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

Good afternoon, and welcome, everybody, to the final day of Needham's 26th Annual Growth Conference. My name is Quinn Bolton and I am the Semiconductor Analyst for Needham & Company. It's my pleasure to host this fireside chat with Allegro MicroSystems. 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 a leading -- as well as the leading position in current sensors. We believe Allegro is well positioned for growing content per vehicle driven by the trends towards safety and ADAS and electrification. Joining me from the company are President and CEO, Vineet Nargolwala and CFO, Derek D'Antilio. Vineet, Derek, thank you for joining us.

Thanks for having us, Quinn.

Good morning.

I wanted to start with just sort of some general questions about business conditions. I know we're late in the quarter, quite a period. So if anything gets too close to earnings, just say so. But let me start with kind of the Automotive market. It's really to date the only end market, where we haven't yet seen a major inventory correction. But a couple of weeks ago, we got a pretty nasty, pre-announcement from Mobileye that I think has raised concerns OEMs and Tier 1 suppliers may have been building inventory for the past couple of years. Can you give us your best sense where you think OEM and channel inventory are in the Automotive segment?

Sure, Quinn. I've been in automotive for a very long time, longer than I would care to mention. But Automotive OEMs have traditionally not been known for building inventory, right? So they're really invented and perfected the just the time model. And I don't think they've really gone away from that even in the tire days of the pandemic and the supply chain crisis that followed. However, their contract manufacturers and tiers certainly have held inventory. Traditionally, that's been pretty lean. I think during the pandemic and the supply chain crisis, they were asked by the OEMs to hold more inventory. And the OEMs very uncharacteristically for them had given them some subsidies to go to, right? So they were giving price premiums, they were giving support in other ways around expedited payments and some additional inventory payments. And as that sort of has come to an end and higher interest rates and continued higher interest rates are obviously getting -- taking a larger bite in terms of carrying costs, we are going to see contract manufacturers and tiers, [ payback ] their inventory positions. I think that's natural. That's healthy from an automotive perspective. But it does mean, and we had some conversations with OEMs at CES last week, where the OEMs still want their contract manufacturers and tiers to hold -- call it some in the range of 8 to 10 weeks of inventory, but the CMs and the tiers are trying to pay it back more towards the 4 weeks or 5 weeks of inventory. So I think over the next couple of quarters, we will see some [ payback ] of the inventory. But, what's more important here is what is the end market demand look like? Because I know a lot of people are trying to draw comparisons to Industrial and Consumer, the backdrop here is that the Automotive end market demand continues to be pretty stable. Last year, the global automotive production was something in the range of 88 million units. This year, it might be closer to 89 million. Within that, EVs grew about 29% last year, they'll grow probably about 27%, 28% this year. So the end market outlook is pretty stable. So inventory adjustments are a natural part of the industry. They will happen, they will continue to happen. But what I focus on is what is the backdrop of the market. Compare that or contrast that to Industrial and Consumer, where not only was it an inventory buildup, but the end market demand really fell off, which exacerbated the inventory position. So I think it's important for us to recognize that some of the inventory management, that will happen in Automotive that is happening at a Automotive is natural. It will continue to take place over the next couple of quarters. but it's a different dynamic compared to Industrial and Consumer.

Got it. It sounds like 2 key parts of that message, at least it feels like I would take away from that as one, we may be talking being a few weeks of adjustment at the contract manufacturers. It doesn't sound like it's months and months of excess inventory and the fact that the end market demand is still pretty healthy, that seemed to be a part -- in the consumer markets, they fall for an end demand really exacerbated that inventory correction and it just doesn't seem like we're seeing that on Automotive production, especially with rising EV and ADAS penetration rates.

Exactly right.

Got it. Okay. because I know we've gotten a lot of questions around thoughts on the auto and inventory situation. Another question, I think on the last call, you had mentioned that Disti inventories were sort of in the range of 10 to 12 weeks, maybe at the higher end of that. Is that still sort of where you see the distribution inventory levels?

Yes. So let me start off with that and Derek can chime in as well. So from a contextual standpoint, our distribution business largely serves Industrial and Consumer. There's a little bit of fulfillment that happens in Automotive largely in Asia. But predominantly, it's our Industrial and Consumer business that goes to distribution. And so we just talked about the end market demand and the resulting inventory overhang and the digestion that needs to happen. So we do see our inventory levels still remain at the higher end of the range. The point of sale is starting to look encouraging, but it's still early days, and we're going to watch that pretty carefully.

Yes. And that really varies by region, Quinn, as Vineet said to talk about, right? When you look at that average I gave, right, that's the global average. There are some pockets of the world like North America and Europe that still need some inventory fulfillment. We were stocking the channel in Japan early the year have made the transition from Sanken. But parts of Asia, we've talked about for a while, particularly in Taiwan and China for industrial and solar and data center has been at elevated levels, and we expect that to last a few quarters.

Okay. Yes, that was my next question is in some of those Industrial and nonautomotive markets. It still sounds like you think we may have another quarter or 2 to go in that inventory correction process.

That's right. And that's what we talked about on our Q2 call in the beginning of November, but that's probably a couple of quarters to digest through that inventory in the clean Energy Space and in the Data Center space specifically, which is really in Asia.

Got it. No, It's late in the quarter, I'll ask, but kicked us to earnings if you feel that's more appropriate. But just can you make any comments, as we were coming through this inventory correction, just how your order environment has been? My guess is it's probably held up better on the Auto side, been a little bit weaker on the Industrial and other segments, just given the inventory correction. But any comments you can make around just order trends or the order environment?

Yes, without getting into too much detail, I think what you laid out, Quinn, is directionally correct. We have always maintained that our visibility to the business really comes from our design win pipeline. That continues to be really robust, whether it's with our core portfolio or our TMR technology, which we are very, very excited about and that we have now augmented with the Crocus acquisition. That continues to be super strong. And we'll get more into our order patterns when we get to our needs.

Perfect. Okay. Just a couple more for me. And I think this has probably been the case for a couple of months now, but sales in the U.S. of electric vehicles seem to be a little bit softer, and that seems to be perhaps skewing some investor expectations. I think data elsewhere around the globe, especially in China has been a little bit stronger. But just what are you seeing from the different geographies in terms of EV demand?

Yes, it's a great question, Quinn, and you're not alone or we are not known and wondering and worrying about this dynamic, from our part and where we sit, we have visibility to all the OEMs globally. And one thing that is in common is that every one of these OEMs is investing very heavily in their EV portfolio. In fact, I can't tell you a single OEM that is investing in new ICE platform. So it's all on EV, all the time now. And so there is a dynamic or a different dynamic in each geography. We know and we see the proof, the Chinese OEMs are clearly ahead of the pack. I think they're the ones that have really figured out the economics of building compelling and cost-effective EVs. I think they put their arms around the battery supply chain. As to some of the OEMs, the obviously, major North America EV OEM, really has got the economics figured out. I think some of the stumbles we've seen, maybe some of the trepidation we are hearing in North America is largely around some of the legacy OEMs, as they are figuring out the economics of EVs. And so there's always going to be a few fits and starts, maybe some was out of the starting blocks. But we have visibility to everybody's 3- to 5-year plans. They are all very robust in terms of new EV programs, EV designs, and they're all pushing the block to get to the right economics as quickly as possible. Which is why we also see the design cycles, at least initially compressed for some of the new EV platforms, as OEMs try to bring out the latest, greatest technology in quick cycles to the market. So short term, I think as I've said before, the EV transformation is not going to be a straight line, but there's going to be a few fits and starts, but the long-term trend here is pretty compelling.

Got it. You mentioned TMR. That was sort of my next set of questions. The technology is the newer, more precise magnetic sensor technology. Can you just -- for folks who may not be familiar with TMR or the xMR technology, what are the benefits of TMR sensors versus Hall effect?

Yes. So I'll remind everybody that we are the leader in magnetic sensing by far, we have a really comprehensive and a wider portfolio of Hall effects sensing technologies as well as TMR sensing technologies. And we also believe that Hall will be perfectly fine for a broad spot of applications for a long time to come, and we'll keep investing in all. What we are more excited about now is the TMR portfolio. And as applications become more demanding, the need for higher accuracy, better resolution, better response time, is really starting to become more pervasive in applications around advanced steering and braking, around battery management and really understanding very accurately to current draw across the different parts of an electric vehicle. That's where TMR comes in. So TMR stands for tunnel magnetoresistance. It's a very advanced form of magnetic sensing. And it is 8x more accurate than Hall, the response times are in nanoseconds versus microseconds for Hall and from a power draw standpoint, TMR is really ultra-low power. So any application that runs on a battery, will want to use TMR because it will draw very less power and can make the battery last longer. So one great example is the application we inherited through our Crocus acquisition for continuous [indiscernible] monitoring. It's a small application today, but has really great potential. And these are consumable devices, but they need to operate for at least 2 weeks and the TMR application is perfect there. So, we will see more and more demanding applications, whether it's in Automotive or E-mobility, whether it's in Industrial, Clean Energy or Automation platforms, gravity towards TMR. And we had roughly pegged the SAM to be about $1 billion by the end of the decade. We think it's going to be much bigger than that as we've dug into the technology, and we've had customer engagements Anecdotally, last week at CES, we had a really great slate of customer meetings and over 75% of the customer meetings, we're focused on how we can accelerate TMR to bring into their applications and really give them to use and take advantage of this technology. So couldn't be more excited about where the industry is headed, where we are headed with TMR and how we can serve our customers in a much more value-added way with not just our native TMR, but also what we had different focus.

Understanding, it's probably a more expensive manufacturing process than Hall effect. I could imagine that if it's much lower power consumption, it could apply to a good part of the EV auto market over time. Anything that's power-sensitive, anything that's high performance sounds like a natural use case for TMR. But do you see TMR taking over a good part of that higher end of the market, particularly in EVs over time?

We believe so. So the more demanding applications should gravitate towards TMR, so whether it's battery management solutions, whether it's more advanced tiering, breaking applications, maybe more advanced inverter and onboard charger applications. Anywhere higher resolution, more accuracy, faster response time is required, we see that being a natural fit for TMR versus Hall. And over time, we think the economics of TMR should look very similar to that of Hall, but we have some work to do to get there. But I think the margin profile would look very similar.

And you mentioned the higher precision. It certainly sounds like current sensors and measuring current flow off EV batteries certainly could be another application.

That's exactly right.

Okay. I wanted to ask again about the Crocus acquisition. Allegro had been internally developing TMR technology, you acquired Crocus to sort of complement your internal design efforts. What did Crocus bring to Allegro, Were they sort of applying TMR in different end markets? Do they have a sort of a different flavor of the technology, that might be more applicable to certain subsegments of the market? How did it complement Allegro's TMR development efforts?

Great question, Quinn. We had been investing in TMR for almost a decade, and we are in the market today in Automotive TMR. So the top 2 EV manufacturers globally, today use our TMR position sensing. But we had really developed TMR for Automotive. Crocus on the other hand, had come out of the MRAM world and was really perfecting the TMR stack on a stand-alone basis and had found application in Industrial and Consumer, including Medical. And so we felt that while our overall TMR solution was really strong, their TMR stack on a stand-alone basis was very superior and really best-in-class. And so it natural fit the physicists that we've inherited with Crocus, are now integrate part of our engineering team, working very closely with our IC designers. And so as a combination, we believe we got the best TMR technology in the world. And the applications are complementary as well. Crocus TMR wasn't auto qualified. We're in the process of doing that now. And very soon, we'll be able to sample the XtremeSense TMR, which is now the joint brand for Allegro, across our TMR portfolio with Automotive customers. We are well in the process of doing that. And we will then also expand the position that Crocus had in Industrial and Medical with our own portfolio and our own sales resources. So it's really exciting to see the 2 teams come together. By the way, I'm really pleased with the speed of integration in the 2 months, that we've owned Crocus the business is now completely integrated. All Crocus parts are now available to order through the Allegro channels. Our sales people are empowered to go sell Crocus. And so it's really gratifying to see the 2 teams come together and just highlights how middle of the fairway this acquisition was for us. We know the technology, we know the business, we know the customers, we know the supply chain. So from that perspective, it's just been a complete stand-up for us.

Excellent. I was going to ask how integration is going, but it sounds like that's done. The other question I had was you sort of touched on it your efforts to make the Crocus TMR sensors, automotive grade. It sounds like that process is underway. How long does that take? Is that something that's measured in months or quarters? Or is this a kind of longer process, where you've got to do burn-in and really kind of stress the quality to bring it to the automotive grade level?

Yes. It's another great question, Quinn. So in diligence, we had already put the Crocus TMR stack through its paces. And we are very close to having, what I would call a generic order qual for the Crocus TMR stack on our CMOS. Now as we start to engage automotive customers, there is a unique qualification cycle that will happen with each customer and each part. And it's multilayered, right? So we will qualify the part in our labs and our 4 walls, who will then qualify a part as part of a subsystem with a tier or a contract manufacturer. And the final qualification will be done by the OEM, at a vacant level through winter and summer test. So it's Automotive, safety is always top of mind. And so, it'll take a few cycles, a few couple of years before we start to see the Crocus TMR parts in cars on the road, but the order qual process is already underway and very soon here will be notching design wins with Automotive customers with the Crocus TMR stack and our CMOS and moving very quickly to production.

Great. I wanted to move to a few product and design win related questions. The first kind of just a bigger picture, Tesla's cyber truck, I think maybe the first vehicle manufacturer to use a 48-volt electrical system throughout the entire vehicle. And I think Tesla has begun to recently share that architecture with other auto OEMs. I know that I've seen some press releases talking about sharing it with Ford, Generally, how do you see Allegro transition as we move from a traditional 12-volt to 48-volt electrical system in vehicles?

Yes, it's a great question, and I think this is an exciting development in the Automotive industry. I've got to give our engineering teams a ton of credit. They have very prescient, in seeing a future transition towards higher voltages. And so about 5 years ago, we converted most of our portfolio to be scalable all the way from 6-volt to really 110-volt. And so the good news is most of our portfolio is already ready for 48-volts. And if somebody were to read the specification that Tesla put out on 48-volt, essentially, it's a manifest of how to build a 48-volt architecture, you would notice that it has a bunch of Allegro parts listed. And so the inbounds from other OEMs have only increased in intensity. Everybody had been experimenting with 48-volt architecture and sort of put it to a side saying, well, maybe now is not the right time. But believe me, now has become the right time, as that document was put out and now every customer wants to talk to us about, are your parts 48-volt ready? And we noticed you're on the list of parts that was put out as part of the specification. So I think for us, this is a very natural extension. And now every one of our customers other than Tesla is interested in sourcing our parts, and they're relief to know that our parts already work on 48-volt, as opposed to requiring new developments.

[ Then ] that's right. I didn't realize that Tesla's architecture kind of went as far as listing sort of approved or specific port numbers as part of that architecture. So that certainly seems like a strong endorsement.

Yes.

Good. Moving to the next question. Can you give us any sense on what you're seeing in the data center side of the business? I know data center cooling fans has been part of your business, it's been a little bit slow for a couple of quarters. But first, maybe just an update on the data center opportunity.

So Quinn, data center is part of our Industrial business. We call it Cloud Infrastructure. Industrial overall is about 20% or less of our complete total company revenues. Having said that, the design win activity in data center continues to be really strong. And we are seeing more engagement on AI-related solution sets, which is really liquid cooling, as opposed to air cooling. A lot of our tiers that we work with, the solution providers have started to really double down on their investment in liquid cooling. That naturally results in more content for us, as these solutions are more complex, require, in addition to motor and motor pumps, they require more IC content to ensure that the right liquid at the right temperature is getting to the right places. So long term, we feel really bullish about, what it means in terms of data center activity and design with momentum. Obviously, as we've been pretty transparent, right now, they're going through an inventory digestion period, which we still think is going to take a couple of quarters to work through.

Okay. No, that was -- I was going to ask about liquid cooling thinking that it might be a headwind to the cooling fan business, but it sounds like you're seeing opportunities in terms of motor drives or the pumps to move the liquid around the liquid cooling systems and sounds like you may have even higher dollar content in some of those emerging liquid cooling applications.

That's correct. And it's still early days in terms of the architectures evolving around liquid cooling. So it's hard to sort of pin down exactly what that content might look like. But suffice to say, it's certainly bigger than that of just fast.

Yes. And I think it's Supermicro [ as ] they sort of stated they think that perhaps as many as 20% of data center X would need to be liquid cooled. So that sounds like that could be a nice opportunity for Allegro, as well over time, understanding that we're going through some inventory digestion in the near term in this segment.

That's correct.

Got it. Kind of moving to other applications within your industrial segment. Can you talk about some of the larger opportunities you see in the Clean Energy segment?