Allegro MicroSystems, Inc. (ALGM) Earnings Call Transcript

I'm Joe Moore, the semiconductor analyst for North America and Morning Stanley. And happy to have with us today the management team of Allegro, Mike Doogue, newly President and CEO and Derek D'Antilio, EVP and CFO. So we're going to go through some questions. Just upfront, we're not going to address any kind of unconfirmed M&A rumors, so just to be clear on that. But anyway, Mike, thank you for joining us today, first time in your new role and congratulations on your promotion. Maybe you can give a few moments to speak about your background and your priorities for the company.

Sure. So first, it's an honor and a privilege to take over the position of President and CEO of Allegro. And it's been a long time coming for me. I've actually been with the company for 27 years, if you can believe that. I started as a chip designer in the early days, worked on disruptive technologies that we turned into disruptive product lines. And then the next chapter of my career was really one of both engineering and business leadership. Allegro used to have three business units. I took over one and then two and then all three of those business units. At the time, I was SVP of Products and Technology. And I was responsible for revenue growth, gross margins for the company. We executed successfully up to the time of our IPO, and I continued in that role after the IPO and eventually became our first ever Chief Technology Officer at that time, responsible for technology development, responsible for corporate strategy. And along the way, I actually had the good fortune to take over all of our global operations as well, which was running our internal factory, working with our OSAT and fab partners, being in charge of quality et cetera. So that really is a great springboard to taking on this new role, having such breadth and depth in the company. And as I look forward, there's a few priorities that we have as a leadership team. Number one is to keep innovating and driving forward our competitive advantage. A big part of doing that is releasing not only new products but the right products. We talked recently about releasing a lot more new products at an accelerated velocity. My plan would be to continue that, but especially in high-impact areas like TMR sensors, isolated gate drivers. Along the way, we'll get closer to our customers. We have great relationships with them, but there's always new winners in the marketplace that we'll get to know. We have operational efficiency initiatives to undertake, especially important would be our China for China supply chain strategy. And in the end, we have to sell it all together by executing on our financial commitments, both in the short term and driving forward as a leadership team towards the long-term financial model that we've published many times over. So it's exciting times. I believe that with the breadth and the depth of my experience, I can help accelerate some of our strategies, unlock shareholder value. And I'm excited to get to work with a great team at Allegro.

Great. Well, congratulations on the job and it's a great background. It's a lot of loyalty to Allegro over those years. So congrats. I guess under other situations of CEO transitions, companies have reiterated guidance if it hasn't changed. Fair to say that you're still comfortable with the guidance that you've given.

Yes, Joe, we're reconfirming guidance this morning. So revenue of $180 million to $190 million of our guidance range for the fourth quarter here, which at the midpoint is up 4%. And as we talked about on our January 30 call. Within that, we expect that China will be down marginally for the -- due to the Chinese New Year. North America will have a nice rebound that was down pretty significantly with a lot of inventory clearing in the December quarter, and we're reiterating the gross margin guidance and the EPS guidance as well for this quarter.

Great. Well, on that note, you had a good earnings from a top line perspective. You had auto up sequentially in December. Can you talk about that dynamic? You guys have seen a maybe more severe correction in autos earlier than others. And now you seem to be recovering maybe a little bit early, kind of first in, first out, is that what's happening here?

Yes, a little bit. So let me correct the December quarter a little bit. The December quarter, our sales were down 5%, which is actually seasonal for the last 15 years. Typically, sales are down about 5%. The only quarter that has actual seasonality in totality is the December quarter, which is down 5%. And in full transparency, this 5% is different. This 5% was actually auto down 8% this particular December. So we troughed in the December quarter here of auto revenue about $130 million. And what really drove that down was we expected that, we expected North America and European auto to be down significantly in the December quarter, about 20%. North America was down 26%. And clearly, the North American auto market was not down 26%. So we were pleased to see a lot more inventory come out of that channel. We have seen some green shoots within industrial, and industrial was up another 30% in the December quarter, and that's the law of small numbers because it was up $5 million, but we're seeing things like life in data center, medical returning. So as we go into the March quarter, we do expect that right now, this December quarter was the trough in auto, and we're seeing some life in North America and auto. And we're seeing continued good things in places like Asia, China, Korea and auto for us.

Great. And I guess the gross margins were a little bit lower than you thought maybe in March. Can you talk about the reasons for that?

Sure. So the gross margin guidance for the March quarter was 46% to 48%. It's the lowest it's been in a couple of years. And there were really three things driving that down. That's about 200 basis points, which for context is about $3.8 million. And those three things are: one is pricing is typically negotiated in the March quarter, with auto customers, and that happens every year. But the last couple of years were a little different in the auto space where there were pricing increases. So this year, there's a little more friction on the pricing coming down and on smaller numbers, it shows up more. And within that, you see pricing come down first on the top line before some of the cost negotiations that we've done start to roll into our P&L. What I mean by that is it takes about 2 quarters to cycle through inventory. And if you look back to January of '23, we had our all-time high gross margin. And at that point, I actually said before our analyst call that, that was somewhat high because of the fact that we had pricing go up before the cost kicked in, and that happened in that quarter. So it's the same dynamic. The second piece of that really is as we're going into the March quarter, we continue to adjust our production levels. So we've been building some inventories, some finished goods inventory of high runner parts for the last several quarters. We're going to adjust that down a bit in the March quarter. And we're not going to get rid of the capacity because we think we're going to need that capacity going forward. So we'll have a little bit of extra capacity charges here in the fourth quarter. And what I said on our call is we do expect that to be the trough for gross margins, all else being equal. And so I expect the March -- the June quarter of gross margins to rebound from there.

Great. That's helpful. And I wonder if you could just talk -- get into some of the end markets, but generally about lead times and visibility, what you're getting now from your customers and you -- I think you mentioned last quarter, turns orders have picked up. Just how much visibility you're getting from the customer front?

Yes, I'll start with that, Joe, and then Mike can talk a little bit about on the customer front. So -- what we saw here over the -- and typically, in the pre-pandemic, we would have had about 2 quarters worth of backlog. It doesn't mean we have the next 2 quarters booked, but there would have been about 80% of that next quarter actually booked and then they'd be within quarter turns business of about 20% that did not exist in '22, '23 and '24 during the wafer shortages and during the chip crisis. So now coming into the September quarter, we were actually below that fill rate, but we saw the bookings rate go up. And we talked about on our call how the bookings and all the forward-looking metrics were the most positive they've been in the year. Bookings were 50% up from a year ago, above 1:1. In 1 month or 1 quarter, it doesn't make a trend. But as you start to see those things move in the right direction, the push-pull ratio moving in the right direction, cancellations have largely abated. In-quarter orders have stayed, the fill rate is higher, which means that customers have lack of those inventory parts on and they're willing to order from us within the quarter. So those are generally all positive forward-looking things. Conversely, if you roll the clock back a year ago, when we were kind of hitting on all cylinders in revenue at $280 million, you see those negative things. You see cancellations coming fast and furious push outs. And to touch on your last question, Joe, we did. We took some of our pain a little bit earlier. We let customers out of some of those long-term agreements early in the cycle. We think that's the right thing to do. We've had these customers for 30-plus years. And in the June quarter, we were down quite significantly in 2024. It was down 30%. China was down 54%. But we're seeing a lot of inventory clear in the channel, and we got a lot of credit from that from our customers.

Great. And maybe you could also talk to customer behavior, maybe starting with autos. The -- when we were in the midst of the shortages, the automotive kind of Tier 1s were saying we're going to build a lot of safety stock. It's different this time. We're not going to let the shortages happen again. It feels like it's pretty much the same this time . We went into a downturn. People started maybe built inventory for a little while, but have seemed to reduce -- my perception is some are getting to low levels, some are still higher than others. But just can you generally characterize your customers' attitude towards supply chain, both from the standpoint of inventory management and also longer term thinking from here.

Yes. So I think you nailed it in terms of talking about the behaviors of the past, I think now there is a mixture of what we see from customers. Some customers starting to get to lower levels of inventory. So we do see pockets where some customers have larger levels. What I think will be interesting coming through this next period is that what I saw with a -- seen in front of many of our customers doing negotiations entering the crisis. They just didn't have that awareness of how long the manufacturing cycle time was for semiconductors in the past in the automotive space. There's been a big level of education throughout the last crisis. And let's hope that they've learned some of their lessons such that they understand that things can't be turned back on too sharply, after an under-inventory situation that could be brewing.

Yes. I mean my thesis has sort of been that there will be a memory of how severe those shortages are, but the memory kicks in when there's something tight somewhere down the road. When there's obviously enough, then many people are still having the same behavior.

I mean on a positive point, as Allegro, we now have situation with our own internal inventory that we're ready to help support customers when the demand does come back, which has been different from prior cycles as well.

Joe, one of the things that's kind of interesting here is it all revolves around incentives, right? If you go back a few years, where the Tier 1s wouldn't necessarily carry extra inventory based upon their working capital needs and those sort of things, right, in their operating margins. They were given incentives by some of the OEMs to do that. 5 years ago, interest rates were the lowest they have been in 80 years, right? And those 2 things have changed now, coupled with the fact that everybody in the semiconductor industry has some capacity right now. So we can fulfill orders within lead time. We've sent letters to our customers saying we can do that for you right now. We may not be able to do that in 6 or 9 months. You'd like to think a flurry of orders comes in, it doesn't happen. But as the whole supply chain starts to tighten, that's when that happens and people buy parts from brokers at 30% above. And so those behaviors seem to trickle back in over time.

Great. And I know part of the enthusiasm for Allegro is the SAM expansion that you have in the automotive market. Can you talk to that generally? And is that -- that's a long-standing trend, of course, but are there inflections over time where you see increasing content per vehicle?

Yes. It's a good story in terms of our automotive SAM. We put it in the neighborhood of around $8 billion for Allegro. Of that $5 billion is in what we call e-mobility, right? So this is the electrified powertrain and also the ADAS portion of the marketplace. When you look at the projected growth rates for that portion, so up within our $8 billion SAM, you have this $5 billion e-mobility space. It's above double-digit growth rates because of the increased semiconductor content, both in the EV powertrain and in these autonomous or semi-autonomous systems that really do incorporate a lot of our products, the trend over time, having been in the company for a long time, you would see a power steering system in a car that might have 5 or 7 of our chips. Now you see it getting up into the 11 or 12. And we do see those numbers getting even to higher levels as the level of autonomy or the level of assist in the cars continues to climb. On the EV side of things, certainly, when we look at our SAM, it's important to remind everyone, in a full hybrid or BEV, we already have far more content available to Allegro than you would have in an ICE car. But as we roll out some of our new technologies like our isolated gate drivers, the SAM increases by more than $2 billion as well. So I think there's a market dynamic where the semiconductor content is going up in cars, and then we also have product introductions that gives you kind of the double kicker as part of the growth story.

And I guess maybe in a bigger picture, what are you seeing from automotive investment in those 2 areas of e-mobility and ADAS, maybe take China separate because I think it's different. But I feel like in the North American and European markets, there's been maybe more focus on the EV part of the business, maybe a little less on ADAS than I might have expected. Jensen promised me there'd be no steering wheels by now, and they're still steering wheels. So the ADAS has kind of slowed. Do you see that changing a little bit? I mean, it seems like FSD from Tesla has really made some great strides. China is making great strides. Do you see the Western automakers start to replicate some of that?

Yes. So look, I think the sweet spot for Allegro where our dollar content really starts to rise, you don't need FSD. You need the systems in place that are going to take over control of the car. So even when you have lane assist in your car, and trust me, I'm not going to go on record saying I love lane assist. Well, I do love it because of what it means inside the car. So the minute that the car starts taking over the driving itself without the driver intervening, the companies are investing in redundancy of components to make sure that you have fail-safe mechanisms to keep the car safe during those steering conditions. So those are the dynamics that increase the dollar content for Allegro. And it's a strong dynamic. And certainly, we continue to benefit as you go to full self-driving, but I wouldn't correlate full self-driving adoption too heavily to our ADAS growth story. There is more going on well before full self-driving.

And Joe, one statistic on the EV side that was kind of interesting is it's sort of interesting from a North American perspective, you hear that sort of EV is slowing or EV is dead and these kind of things. The data certainly doesn't bear that out. And as we go through our strategic planning process every fall, and we kind of do it throughout the year, but for our Board, we published a new investor deck and we refreshed that with some of the most current data. And what's really fascinating is our xEV business is both powertrain for EV and hybrid, which has similar content until you go to an 800-volt battery. But the xEV projection of units going out through 2028, 2029 is 65% better today than it was 5 years ago during sort of the EV hype. So the data is still really, really good. And that's across the globe, of course.

Yes. Now a lot of that seems to be happening in China like -- maybe that's the degree to which I'm surprised relative to 5 years ago. Can you talk about your positioning there? And it seems like even in China, your Competition is largely coming from Western companies.

Yes. So let me start with competition just to answer that because it plays into the final answer of how we're doing there. We do still compete with a lot of the Western companies we compete with all over the globe in China. There are also local China players there as well that we have to contend with. We lead with an innovation foot forward. Certainly, when you can deliver chips to customers that solve problems for them, they respond. In some cases, customers are looking more for a middle of the fairway and just good enough device. And that's really where we bring forward our quality record. I can tell you that in the China market, we see the same intense focus on quality in the automotive space that we see throughout the rest of the globe. In terms of differentiating Allegro in the marketplace, we're also -- we've talked publicly about our China for China manufacturing strategy. That's fairly unique for Allegro. That's progressing nicely. When you put it all together, we have a good story with our customers in China. We have good design wins and good solid business with the EV folks in China as well. And what's interesting is when you look at what is most likely to happen, we have good business in China today. They are now focusing more on the export market. And when they focus more on the export market, all the traditional Allegro value drivers of innovation, quality, et cetera, become even more important. So we're feeling good about our position in EVs in China.

And when you talk about the domestic part of the market, is it still Infineon and Melexis are the main competition for those buckets?

Those are two of our biggest competitors in the marketplace. On the sensing side, especially, they also compete on the power side as well. So those would be two primary names.

Okay. And then this Chinese New Year related kind of seasonality in March. I mean, I feel like others are kind of more maybe not giving us the granularity about that, but it seems like there's a clear trend of China is good, other markets still tough. It seems like you guys are a little bit more geographically balanced in terms of the recovery you're seeing. Is that fair?

Yes. One of the nice things about our business model is we're very well geographically balanced. So China is anywhere from 25% to 28% of our business in any given quarter. And about half of that is reexported out of China. So the actual China exposure is probably 12%, 13% domestic China exposure. About 18% or 19% of our business is Japan, which is really unique for a non-Japanese company, about 20% is rest of Asia, 15% is North America and Europe. So it's fairly well geographically balanced. So when you have Lunar New Year, where there's clearly a week or 1.5 weeks in China without shipments and you have the summer in Europe, those things are offsetting each other. So that's been helpful. And no customer is more than 2% or 3% of our business, right? So we have a wide spectrum of customers across both the Western world and Asia. And what we're seeing across our business is China is in pretty good shape from an inventory standpoint. We took a big hit in China in June of last year. Like I said, it was down 54% in one quarter. A lot of inventory came out. It was back up 50% in September, not quite to where it was before. We saw places like Korea clear a lot of inventory in the fall time frame. Japan has been in pretty good shape, shipping to, I would call it, demand in Japan, albeit muted demand. The regions where we came into the December quarter still having inventory was North America and Europe. North America, we feel really good that we cleared a lot of inventory being down 26% in the December quarter when clearly North American auto was actually up 1% or 2%. So that was good. The region that's probably got a little ways to go, both in terms of inventory and even so from a market standpoint appears to be Europe for us.

Okay. And that seems pretty consistent across everybody. That's the part of the weakest part. You talked about customer diversity. Can you give us a sense for that? And how much of that is that you're multi-sourced in the similar sockets that you have multiple competitors in the same car? Like why isn't there more customer concentration?

Yes. So when you look at the target markets, right, we focus within auto and industrial, there's a good distribution of both, let's take automotive, Tier 1 and Tier 2 players for Allegro to participate with. We -- if we take our sensor business, you have a component that is usually worked into or incorporated into some other type of subsystem, which does allow you to cover Tier 1 suppliers in automotive, Tier 2 and sometimes Tier 3. I think that diversity of customers is one of the main reasons why we have such a broad spectrum of customers, none of them having an outsized portion of revenue especially because even some of the large Tier 1s in automotive, they actually incorporate components from the Tier 2s and Tier 3s. So if you pick one of the large Tier 1 names in automotive and you might think, for surely you would have a bigger position with the company like company X, Y or Z, a lot of times you do, but you actually accumulate that revenue through selling through the Tier 2s and the Tier 3s. And then in our target industrial markets, the industrial market being much more fragmented in general, you just have the inherent diversity both in application but also just in customer name as well.