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

Okay. We'll go ahead and get started. Welcome everybody to the third day of the Needham's 24th Annual Growth Conference. My name is Quinn Bolton. I'm the semiconductor and semiconductor capital equipment analyst for Needham. It's my pleasure to host this fireside chat with Allegro Systems. Allegro is a leading supplier of magnetic sensors and power ICs, targeting the automotive and industrial markets. The company holds the #1 share position in magnetic sensors worldwide as well as the #1 position in current sensors. We believe Allegro is well positioned for a recovery in automotive production and also for growing content per vehicle driven by the trends towards safety in ADAS as well as electrification. Before I hand the presentation over to Ravi for a couple of introductory slides, I just want to remind investors, if you do have a question, please submit those questions at the bottom of your screen in the ask a question dialogue box. Joining me for the fireside are Ravi Vig, President and CEO; Paul Walsh, CFO; and Katie Blye, Senior Director of Investor Relations and Marketing and Communications. With that, let me hand it over to Ravi.

Thank you, Quinn. And thank you, everyone, for joining us. We will start this session with a few slides just to get you a normal view on the company. And after that, it will be opened up for a Q&A. Just as a high level view of Allegro. Allegro has been in the business of semiconductor business for over 50 years, and with 3,700 employees, many of them in our facility in the Philippines. Great customer base, so with 10,000 customers. And just recently, about a year ago, a little more than a year ago now -- time flies, we were listed on NASDAQ and right through the pandemic, and it's been a great ride ever since. #1 leader in MAG. Why is that important? It's a $2 billion business, but it's also integral into the electrification story, both in vehicles but also in solar. So the MAG portfolio that we have is extraordinarily valuable in that particular space. Our power IC business has really been tacked towards the embedded IP. So it is smart power where we would integrate various solutions, various IP into the part along with the power drivers, deep rich history of patents and IP. As a company, our most recent quarter was $194 million, and our gross margin story is a pretty good one over the last 4 years, and we've been going through a transformation of the company. We've improved the company over 1,000 basis points at the point of IPO and which brought us to close to 50% at that point. And since IPO, we've continued down the march of improving our gross margins, where in the last 4 quarters, we have improved gross margins almost 400 basis points. So it's been a great progress for the company. What makes us tech is that we're not -- we're really a broadly diversified company with top 20 customers, having about 50% of our revenue. No one customer is more than 10%. So it gives us a little bit of stability in terms of our customer base. But more importantly, we've got over 10,000 customers in our distribution channel, which we service through our distribution channel. And that's really important because those customers really offer us their lower volume customers and because of the price volume curves, they offer us about -- up to 10 margin points better than OEMs. In terms of also in diversification, we think we believe we're pretty unique. We'd like to call ourselves 20%, 20%, 20%, 40% in approximation, 20% North America, 20% Europe, 20% Japan, 40% Asia. It's a little bit different based on which quarter we're looking look at. But you know the interesting thing about Asia, ex-Japan is that it's only half of that is China, a little more than half. So again, there's diversification in Asia and Korea as well as in Taiwan. Next slide, please. Three great portfolios that we have. MAG. MAG really addresses 4 different core application sets: Measuring speed, which may be gear speed or ring magnet speed. Measuring position, which is both a linear and angular position of a motion control system. Measuring digital position of a motion control system as well as current measurement, which is our really exciting portfolio that we have. What makes us tech great new tech. We've got a history of innovation, whether it's in the current sensing area, where we have the broadest portfolio with the most innovative solutions out there or the next investment that we've made, integrated GMR and TMR and silicon. And why that's important is that come to 2030, the analysts are forecasting that 40% of the MAG business will be GMR or TMR. So that's a wonderful investment on our part. So when we look at the power business. Again, embedded motion control is really an area that's been embraced by our customers where we make the solution set much simpler for our customers. And when we start looking at this, whether it is brushless DC motors or whether it is in the DC-to-DC LED driver area both of these have an extraordinary TAM. Our power business is growing roughly 2x the market, which is, again, an area that we are really proud of. And finally, we've made a long-term investment in Photonics. This is really for Level 4 plus LiDAR systems, front-facing LiDAR. It's 1550 nanometer complete solutions that we provide. We're a component play, not a LiDAR systems play. And so that -- and we are in the process of industrializing the technology that we acquired from a company called Voxtel that is now part of Allegro. So why -- when you start looking at our markets, we win when cars electrify. We expect that our xEV market will grow beyond market expectations. xEV area is expected to have a 26% CAGR, which gives us great tailwinds. Our current sensors are in inverters, onboard chargers, battery charges. For example, an inverter may have anywhere from 6 to 12 sensors and each main motor, for example, a dual motor system will have 2 sets of inverters. So each main motor will have -- could have a Allegro current sensors in it. We believe we're in 1 of every 2 inverter systems in automotive at this point. So again, great established presence, really well anchored and growing. ADAS is really a sensor thing to act kind of a system. Sensing is a camera piece of it, and we already spoke about at Photonics business where we are making a long-term play. But our real play is really today is in the [ ACT ] area where sophistication -- system sophistication is increasing for steering and braking systems because when the CPU tells the car what to do, the steering systems have a self-drive where the braking system has to brake. And so the safety aspect of it really is changing. It changing these systems dramatically. Again, ADAS Level 1 plus is growing at a 42% incremental rate. When we look at Allegro's business in this -- for example, at Ford F-150, the 2017 model, which was not a Level 1 plus vehicle, had about $4 of content. Now 2021 F-150 has up to $12 of content in the steering system. So not every vehicle has that kind of incremental increase, but that really indicates our Allegro's content growth opportunity in these particular systems. Next slide please. Finally, when you start looking at data centers, this is a great area where we've been able to combine the tech that we developed for automotive, 12 volts to 48 volt kind of tech and apply it to similar applications in data centers, which is highly efficient cooling systems, 3-phase fan drivers and embedded motion control. We recently announced that we've secured long-term contracts with 3 of the largest cooling systems manufacturers, who service data center providers, cloud providers, and we are in the process of ramping. We believe this is going to be impactful for us. And green energy, personal mobility, no one large debt, but there is a bunch of smaller applications for us that go anywhere from the Roomba vacuum to solar power to industry various factory automation, et cetera, applications. Next slide, please. Finally, Paul and I, we've had a really great run together. Paul has been really -- we've been tied at the hip for a bunch of years. Paul's decided that he would like to pursue some personal goals and retire. And it's -- from my perspective it's, we've really had a great run, and so we'll miss Paul tremendously. But we're extraordinarily excited about Derek coming on. Now we had a long search process to look for Derek. We think he fits in really well with the company our size. He's got the right mix of being able to roll up his sleeves and dig into the financials, but also has the right exposure to public company environments as well as through M&A as part of a much larger organization. So we look forward to Derek really helping us get to the next phase in our company. And with that, I'll turn it over to Paul. You're on mute, Paul. Yes, good enough.

How about now? Is that better? Yes. Yes. Sorry. Yes, we have begun this transition. I've had a number of professional and personal goals, and I feel like I've attained those. This is an ideal time to begin the transition. We've established a really strong financial foundation as a company -- as a public company. We have an excellent team of professionals internally in all aspects of finance. And so I think this is an ideal time to turn over the reins, and it allowed me to pursue different personal goals going forward. And I think there's a great opportunity for Derek, and he -- you are in good hands with him. So just a quick snapshot of where we are. The Q2, that was our September quarter. We're in fiscal '22. For those of you who are less familiar with us, we had a great quarter in the September quarter of $194 million. We hit gross margin milestones of just shy of 54% and EPS of $0.20. That was above -- all of that was above consensus. For the December quarter, we guided down as we had -- we were impacted by some COVID shutdowns in the month of September, which impacted our December quarter, COVID shutdowns in 2 of our assembly subcons in Malaysia. They are since fully recovered. Those factories are at extremely high vaccination rates, and we are back on track in that regard. But the revenue guidance, you can see that we had there was a $182.5 million was above flat for gross margin and about $0.18. And we'll talk more about Q3 in a few weeks at our earnings call. The long-term model for the company is low double-digit growth on the top line. We're seeing that even in the September quarter's earnings call, we did provide some preliminary outlook for fiscal '23, which begins with the June quarter of about -- the Street consensus has us at about [ 850 ] and that's in that low double-digit to mid-teens range. We feel really good about that in terms of balancing our supply with a demand picture. We have a 55% margin target and what we've disclosed publicly is that the goal is to do that in fiscal '24. We're on a nice trajectory. And 2 years ago, when we had a fab and when we had 2 back-end facilities, we're at 40% gross margin. So we've come a long way, and we've really done a tremendous amount to expand the profitability of the company. And OpEx as a percent of revenue is -- the target was about 30%. We're above that level right now. We'll probably finish the year a little bit north of that or in that range, which means we're already at the model. And we do think there could be the expansion there as well in future years. Next slide, and that's it. I think we turn it over to questions. I'll turn it over for questions now.

Okay. Ravi, Paul, thank you very much for that introduction. You covered my first question, which is the CFO transition, and let me just take this time, Paul, to say it's been an absolute pleasure working with you. I wish you the best in retirement, and just thank you for everything you've done for the company. We certainly look forward to Derek on board, he's got big shoes to fill. And Ravi, at some point, maybe we'll hear from Derek about gross margin goals beyond 55%. But let me get to that in the Q&A portion.

Yes. Absolutely.

I wanted to start just sort of big picture. Obviously, auto production has been in the news for a while now. But what are you, sort of, can you walk us through sort of expectations for vehicle production? What was vehicle production in '21? Where do you see vehicle production going in 2022, '23?

Well, I think last year, we probably ended up around 77-odd million vehicles, so which is down from the previous expectations. Actually entering the year, we were expecting to be in that 84 million to 85 million vehicles. And despite that, what you see is that the semi demand has been quite, quite high. The puzzle for everybody is that it appears fairly that we don't really understand on a consolidated basis what the increase in semi content per vehicle has become as a result of this. And when you go into a new vehicle, you feel it, right? You feel the new dash, you feel the new displays, you feel the new tech in the steering, braking systems, in the lighting systems, et cetera. But the -- so all that tech requires more silicon, but it's not -- we don't have a great consolidated number out there. So we anticipate that this -- that there will be a rebound next year. We anticipate that we will get back to that mid-80s next year sometime. But -- and then beyond that, we'll still be back on the trajectory to get to that 90 million vehicle level where the industry likes to settle in, but -- that there will be silicon challenges. I think -- I don't think that the industry really understands how much silicon they need at this point and the supply chain is constrained.

I guess, I was right. My next question is, I think vehicle production on an annual basis flat to maybe even down a little bit in calendar '21. The company's business up about 30% in automotive. I think that's probably seen across multiple automotive semiconductor suppliers. And so do you think that that's really a function of a mix shift to more feature-rich vehicles with higher dollar content? Or do you think that the auto OEMs maybe starting to stockpile available components as they wait to secure critical path components?

No, I think it's actually a combination of the baseline year, which was a COVID year, was one where there was a tremendous inventory adjustments. And it was coming off in 2019, which was an even larger inventory adjustment. So I think we're -- so yes, there is -- this 30% includes some of the resetting, saw the impact of some of the inventory adjustments, but it also includes a content increase. I don't see our customers being able to really stockpile parts. We just don't see it. We from the level of tension that we have with our customers today in terms of deliveries, we just don't -- we don't see that there is a -- there's any slack in the supply chain at this point.

Great. And as you mentioned that auto production going to mid-80s and perhaps, [indiscernible] and back to the mid-90s longer term. As that incremental production capacity comes back online, do you think the mix shift back to kind of more mid-range and lower-end vehicles? Is that for a period of time hurt semiconductor or maybe just cause semiconductor content per vehicle to pause for a little bit as you think you may shift to perhaps a more normalized mix between high-end and low-end vehicles?

Yes. It is a fascinating time because we are going through all these transitions, right? So we've got electrification coming on as a transition. We've got Europe specifically driving the energy efficiency targets with their legislation. We've got China driving electrification. U.S., I think the car companies have all recognized that they need to push a little more aggressively on efficiency. So you've got electrification coming on and Level 1 plus ADAS coming on, most of which really drive electronic content. And it's becoming much more ubiquitous because so many -- whether it's a high-end or low-end vehicle, they all tend to have these several ADAS functions in them today, and I think that's going to continue. So I don't -- I think that ship has sailed on that bare-bones vehicle that you use to rent. And I think it's pretty interesting that Hertz itself has recognized that their agreement with Tesla to purchase, I believe, they said with 100,000 vehicles, which is quite a statement to the transition from the bare-bones vehicle that you would rent to, again, one of the most advanced vehicles in the market today. So I don't see it, but we just don't see a backward step today.

Yes. Well, it's Hertz goal that I remember, I'm certainly looking forward to getting back to traveling and maybe get one of those Teslas. Moving to supply chain. Obviously, lots going on in environment. Paul, you mentioned that the supply chain constraints affected the December quarter outlook with subcons in Malaysia. It sounds like you think that that's mostly behind the company, and that's really just a one quarter event?

Yes, that's correct. Even as we were in the early part of the December quarter, the recovery was well underway. And so we believe that's behind us. Certainly, the biggest supply chain constraint for most in our industry is really on the wafer side. I mean, for us, much of the back end is internal. We can control that and -- but wafers is what -- wafer supply is what everybody is looking for, including us.

Okay. We'll get to wafer supply in a second. But just -- in Malaysia, there was some recent flooding and obviously, Omicron variant is spreading pretty rapidly. Have you seen any impact from either the Malaysia flooding or just folks falling in sick with Omicron either at your subcons or at your both test and assembly factory?

We haven't seen anything that has impacted our ability of supply at this point.

Great. Okay. Moving to the wafer front. Can you talk about sort of the Polar relationship and UMC. How much available -- additional available wafer capacity you think you might be able to get from those suppliers. And then I'll turn it to [ Ravi ] next.

So UMC is the predominant supplier for Allegro today. They're more than 50%. Most of the balance is made up with Polar. But 3 years ago, we entered into a strategic relationship with TSMC. And that is now -- we are now in production with TSMC, and we are seeing a nice linear ramp with TSMC beginning now. That will have a more meaningful impact in fiscal '23 starting with the June quarter. And that's part of what's comprehended in the guidance that we -- or the preliminary guidance that we provided at the September earnings call from a supply perspective or from a wafer supply perspective.

Could you give us any sense for fiscal '23? How much of the wafers might be supplied by TSMC? Is that a single-digit percentage? Could it get into the double digits?

It will grow consistently throughout the year. Longer-term, we haven't established a time line, but longer term, it will have -- it will have a meaningful percentage of our supply.

Okay. And then just generally speaking, whether it's UMC or TSMC to the extent that we start to see demand for smartphone chips or PC chips maybe starting to moderate. Do you think that potentially frees up capacity for Allegro?

I'll start this, and I'll let Ravi pick it up. I think that is a -- that was probably a case-by-case type of discussion. Certainly, the wafer processes that we -- our products run on versus what PCs and other consumer-related products around are different, but there may be tools that could be shared, and it all depends on whether it's 200 or 300 millimeter.

Okay. I guess moving to input costs. Obviously, there are a number of input costs that have gone up, whether it's wafer pricing, [indiscernible] pricing, labor costs, freight shipping. Talk about what you're seeing on the input cost side and whether you're able to pass along some of those higher input costs to customers or especially on the automotive side, we have long-term contracts that make raising the pricing a bit of a challenge.

So the input cost environment has been under inflationary pressure for quite some time, probably better part of the year, if not more. And that goes across the supply chain from raw materials up through other services provided in the manufacturing process. We've been able to comprehend what these are and factor those into a pricing strategy and what we've been -- we've had a couple of rounds of price increases, but the strategy has really been to focus on price increases where it makes sense strategically for our customers. But the ultimate goal of trying to keep margin neutral at best, I mean neutral at a minimum.

Great. I just wanted to touch on the demand side for a minute. And if you defer these to the fiscal third quarter call, I understand, but to the extent you're willing to comment, what are you just seeing generally in terms of demand in POS out of disti.

So on the demand front, the demand continues to be strong. The bookings rates just continue to be there. We've seen this throughout the year and with demand exceeding supply. From an inventory perspective, what we talked about in October for the September quarter is, it will probably persist for quite some time. It will be difficult to build inventory because pretty much any additional or incremental supply we get will be used to service demand. And I would apply to direct customers coming from our inventory or channel customers coming from our disti partners inventory.

Obviously, demand and backlog are good indicators of near-term future business trends, but design wins for the company have been up pretty meaningfully. I think on the last call, you talked about design win revenue up over 50% year-on-year. Can you talk about sort of that longer-term visibility you have with that design win pipeline? And how quickly do you expect to convert design wins to revenue?

Yes. So we're actually really proud of our design win activity. It's -- as you said, it's 50% up on an LTM basis. 55% of our design wins are really in what we call our 3 key areas, our emerging segments of xEV, ADAS and industrial and which is really 35% of our overall business. So we can see that there's real great acceleration in these -- in the key targeted market segments for us. Design wins for Allegro are planned only. They're actually tied anchored to our sales compensation. So they're claimed right at when a product is completely qualified and a purchasing agent has come back and told us we either have the order or they've given us a commitment. So for us, a design win to start up production could be anywhere from 3 months to 12 months, typically.

Okay. So it's not a 3- to 4-year kind of look, it's...

No. We don't claim design wins at the entry of the pipeline because clearly, the pipeline for -- to win a design is about 3 years in automotive, but we claim the win. We've seen too many cases where these activities go south, whether it is customers are losing the business to other competitors or whether it is they bring on a second source halfway through a qualification, et cetera. So we don't claim the pipeline for -- as a design win. We claim that it's actually been one. That means a customer has a business and we have the business.

Great. Ravi, you talked about a number of the applications for current sensors where Allegro has a market-leading position. So I won't ask you to repeat some of those applications, but what separates Allegro in the current sensor market from some of your competitors? And who are the biggest competitors you see in the current sensor market?

Yes. We started this activity 5, 7, 8, 9 years ago here in terms of really targeting electrification as it related to solar. And back then, there was a really big push for solar power, and so we created this portfolio and solar power also has inverters basically. So we created this portfolio of products there to service solar, and as cars became hybrid electric, we started seeing the application of our products and things like the Prius, et cetera, and in those kinds of inverters. And what separates us is that we have one of the largest portfolios. So when we talk about measuring current, there's all kinds of sub applications, whether it's high voltage measurement, whether it's high current measurement, whether it's with high isolation, whether it's precise plug and play products that we provide. So -- and so what separates us is really deep tech that's created a really broad portfolio and this tech is continuing to evolve. So while our competitors may be in Gen 1 or Gen 2 of their per systems, we've been doing this for a long time in terms of our products and it shows. So today, our customers have voted with us. So we believe we are in 1 of every 2 inverters out there in the market and that's a great stat for us because it just kind of talks about the application space. But as we discussed, the inverters are just one piece of electrification in the vehicle for us. You've got the onboard chargers. You've got the DC-to-DC converters also. You've got the wall chargers. You've got the infrastructure charging systems out there. So there's a bunch of applications within a vehicle on -- for our current sensing.

And maybe just with the change of opportunities, maybe spend a minute just talking about the EV ramp. What are you seeing in terms of -- pulling in the EVs, it seems even at CES, I think we saw more OEMs announcing complete EV lineups over the next several years. But what are you seeing in terms of EV ramp pull-ins? And what's the kind of lift -- content lift for you as you go from an internal combustion engine to an EV?

Yes. So we get approximately 50% content lift when you go from an internal combustion vehicle to a EV and part of the reason is the products we have in the powertrain for an internal combustion vehicle get replaced by many more products in the EV inverters, for example, with the EV powertrain. So our content actually goes up quite dramatically and It's a really good play for us. What do we see in the market? When you turn -- every time you turn around, there's more announcements of acceleration. But I would just caution everybody that automotive is not like -- it's not a near-term step function kind of an industry. It's a -- you're going to change the trajectory, but the real meaningful revenue will come a few years out. So EV will continue to ramp. The most positive thing that we see is, all the announcements from the car companies stating specifically that they're transitioning their portfolios. I think the most recent one was Chrysler saying that by 2028, they would go 100% electric. I mean -- and that's new.

Yes. That was one I think I saw last week at CES. So...

Yes. And so you start seeing that. And yes, we do have the startup car companies also out there, but the Volkswagens, the BMWs, the Toyotas, I mean there -- I mean, the Hyundai Motor Company, these companies are going to be here to play in this space. And they've got the benefit of very large selling systems and very large factories and manufacturing design, organizational design. So we're penetrated in Hyundai as well as in Daimler. We are penetrated in Toyota as well as in Volkswagen. We had a great discussion with Ford today. I mean it's -- so those -- we are with Tesla. So as a company, we just look at this has offering enormous opportunity to Allegro.

You mentioned in your prepared comments the GMR technology become [ 40% ] of the MAG sensor market over time. Just talk to us about the benefits of xMR technology and your position in that segment?

So xMR provides significant more signal to noise in terms of a sensing system. So in general, it is a -- it was, of course, the preferred sensing device. It was extraordinarily difficult to apply. It was designed for undeveloped for hard disk drives, which are 1s and 0s. But as you know, sensing systems need analog feedback. So we've spent about 5 to 7 years investing in R&D in xMR to optimize xMR so that it can provide us the appropriate kinds of information. But not only that, we invested in an xMR on silicon. So it was how do you deposit this xMR on a wafer so you can integrate into silicon, the circuit design and the circuitry, et cetera, and have the xMR deposit there on top. It's pretty interesting because it offers us great advantages. We've already started shipments in this, in this particular area, we've started via shipping wheel speed sensors today. We have started acceleration into gear speed sensors at this point. That's a next step that's also started, and we're starting sampling our redundant angle sensor. So these are -- and we have current sensors. So Allegro's main claim to in this particular area is that we do xMR silicon, and we have already engaged in a very broad portfolio. Again, that comes from starting the activity way before the market really went there. So this was 5, 7 years ago, we just began our investments.

I wanted to move to the power segment. You touched in your slides that the recent data center wins with data center cooling providers. I think those are pretty meaningful input. Talk about the magnitude of that revenue as those contracts ramp to production?

I don't think we've really disclosed Paul the revenue. So what we've just said is that it's going to be meaningful in the second half of this year. So we believe that -- but it is meaningful, Quinn. And we are -- and as quarters go on, we'll provide the market a little more specific data on that.

I believe on the second quarter call, though, you said that those contracts could potentially double your data center revenue. Is that right?

They more than doubled.

So at least as a part of your data center business is obviously meaning?

Yes, it's really meaningful for our data center business, yes. And we see this as a great validation of power tech, which is embedded motion control is really being accepted now by our my customers. And in the past, it was not -- customers are looking at cooling systems as being low tech and lower end -- but as these data set providers are moving towards carbon neutrality and more efficient cooling systems because, as you know, the challenges of data center cooling, is tremendous. Our products are being accepted. The fans are moving to 3 phase, and it's been wonderful again. We are on Gen 3, Gen 4 in the data center part. So this is not a new activity or new initiative for us.

Great. I know we're coming up on the end of our time, but could you talk about your development efforts in LiDAR? Obviously, coming back from CES, lots of -- lots of companies focused on LiDAR. Maybe give investors an update on your efforts there?

Yes. So we have -- we continue the path that we are on, which is industrialization of this a really great tech that we got from Voxtel, what we acquired. Voxtel did 1515 nanometer LiDAR for the military. Our challenge has been to how do we now transform this portfolio that it becomes automotive friendly, automotive quality, automotive reliability. And so that's progressing quite nicely. We'll be having some announcements in this particular product area shortly.

Great. I guess, maybe lastly, just Paul or Ravi, just thoughts on your ability to kind of get to the 55% gross margin target that you set? And do you think that there's potentially upside to that over the longer term?

Yes, I do, Quinn. I think 55% is a significant milestone in the journey on gross margin, but I do think with the increasing mix for the growth sectors of the company, those are higher-margin devices, and that will provide a sustainable tailwind to gross margin longer term. Where that ends up north of 55%, the exact point is to be determined. And certainly, when it gets -- if it gets high enough, there's a whole discussion around growth versus profitability.

Great. Well, looks like we're at the 40 minutes. So I will end it here. Ravi, Paul, Katie, thank you very much for joining us at Needham Growth Conference really appreciate your time this morning. And again, Paul, pleasure working with you. Best of luck in retirement.

Right. Thank you, Quinn.

Thanks, everybody.

Thank you, Quinn. Bye now.

Bye-bye.