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

Good morning, everyone, and welcome to the special conference call for analysts and investors to discuss Allegro MicroSystems intended acquisition of Crocus Technology. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to Jalene Hoover, Vice President of Investor Relations and Corporate Communications.

Thank you, Felicia. Good morning, and thank you for joining us today, and welcome to our special analyst and investor call to discuss Allegro's intent to acquire Crocus Technology. This morning, we announced the signing of an agreement to purchase Crocus Technology. I'm joined today by Allegro's President and Chief Executive Officer, Vineet Nargolwala; Allegro's Chief Financial Officer, Derek D'Antilio; and Allegro's Chief Technology Officer, Mike Doogue. Vineet, Derek and Mike will give you an overview of the acquisition, providing color on the strategic rationale, the technology and financial details. We have also added a few slides to address this acquisition to our investor presentation, which is available on the Events and Presentations section of our IR page at www.allegromicro.com. Following their prepared remarks, Vineet, Derek and Mike will take questions. This call is being webcast, and a replay will be available in the Events and Presentations section of our IR page shortly. As a reminder, our investor presentation includes certain non-GAAP financial measures, which are not intended to replace or be a substitute for our GAAP financial results. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in the presentation. During the course of this conference call, we will make projections or other forward-looking statements regarding future events, the benefits of this acquisition and the financial performance of the company. We wish to caution that such statements are based on current expectations and assumptions as of today's date and as a result, are subject to risks and uncertainties that could cause actual results or events to differ materially from projections. Important factors that can affect our business, including factors that could cause actual results to differ from our forward-looking statements are described in detail in our press release issued this morning and in our most recent periodic filings with the Securities and Exchange Commission. Our estimates or other forward-looking statements may change, and the company assumes no obligation to update forward-looking statements to reflect actual results, change assumptions or other events that may occur except as required by law. It's now my pleasure to turn the call over to Allegro's President and CEO, Vineet Nargolwala. Vineet?

Thank you, Jalene. Good morning, everyone, and thank you for joining us this morning at short notice. We have really exciting news to share. In our March Analyst Day event, we laid out a financial model and a comprehensive set of strategies to achieve our growth ambitions. We also said that we would employ both organic and inorganic levers to drive growth and that any M&A would be deeply tied to our strategy and help us accelerate our technology road map and growth ambitions. In that spirit, and embodying our core value of innovation with purpose, I'm excited to announce we have signed a definitive agreement to acquire Crocus Technology, a leader in TMR solutions. Crocus is a privately held company that brings best-in-class TMR technology with industry-leading accuracy and performance over life to Allegro, and accelerates our plans to deploy TMR to highly demanding applications by several years. Crocus' products and over 200 patents complement Allegro's portfolio and greatly expand our ability to serve existing and new customers in e-mobility, clean energy and automation applications. Crocus' industrial presence is complementary to Allegro's strong leadership position in automotive and target industrial markets, allowing customers to benefit from a more comprehensive product portfolio in addition to a strong and global sales, engineering and supply chain footprint. In addition, we welcome the deep expertise and technical talent that Crocus will add to the Allegro team. Putting this all together, Allegro as the leader in magnetic sensors has a unique opportunity to drive a broader and accelerated adoption of TMR products in our strategic focus markets. As a reminder, the magnetic sensing market is expected to increase to over $5 billion by 2030 with TMR representing the fastest-growing segment of that market. We estimate that the TMR segment will reach $1 billion in addressable market by 2030. Automotive and industrial applications are expected to fuel TMR's estimated 30% compound annual growth rate, which significantly exceeds the growth of the overall magnetic sensing market. TMR also facilitates use of GaN and SiC technologies, greatly enhancing efficiency and reliability in high-voltage applications. This highly strategic acquisition further demonstrates our commitment to leadership in magnetic sensing. We look forward to welcoming the Crocus team to Allegro and working closely with them to bring this technology in our combined value proposition to our customers. Now I'll turn the call over to Mike Doogue to talk about TMR and how Crocus' technology helps us serve a broader set of customers and applications. Mike?

Thank you, Vineet. I am truly excited about augmenting Allegro's TMR efforts and achievements with the technology know-how and people associated with the Crocus team. We discussed the merits of TMR magnetic sensors during our Analyst Day, and I will expand on these merits later. But first, I want to emphasize that both Hall-effect and MR magnetic sensors will bring value to customers for many years to come. And that Allegro will continue to invest in both technologies to deliver the best value proposition to our customers across a wide range of growth applications. Hall-effect sensors offer proven and unparalleled reliability over a wide temperature range, and they are expected to maintain a majority share of the magnetic sensor market through 2030. However, TMR technology offers significant performance advantages over Hall technology. And therefore, we are accelerating TMR technology and product innovation to deliver even greater levels of value to our customers, across e-mobility and industrial markets. TMR technology underpins products with excellent accuracy even at the highest operating speeds. Additionally, TMR sensors have an output voltage signal that is 100 to 1,000x larger than the output signal from a Hall sensor delivering greater accuracy and measurement resolution. Given these truly significant benefits, TMR sensor adoption is expected to accelerate over the next decade, fueled by high-growth automotive applications, including charging and inverter systems and electric vehicles as well as ADAS steering and braking systems. TMR is also an ideal technology for industrial applications, including clean energy power conversion, automation, data center power supplies and EV charging stations. The benefits of TMR can also be viewed at the Allegro product level. For example, TMR current sensors that can operate at speeds at or above 5 megahertz, facilitate the use of gallium nitride or silicon carbide transistors and make power electronics and EV powertrains or an EV charging stations or in solar inverters for efficient. TMR angle sensors provide higher precision and enable heterogeneous redundancy and safety critical motor control systems, including high-performance ADAS, steering and braking systems. And finally, TMR position sensors enable ultra-low power consumption for battery-powered applications. Crocus' technology significantly accelerate our path to bringing TMR to market at scale relative to what we could do on our own. We also accelerate what Crocus can do with our automotive grade CMOS and packaging technology, global resources and customer reach. Putting this all together, Allegro as the leader in magnetic and current sensors has a unique opportunity to take Crocus' technologies and drive adoption of TMR in a broader range of auto and industrial markets. Overall, we expect this combination to solidify Allegro as a leading TMR semiconductor company. And now I'll turn the call over to Derek to discuss financials.

Thank you, Mike, and good morning, everyone. At our Analyst Day in March, we said that we would expect to have both organic and inorganic opportunities to help continue to drive Allegro's above-market growth. We also articulated a very focused set of criteria for M&A, and I believe Crocus Technology is very well aligned to those areas. Specifically, Crocus' technology is highly complementary to our expertise and our customer base. We expect the acquisition to accelerate growth in our strategic growth areas, as Mike mentioned, of e-mobility and industrial markets, and we expect the acquisition to be aligned to our target financial model. We expect Crocus' sales for calendar year '23 to be in the low double-digit millions, and we expect the sales growth rate to significantly outpace our overall sales growth rate. The purchase price is $420 million on a cash-free debt-free basis, which we expect to fund with a combination of cash on hand and a new debt issuance. We expect the transaction to close by the end of calendar '23, subject to customary regulatory approvals and closing conditions. In summary, we expect the acquisition of Crocus to accelerate Allegro's leadership in TMR sensing for high-growth applications in automotive and industrial markets and we are very excited about partnering with the Crocus team to realize the full potential of TMR technology. I'll now turn the call back to Jalene for questions. Jalene?

Thank you, Derek, and thank you all. This concludes our prepared remarks. We will now open the call for your questions and ask that you focus your questions on the transaction announced today. To ensure that all participants get a chance to ask questions, please limit your questions to one with one follow-up. Operator, please review instructions.

[Operator Instructions] The first question comes from the line of Gary Mobley of Wells Fargo.

Seems like a great fit from an acquisition standpoint. And relating to Crocus in the over 200 patents and what seems to be more of an IP focused go-to-market strategy, I wanted to ask about the company's existing relationship -- licensing relationship with NXP and Murata. Can you explain to us how that might -- those relationships may be maintained going forward? And what the composition of Crocus' revenue is now from a licensing perspective and from a product sales perspective?

Gary, this is Vineet. Thanks for the question. We -- through our diligence, we verified that all those licensing agreements were actually in the past and have since expired or been terminated. So we feel really good about our ability to maximize the potential of the technology here.

And Gary, this is Derek. I'll add one thing to add to the second part of your question. The majority of their revenue, if not most of it, in 2023 is product revenue.

Got it. Appreciate the color. And I would assume that the interest consequence here, interest received and paid is about $30 million, and correct me if I'm wrong there. And with revenue where it is today, I would presume that this acquisition might be minimally EPS dilutive. Is that a fair assessment?

Yes, Gary, we expect it to be accretive within about 2 years of the acquisition, but we also expect it to fit well within our target financial model. And as this is a small company with great technology, one of the things that's most exciting about this acquisition to me at least is we get to take this technology and leverage Allegro's sales team, Allegro's sales channel and our supply chain.

The next question comes from the line of Joshua Buchalter of TD Cowen.

Congrats on the announcement. I guess for my first one, I mean, Allegro had investments in TMR sensors. Is there any way you can explain to us in sort of somewhat technical, not fully technical terms of what Crocus brings to your IP portfolio? And how it complements or adds to the investments Allegro was already making in TMR?

Josh, this is Vineet. Thanks for the question. So I'll get started, and then I'll invite Mike to add more color. So this was a unique opportunity for us many months in the making, okay? We saw an innovative [ scrappy ] team that was hyper focused on TMR. That's been their sole focus. And they have a great team, including some of the foremost experts on TMR across the industry. So they've been able to build a TMR stack, that's actually really good. And we've done a lot of technical diligence in testing their parts. And what we've come to find is that it's highly complementary with our product development efforts. It allows us to access new applications, new markets in industrial, notably medical. It allows us to open up new EV applications where our combined technology now can offer best-in-class accuracy and robustness over life. And from Crocus' perspective, they saw an opportunity to partner with the leader in magnetic sensing and really take advantage of our broad channels to market and our strong customer relationships and our grade automotive pedigree and DNA. And so we believe that we are stronger together and better able to shape the technology curve as well as serve our customers globally. Mike, do you want to add any more color?

I would. And well said, Vineet. Let me just add a few things. So when we looked at our TMR investments, as we mentioned during our Analyst Day, we approach markets with an automotive first mindset. So we developed our TMR technology, specifically for certain automotive applications. And when we looked at the products and the technology and IP from Crocus, what we saw was a set of technologies, a set of IP more squarely focused on the industrial markets. And we also said during Analyst Day, our strategy is always to have a broad portfolio across all of our target markets. So we're really excited about putting together the best of an automotive-focused portfolio and an industrial tailored portfolio of TMR technologies and products.

I appreciate all the color. And I guess for my follow-up, Derek, in the prepared remarks, you mentioned it was going to grow well more than Allegro's corporate average. Any more details you can give us there? It's sort of a time line to inflection. It sounds like it's more industrial focused, so it might be more gradual growth versus a design win based hockey stick. And just any details you can give us on the expected revenue funnel.

Yes, Josh, what we released in the press release talked about TMR, the market for TMR expected to grow at 30%. When I compare that to the overall target model we put out at Analyst Day of low double-digit growth, that 30% would certainly be well above that.

The next question comes from Vijay Rakesh of Mizuho.

Just a quick question. Wondering if you could share on Crocus if what the backlog or the pipeline looks like on auto industrial. And if what the -- if there are any mile markers on what revenue targets you are setting for them? And I have a follow-up.

Vijay, this is Vineet. Thanks for the question. So it's -- as Derek pointed out, it's a small revenue company today. What we really like is the pipeline they're building and the momentum they have in the markets and the customers they serve. We're not going to provide the backlog. I mean we don't provide our backlog, so it doesn't make sense to provide their backlog. So -- but we're really excited about the momentum they have in the market. It mirrors ours in a lot of ways. And obviously, the TMR technology stack that we would get here is really exciting for us to build on.

Got it. And I know Derek mentioned this is more -- mostly product than IP here but small revenues. Is it accretive on the gross margin line? And are they going mostly through a foundry so -- makes it easier for you to aggregate?

Yes. So I'll start here, Vijay. They are using a foundry. They are outsourcing the back end of their facilities. So there's a real opportunity here for Allegro to kind of work with Crocus and integrate them into our supply chain, that's why we see a real opportunity there, coupled with the sales side of the organization, right? They have a small sales force as a small company. We have a global sales force, good presence in all key markets of the world. So that's really where we see the opportunities from a gross margin with Crocus. But their products have excellent adoption in the market, and the customers view them quite well.

The next question comes from the line of Blayne Curtis of Barclays.

Congrats on the deal as well. Maybe just a follow-up on that last one [Technical Difficulty]

Blayne, sorry, we couldn't hear anything you said. Your line is pretty bad. I don't know if you're able to maybe redial in and reask the question.

The next question comes from the line of Darren Lin of Needham & Company.

This is Darren on for Quinn Bolton. Congrats on news. It seems like a great acquisition. So my question is, does Crocus make discrete or integrated TMR sensors? And if it's discrete, can you kind of explain how [indiscernible] How we'll try to integrate Crocus Technology into its NOI process flow over the next few years?

So this is Mike. Great question. They make integrated TMR sensors where they're integrating their TMR technology on top of a base CMOS wafer. So this is identical to the approach that Allegro takes in the marketplace. We believe it's a real source of competitive advantage to have a fully integrated solution, and that's one of the reasons we found their technology and their products attractive.

Okay. Great. And I just have a quick follow-up. I know you mentioned the $1 billion on TMR TAM by 2030. Can you quantify how large that TMR market is today?

Yes. Our belief when we look at both external and internal sources, the TMR market size today was around $300 million.

[Operator Instructions] Your next question comes from the line of Blayne Curtis of Barclays.

I'm hoping this is better, how do I sound?

You sound great.

All right. Sorry about that. I missed a little bit, so hopefully, it wasn't asked, but I just wanted to follow up on the gross margin comment. In their press release, they mentioned [ CMOS-based ] a lot. It's kind of a technology question, does that impact the cost? Do they have any advantage from just the architectural wise? And then just in scale, it seems like these are a different fabs. So I'm just kind of curious in terms of your visibility improvements on the gross margin side over the next 2 years?

Yes, Blayne, thanks for the question. I'll get started and maybe Derek can jump in as well. So as Mike pointed out, they use a very similar architecture to our approach. And so we see a lot of complementary aspects from a product architecture and then consequently, a supply chain perspective. And so we see a very strong ability to bring them on to our supply chain, our base of suppliers. And you can imagine that, that starts to become very complementary from a cost basis.

And Blayne, the way I look at these things, whenever I look at any acquisition, I look at variable contribution margin. Is the customer willing to pay for their product. In this case, their variable contribution margins are well within our acceptable levels. And as they scale and integrate into the Allegro supply chain, we expect their gross margins to be well aligned to our target financial model as well.

And then just, Derek, on the accretion in a few years, I just want to make sure I have the math right. I mean just gauging on the size of the company, it doesn't sound like -- it sounds like you're keeping most of the employees. So I didn't hear anything about synergies on the cost side. So is this just in terms of getting to the accretion, just a revenue story. And I guess by my math, it seems like you got to more than double maybe in triple revenue. I just want to make sure those are the right metrics to think about for your comment about accretive in a few years.

Yes. So Blayne, we haven't talked about synergies. The part that I did mention, though, is there's 2 opportunities really here. One is to continue to drive the growth in their revenue with our sales team, our global sales team, our distribution channel. The second piece is we think there's a real opportunity to leverage our supply chain. As I mentioned, this is a very small company. So as you might imagine, the pricing they're paying is for a very small company. And as Allegro just crossed the $1 billion mark, we have our own supply chain. We have our own back-end facility in the Philippines. We see a lot of opportunity there for improvement in sales, but also on the gross margin.

Guys, I guess you didn't hear my congrats. So I'll give it to now on the phone line again. Congrats, guys.

It looks like there are no other questions. I would now like to turn the call back over to Jalene Hoover.

Thank you, Felicia, and thank you all for joining us this morning. This concludes this morning's call.