced from Polar, which at one time was part of Allegro Micro. More recently, you have been sourcing from UMC and as you pointed out, increasingly at TSMC. Could you talk about how you've been able to fulfill demand upside amongst those 3 different fabs? How that has impacted the gross margin? And then longer term, the magnitude of the cost of good decrease once you're more fully sourced from UMC and TSMC versus Polar?

Sure. So we have 3 foundry suppliers today, UMC, who we've had for 5, 6, 7 years. They supply more than 50% of our wafers. We've had Polar for a long time. As you pointed out, Gary, they were part of Allegro until we divested them. And then we started an engagement with TSMC about 3 years ago. And we expect that to be a more meaningful portion of our wafer supply in the next fiscal year or in calendar '22. What we've also seen is -- throughout the past 2 years is a significant migration in gross margin from 40% when we had Polar to 50% to the 52%, 52.5% range when we consolidated our internal back end into one. And what we -- and then what we see as our -- getting to our target of 55% is we're making good progress there. We were 53.8% last quarter. It comprehends the fact that Polar wafer is more expensive. But longer term, 55% is a milestone, and it isn't necessarily the endgame. We believe that as the mix of products from the emerging growth vectors of xEV, ADAS and certain aspects of industrial, as those become a larger portion of the company, those have naturally have a higher margin. And so we'll get some sustainable lift in margin from that product line there. We'll also get the benefits of some scale and utilization. And over the longer term, we will -- as UMC and TSMC, the predominant wafer supply, they will -- that will have some margin lift as well.

Okay. I appreciate that. It sounds like there's a lot of leverage to the gross margin improvement. I wanted to shift gears and talk about the types of conversations you're having with your customers, such as Continental. There has clearly been a shortage of semiconductors in the automotive industry, which is elevated discussions with semiconductor companies in terms of priorities for not only the Tier 1s, but the automotive OEMs. So I'm curious to hear from you what sort of feedback you've been getting from the Tier 1s from the automotive OEMs in terms of how they're going to manage their supply chain going forward? Will we eventually reach a new normal in terms of the amount of inventory they're willing to carry of semiconductors given the shortage that we've gone through over the past year or so?

Yes. We have been in conversations with our customers, both the Tier 1s and the Tier 2s. Our product portfolio is so diverse that we at the end of the day, we have to service the car manufacturers and who buy from so many different levels of the supply chain. And in most part, we found our customers have been understanding, they're willing to partner at this point. They're willing to -- they appreciate that the supply chain in semiconductors is overly stressed. They appreciate that they need to -- that we all need to adapt to what's going on. So they -- we are signing up for long-term agreements with them in terms of demand, in terms of making sure that we don't have -- we have only what they absolutely need on our books. We've done some cost sharing with them to pass through these costs. We are securing multiyears of capacity from our foundries, which is different to start talking to customers about multiyear kinds of agreements. So they are -- we're finding that our customer base for the most part is remarkably cooperative and understanding that we are in a new reality that we need to fix. This is not an easy situation. They will obviously like to build inventory. There's just no capacity in the semi supply chain today to provide inventory. We are being awfully careful about feeding into inventory or into inventory situations versus feeding to pure demand. At this point, our demand far exceeds supply. So we've got to be very discerning in how we deliver our products.

Okay. Ravi, I want to get your opinion on one of the greatest debates amongst investors as it relates to investing in the automotive semiconductor market. That is the divergence between automotive semiconductor sales levels and growth compared to something that is completely different in terms of light vehicle production, light vehicle production being down more than 15% from pre-pandemic levels, but yet automotive semiconductor sales more than 25% elevated above pre-pandemic levels. Why the divergence? And is it explainable by building of inventory in the supply chain from your perspective?

Yes. The thing about automotive is that the supply chain is so long, it's so lengthy, that goes through so many different tiers that looking at anything that happens within a single quarter is -- does not tell you the true story. The simple math of vehicles divided by or revenue divided by vehicles doesn't really work out in a single quarter. We have to look at the long term. But you know that you're coming into COVID was a big pullback here. 2019 was a big pullback here for auto semis. Inventories were pulled down far below car production levels. Coming into 2020, with the -- with COVID, as inventories were pulled down even more to a point where it was not sustainable to even operate production lines. So today, we are just simply talking about bringing production lines to a stable state where they have enough whip in place to ensure smooth operation, which is a little different than building inventories upfront. So that's the first thing that's been happening. But from an Allegro perspective, we've been awfully cautious in terms of making sure our products are going to demand. So last quarter, our automotive sales actually declined quarter-over-quarter, 6% versus car production of 15%. And we were much more -- we were discerning in that we wanted to make sure that we were not -- we were allocating or directing our material to where actual production needs were, both in automotive and industrial, both which had great growth vectors for Allegro. But as time goes on, we'll start seeing that car production that was impacted by Malaysia dramatically last quarter, we'll start popping back up again and demand is coming back up. We're seeing car lines are running full steam at this point. So we'll see car -- semi demand, again, continuing to accelerate. And the key thing is that you keep -- every time you look at it, you see the acceleration of both ADAS and xEV in automotive. You start seeing more and more platforms coming out, the volumes increasing. I think Europe was almost 20% last quarter for xEV, which is quite incredible, right? I mean for battery, plug-in hybrid and battery electric, which everybody was expecting it to be in the low single -- low to high or mid- to high single digits. So there is an acceleration, consumers are accepting it. Features are accelerating in vehicles. So all of which drives semi content.

That's a good way to transition into the next topic, and that is electrification of the automotive powertrain and ADAS features. So I was hoping that you could compare the amount of content that you're winning in an EV platform or an ADAS rich vehicle versus a feature less internal combustion engines, say, from 5 or 10 years ago? And for your automotive business, which is more than 2/3 of your total revenue, how much of the growth is being fueled by content gains versus the cyclical tailwind that characterizes the overall automotive semiconductor market?

Yes. So when we start looking at electrification and ADAS, couple of simple statistics. When you go to a full battery electric vehicle versus a plug -- versus a gasoline vehicle, our Allegro content increases of semi increases about 50%. And one of the reasons is that when you may replace the combustion products that we provide, like crank sensors and camshaft sensors, those would go away. But what they get replaced with is inverter current sensors. Now in an inverter, you could have anywhere between 6 to 12 Allegro current sensors in it versus up to 4 engine sensors in a gasoline engine. You get an onboard charger, which may have 3 to 5 current sensors in it. You get a DC to DC converter, which has a couple of Allegro current sensors in it. You get the wall charger that comes in, then of course, you get the base -- the charging infrastructure that is also being there. So there is -- electrification is really aligned with Allegro's key strategy and Allegro's key products. And when we start looking at electrification, it also brings up new things like it reimagines the platform -- of the vehicle platform and architecture. You're going to start seeing EMB, which is breaking on wheel as opposed to a central single braking system, which will create 4 motors, one per wheel. Just the growth potential for motion control in the safety-related side of it is great. And that's where we play. So ADAS, electrification, they just intersect the way we're reimagining the vehicle, and it's really lending itself to power management as well as to motion control, both of which are key strengths of Allegro.

Thanks, Ravi. And switching to the power side of the business, I think that's probably one of the more underappreciated elements of the Allegro Micro story. So maybe if you can expand on what type of growth you're seeing there? What the long-term growth expectations are? Is it margin accretive? And anything you can share there?

Yes. So when we came public, the market narrative for Allegro was or market expectation of Allegro was we were a sensor story very heavily anchored in automotive. That's -- and our narrative back to the investors was: "Just wait. Our investments in power and in industrial are going to bear fruit." And what we are seeing now is a constant acceleration of both of these areas. So when we look at power, over the last 5 to 7 years, we redirected our power portfolio from low-tech power, which is basic power drivers as well as power focused on office automation, which is really a low growth, high churn, low-margin business to embedded power where we embedded motion control algorithms or safety feature sets, self-diagnostics, et cetera, into our parts. And we tapped it towards where we felt was the growth area, which is 12 to 100-volt kind of power in these particular areas. So we are seeing tremendous growth. Last year, our Power business grew year-over-year despite the semiconductor industry being challenged. And this year, we're continuing to see great growth. We are shedding. We have finally shed our old office automation business, which was a burden on the overall growth statistics of our power business. And power now is well underway. It's mid-double-digit growth. It's -- we were able to get great margins for the value we provide because we are, again, focused on embedded motion control. We're focused on providing IP to customers as opposed to pure power drivers. The last quarter, we announced that we had secured 3 major contracts -- contract with 3 major cooling system providers for data centers for -- and these are the 3 major [ fan ] guys that supply to every one of the large data center providers and cloud service providers. So we're doing really well in that particular space. We're going to continue to see acceleration in the coming year in this business.

Okay. Appreciate that. We only have a minute or 2 left, but I was hoping that you can give us an update on your LiDAR initiative. I know it was a small initiative. Is that still alive and well?

Yes, it's still alive and well. We are a component guy. LiDAR, despite the hype is going to be Level 4 and 5 at 2024, 2025 kind of start-up of a business. So we've been holding that consistently in our conversations. Allegro tends to invest in the long term. In the long run, Automotive is a long -- it's not for the faint of heart, automotive investment. You really have to be prepared to be in this for the long haul and ride through the ups and downs. So we're continuing on our road map in LiDAR. Products have come out. We have sampled the first products to a couple of lead customers. We continue to industrialize the portfolio as we speak, and we'll see more products coming out early next year.

Appreciate that. Okay. I think we're running out of time. So Ravi, Paul and Katie, I appreciate the time you gave us today, and best of luck for the rest of your participation in our conference. Thank you, everybody.

Thank you.

Thank you.

Thanks, Gary.