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

Okay. All right. Good afternoon, everyone. Thank you for joining us. I'm Josh Buchalter, semiconductor analyst at TD Cowen. Thanks for making it to the afternoon sessions of Day 1 of the 51st Annual TMT Conference. Very pleased to be joined by Derek D'Antilio, of Allegro MicroSystems. I think some people in the room are probably familiar with your background in the companies, but maybe you can spend a couple of minutes introducing yourself and the Allegro story.

Sure. Thank you, Josh. Always a good conference. So I'm Derek D'Antilio, the CFO of Allegro MicroSystems. I joined about 1.5 years ago, I spent the last 25 years or so either auditing semiconductor companies or semiconductor capital equipment companies or as a senior finance or CFO roles at semiconductor companies largely in the Boston area. Allegro MicroSystems is an interesting company. We're a global leader in sensing and power solutions, integrated circuits, largely serving the automotive market. So 70% of our business is automotive, 20% is industrial, we'll talk about some of the industrial pieces, and then 10% consumer. The company went public on the NASDAQ about 2.5 years, but we actually have 96 years of history starting off at Sprague Electric in Wisden, Massachusetts. We had a fab at 1965 many years before, many semiconductor companies are even founded. So happy to be here as a public company focused on the e-mobility space and some of the more exciting areas of industrial.

Thank you for that intro. And by the way, this is meant to be interactive. If anyone's got questions in the audience, please feel free to wave me down or throw something at me, and we'll get you a mic or just yell loudly. I guess, Derek, to start the conversation again, we get a lot of questions about trying to unpack what's Allegro's technology differentiation. It's magnetic sensing and power ICs are difficult ones to point to a specific metric. Maybe you could spend a couple of minutes explaining what sets Allegro apart, why you've been able to win so much business in the auto market, in particular, what makes -- in many of your applications are sole sourced. What drives that?

Yes, great question. So in terms of size company with our [formal] competitors, Allegro is probably a smaller semiconductor company approaching $1 billion in revenue. But what sets us apart is our extreme focus on two applications, magnetic sensing, we've been involved in magnetic sensing and a leader in magnetic sensing for over 30 years; and certain discrete power ICs. And in the magnetic sensing world and in power, we have two sort of technology differentiators. One is our underlying wafer technology. We're a fabless company working with three outside fabs, which uses their process technology, but our own proprietary technology to put magnetic sensing on top of a CMOS layer. So we're embedding memory, magnetic sensing and CMOS all in the same chip. So it's an integrated chip, smaller, monolithic chip that's more efficient. And that's important for higher resolution, accuracy, energy measurement. So when you think about automotive, for example, we're helping drive efficiencies, particularly extending range in electric vehicles by having current -- measuring current and driving current throughout the automobile. The second piece of that is packaging, proprietary packaging. Our packaging has been under hood for 30-plus years in automotive. Can extend extreme heat, extreme conditions and purpose-built ASICs, and packaging for the automotive suppliers, that allows us to be single-sourced at many of our automotive opportunities. In fact, that's not very uncommon in automotive, working with the Tier 1 suppliers who supply the automotive industry, designing systems or steering systems, braking systems, battery management systems, having an ASIC purpose-built chip and package for their application allows us to be sole sourced in many of those opportunities.

And I guess what allowed -- when you go to the business, you get asked this question all the time, what allows a customer to select Allegro? Is it the resolution? Is it the packaging? Is it a history of reliability? What is sort of -- I know it's all of those, but can you talk to me -- talk through some of the pitch you make when you're going to customers?

It's a great question. So the first entree really is having 30-plus years of experience dealing with automotive customers, that gets us in the door. So we're having technology discussions with the OEMs who are then specking us in with the Tier 1s and pulling us through. The second piece of that is having -- our entire supply chain is automotive grade from design through the fab, through our testing that we all do internally. So having those discussions around reliability and happen to have 10 years' worth of reliability data at a minimum also is helpful with those customers. And then the real piece on the technology side, I would say, particularly in the sensing side is the resolution and the accuracy and be able to manage the current such you can get more range out of an electric vehicle, where you can control the current going from the 400-volt or the 800-volt battery in an electric vehicle down to the other subsystems in a car and make sure you're not losing current. So having less lost current sensors is very important.

And can you talk about how some of -- I mean your history is in magnetic sensing. What are you bringing from the sensing side into -- what are some of the similar qualities on the power side that's allowing you to win business? And can you talk about some of the key verticals there, I guess, outside of autos in addition to what's going on within the vehicle?

Sure. so actually, before sensing, Allegro was a power company. And so part of our history has been a power electronics company for the past 75 years. It's been in business since 1926 as big, started off as a power company. So we have significant experience in power electronics, high power, in particular. And by taking some of the same concepts of the monolithic integrated wafer technology, the proprietary packaging, we've been able to win business in certain power applications, both in auto -- and then to Josh's point, outside of auto, we have about 21% of our business is to industrial. And industrial means different things to different people. Our industrial is very focused on applications where the same use cases are available for harnessing power, capturing power, driving power and retaining power. So things like clean energy, solar inverters, DC-to-DC conversion and solar, DC fast charging. Industrial automation is another piece of that industrial, data center automation in terms of data center fan cooling, power drivers. So a lot of exciting applications within our industrial business. That also have projections for relatively fast growth over the next several years.

I want to shift gears for a moment, and this semiconductor cycle has been unique from my vantage in that the end markets are moving at very different times. Your for you -- mostly better, 70% auto exposed, and that's sort of the one vertical that has yet to see any signs of cracking. I would just love to hear what are you seeing out there in the business environment, both within that and outside of autos. And any signs of any sort of weakening in end demand is we've gotten a lot of concern about [China] EV weakness and vehicle affordability, but it would be helpful to hear your context given how your long track record and exposure to autos.

Sure. Yes. And as Josh mentioned, I've unfortunately or fortunately been through many decades of semiconductor cycles, mostly consumer type cycles or data center-driven cycles. I think within the automotive market, what's kind of interesting is, today, we're -- worldwide, we're producing about 81 million or 82 million vehicles. That's down from 95 million back in 2018, which was the peak. Many estimates by S&P and others project that will get back to 90 million, call it, over the next 3 or 4 years. There might be some quarterly perturbations. But what's really driving that is the EV penetration. So in many countries like the United States and Japan, penetration of electric vehicles is less than 10%. In Europe, it's far ahead of that. So what we're seeing is a bit of a bifurcation of course, between consumer and auto. But even within auto, we're seeing a bifurcation between the growth rates in EV, which we think are secular and pervasive. And just because interest rates increase, I don't see automakers slowing down the production of EV. Could there be quarters when ICE vehicles sell less or even vehicles in total? Possibly. But we don't see that slowing down the production of EV over the next several years. Outside of auto, we're seeing signs of the typical cycle. So for example, in data center, we have products for the data center, There, we've seen some inventory build in the channel. We made a decision to stop shipping into that space for a little while until that inventory kind of digest itself through the channel. And then in the consumer business, which is about 10% of our business with some interesting applications that use the same applications, for example, the [Roomba] does some of the same things with autonomy, we have seen that business line declined by 4% in Q4 and probably would have declined more if we weren't shipping from some delinquent backlog. So we are seeing the same consumer dynamics a little bit in the data center, but auto has held up really good, particularly driven by EV.

And I think a key question there is how is the pricing environment, both within autos and industrials. You've been successfully able to pass on higher input costs all through the last couple of years as inflations ticked up. Any signs of that changing? Any differences in your customers' conversations now versus a couple of years ago?

Yes. So I look at that -- I look at pricing and channels. The channel is the distribution channel, which is sort of the pass on the pricing through the distribution channel. That's market-based pricing. It goes up with the market. It probably comes down at the market at some point. We haven't seen that yet. In the OEM side of the business, that's really ASIC pricing, strategic pricing to customers, purpose-built ASICs, and that side of the business, it's market-based pricing. We don't let our salespeople see the cost side of the equation. So it's not a cost-plus side of the business. So that's really about providing products with a higher feature set, keep releasing new products with higher SPs. The wafer cost remains the same. So we've been pretty successful in improving gross margins by really churning that mix over there. So on that side of the business, I expect pricing to remain relatively sticky. On the distribution side of the business, that is much more market-driven and has historically been as well. So we've got the upside of that. Haven't seen the downside yet, but I think many companies probably will.

How does mix play in there? Because you've been, I would say, arguably leaned in the heaviest to XMR sensors. And maybe you could talk to what benefits that brings and what that does both to your customers and to your own internal mix on your financials?

Sure. So today, the magnetic sensing market is largely hall effect technology, which has been around for 30-plus years, right? And we're the leader in Hall effect technology and magnetic sensing. We're one of the few companies have gone to the next generation of XMR technology. And what that does is it brings essentially about 8x the resolution. And that's important when you start to think about ADAS features when you want to have an angle sensor turning your electromechanical steering to the right place you want to star or to a mechanical braking. So when you need really precise applications. That's where XMR and TMR becomes really valuable. We expect the ASPs there will be higher, and so the variable contribution module will be higher there. That's still in its infancy in terms of the percentage of our overall revenue, but there's not many companies who have that, and that's part of our innovation business. So we believe that's the next iteration of magnetic sensing.

And competitively, are you seeing your peers invest in XMR [indiscernible]? And I guess your fabless and many of your competitors are IDMs. Does that enable you to move quicker? Is it -- on the flip side does that allow them to capture more margins? I would love to hear you talk about the interplay.

Yes, it's kind of interesting. So we became a fabless company just 4 years ago. We were an IDM with two fabs and two back-end facilities back in 2017, 2018. We spun off one of the fab. We still own 30% of that one, but it's not on our books. The other fab we closed. We have one back-end facility. And the primary reason we're doing that were really twofold. One, managing a fab, you have a lot of fixed costs. You have to worry about utilization. But the second reason is, or the more important reason is, it allows us to focus exclusively on customer innovation. We now have an office of the CTO. We focus entirely on design innovation, proprietary packaging and don't have to really worry about spending all of our time on wafer tech side of things. We have wafer tech designers but that's done at the fab level. So that's the first piece. The second piece is, when I think about our IDM peers, right, I'm sure they have to deal with utilization levels and understand how that's going to impact that gross margin and can they be more competitive on pricing. So at some point, when utilization levels drop, they probably will get more competitive on pricing.

Got it. Maybe we could talk through, I guess, some numbers behind the content opportunity. You've laid out -- I think it's going from $20 to $60 or of a basic internal combustion engine to -- with EV and ADAS content uplifts and then even higher with the acquisition of Heyday. I know it's a collection of singles and doubles, unlike some other verticals in analog semis. Can you walk through some of the, I guess, bigger, chunkier sockets within there? What gives you confidence in that almost tripling of the content opportunity? And then longer term, when should we expect -- maybe you can walk through what is Heyday? And how should we expect that to layer into the model?

So we believe our SAM on a typical ICE vehicle is about $39. That goes to 60 on a typical electric vehicle, and that's all in, including Level 1 and Level 2 ADAS features. And the big pieces driving that really are as a vehicle electrifies and you put an electric powertrain in the number of current sensors more than doubles. So having potential opportunity for 40 current sensors, which is our main product on the magnetic sensing market more than doubles to 40. The second piece of that is when you look at ADAS features, it's all about redundancy and failsafe opportunities. So the number of angle sensors, speed sensors, current sensors, all at least double. So think about being on an airplane. You want to have multiple redundant failsafe systems. Those are the ADAS systems. When your car starts doing things for you like lane-keeping assist or self-parking, the car has to have multiple failsafe systems. So there's a number of redundancy in a lot of our products there in terms of motor drivers driving the systems. Heyday Integrated Circuits, we bought that company in September of 2022, very small technology company, kind of an [acqui-hire] in France, about 12 engineers. They make isolated gate drivers for high-power applications. What that does is it helps isolate high power over 1,000 volts and drive that power to fast switching devices, so gallium nitride and silicon carbide. We don't make either of those two substrates, but it drives it to those two. So the opportunity set there is about another $30 in SAM on an electric vehicle in the battery inverter really working on a reference design with the gallium nitrate switch manufacturers in the silicon carbide switch manufacturers.

I guess Heyday is the goal is to be the high-voltage gate driver. And a lot of the peers who do power discretes are also investing in modules. What's the differentiation that allows Heyday to break into that module or break into the inverter? I would love to hear you talk about the differentiation there.

Yes. It's a great product. I was there in France a couple of months ago, and I saw their product. It's about 1/3 of the size on the board of the competitors' products. It's a lot more efficient in harnessing power and driving power. So they came up with some really unique technology, and they presented that technology at Electronica in Munich in the fall, and there was a lot of demand. In fact, that business was brought to us by one of the large OEMs in Germany, one of our customers. So those are the kind of acquisitions I really like because you know you can sell at the existing customer base when they bring it to you. And we have a ton of expertise in power. We put our -- the gentleman who ran our power business and build our power business to a $400 million business is now in charge of this high-power business that includes Heyday integrated technologies. And so having that expertise on top of their technology, we're pretty excited about it.

So I guess we're going to move outside the car. You talked about industrial, means a lot of different things to a lot of people. Some of the key verticals you've highlighted are charging infrastructure, renewables and data center power. Are those meaningful enough yet where they can start to move the needle on your consolidated results? How should we rank order which one of those are contributing the most now and which are the ones you're most excited about? And maybe walk through some of the content opportunities and how that compares to the numbers you were just giving for on the vehicle.

Sure. So when I think about the industrial, it's now 21% of our business, it's actually grown faster than our auto business, coming off a smaller base of numbers. So it's about $200 million business. And the three pieces there really are clean energy. It's really been driven by solar so far. In its infancy, though, and one of the more exciting parts is fast charging stations, DC fast charging stations, where we think there's an opportunity of up to $400 in content on a DC fast charging station for current sensors, motor drivers, angle sensors. So that's a really exciting space. The overall clean energy space, solar has been great for us and continues to be. The second piece in there is industrial automation. So using a lot of the same features for electrification and particularly autonomy, angle sensors, speed sensors and industrial automation, industrial robotics has been a really interesting business. When you start to think about places like China where the working age demographic is starting to decline pretty rapidly. So that's been an interesting business for us. And the third piece is data center. So data center efficiency, fans for the cooling systems, replacement of the back plane and a server rack from 12-volt to 48 volts. So those are the three big pieces. And what's interesting is we've sold those products through distribution, the same products developed for automotive through distribution to industrial, and a lot of that just happened. But recently, we've had a focus on that. So our sales team now is focused on selling into what we call our strategic focus areas. So e-mobility in the select areas of industrial. So they get paid to win sockets in those areas now. So we have a real focus on that. We've put somebody in charge of it in Europe. We just had our first Clean Tech Summit internally in Europe at Allegro. So it's a real focus market for us, whereas before, we sold those products through distribution. People pulled them through distribution. Now we're driving demand.