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

Hello, and good morning. Welcome, everybody. Thank you for joining us at Needham's 27th Annual Growth Conference. My name is Quinn Bolton. I'm 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 the leading position in current sensors. We believe Allegro is well positioned for growing content per vehicle driven by the trends towards autonomy and electrification, and we recently named the company as our Top Pick for 2025. Joining me from the company are President and CEO, Vineet Nargolwala; and CFO, Derek D'Antilio. Vineet, Derek, thank you for joining us at the Needham Growth Conference.

Thank you. Good morning.

Thank you, Quinn. Good morning, everyone.

Guys, I wanted to start off with your biggest business, Automotive. Obviously, lots going on. But if I look at your September -- or the guidance you gave in September for the December quarter, you're guiding overall revenue down about 6% at the top line, but I think embedded in that was a pretty cautious outlook for North America and European auto customers. How much of that weakness that you're seeing in North America and Europe is just sort of overall weak end demand versus the continued effect of inventory digestion?

Yes, Quinn, it's a great question, and I'll start and then Derek can jump in as well. When we look at the overall automotive landscape, we've seen continued strength in China. Our other Asian markets, notably Japan and Korea, have been largely stable with a bias towards growth. And I would say North America and Europe have been the 2 areas or the regions where inventory digestion has taken a bit longer than I think everybody expected. And then in Europe, we're obviously seeing some signs of more challenges related to the legacy OEMs in Europe as they try to figure out their electrification strategy. There's obviously a lot of repositioning of plants and R&D investments and so on. So I think if I look at North America, it continues to be an inventory digestion story. Encouraged by what we saw in terms of Q4 sales, especially December. I was reading a report this morning, which said that xEV sales, so battery electric and hybrid sales rose to almost 20% of total U.S. sales in 2024. So despite all the doom and gloom and sort of the negative sentiment, quietly, EVs and hybrids have continued their steady climb and now are as high as 20% of total U.S. sales, so that's encouraging. And then I think in Europe, once the legacy OEMs figure out their plans, the industry is pretty confident that companies like BMW and VW and Benz will figure out how to electrify their portfolio and start moving towards economic and also compelling products. So a long way of saying inventory digestion, a little bit broadly, but some sort of challenges in our repositioning in Europe. Over the mid to the long term, we're optimistic that they'll figure it out, but we see continued tailwinds from the electrification of the portfolio. And we've said this before, and I'll say it again, we don't actually need global auto production to grow for us to grow. We see content lift from the transition to hybrids and battery electric vehicles, increasing levels of autonomy that will continue to drive our content forward.

Yes. No, and we'll get into a lot of those drivers here in the Q&A. As you head into the March quarter, Vineet, what are your expectations for sort of inventory dynamics at both your distribution channel as well as the direct to customers?

Yes. So I'll talk about it in terms of end markets. So I think in automotive, we're closer to the end of inventory digestion than to the beginning, right, so I think other than a couple of maybe straggling pockets. And we said that before in our earnings call as well in the prior quarter, other than a couple of straggling pockets, I think the inventory digestion is largely going to be behind us. So we should start to shift more into, what we would call, our normal consumption model. I think on the industrial side, it continues to be pretty uncertain. There's a lot of questions around incoming U.S. administration. How much of the rhetoric gets turned into policy, what is the impact on tariffs, so on and so forth. So I think in Industrial, we're seeing some buckets like cloud, data center, medical continue to show green shoots. Broadly, I think it continues to be cautious waiting on sort of certainty, but we know that the inventory positions have been drawn down pretty significantly, okay? Maybe some pockets again here or there, but cautiously optimistic that as trade policy becomes more certain, we'll start to see more normal orderly patterns come through.

And Quinn, as you well know, one of the nice parts about the Allegro business is the well-balanced geographic dispersion of sales with about 1/4 of our sales in China; 20% what we call rest of Asia, which is really Taiwan, Korea, India; give or take, 15% to 20% in Japan; somewhere in 15% in the U.S.; and another less than 15% in Europe. And that served us well over the years as different regions go through different economic cycles and we're seeing the same thing right now. And we're seeing different dynamics, as Vineet touched on, and we talked about this publicly at our last conference call in November and also at our last public fireside chat, given that the inventory clearing, the market dynamics, we did a lot of that early in China back in our Q1. We took a big hit in China. Cleared a lot of inventory. China was back up 52% for us in the September quarter. As you suggested, we did guide to have a lower December auto quarter with North America and Europe, which is no secret. There's been a lot of announcements in both of those regions. And as Vineet mentioned, in North America, we feel good about it in the sense that it's really an inventory digestion taking longer, and there's been a lot of positive news and sentiment in North America from an auto perspective. Europe, as we talked about, has a -- both a macro challenge and the inventory clearing. Now Europe for us happens to be our smallest market for us, but we continue to make inroads there as well.

Perfect. And I know you guys -- we'll talk about this on public calls, but maybe just give us a sense of the design win momentum you saw in '24 on the automotive business.

Yes. Quinn, that continues to be very strong. We don't obviously provide quarterly updates on our design wins. But we continue to see a majority of our design wins again come from e-mobility within automotive and the target industrial markets in the industrial space. So in medical, in cloud, data center space, in the automation and robotics space now. So feels really good. And we are really encouraged by the intersection of what we're working on in terms of new products as well as the design wins we're seeing in the target markets that we are focused on.

Perfect. I know S&P Global Mobility is sort of forecasting SAAR to be sort of flattish, maybe down 40 basis points in 2025. But speaking to your e-mobility business, what kind of xEV growth rate are you looking at over the next few years? Do you still see that as a sort of 20-ish percent grower? What kind of growth rate do you think that, that market is going to be growing at?

Yes, we think so. We think -- as I've said before, we don't actually need auto production to grow. So if auto production is flat and inventory digestion is largely behind us, we start shipping into normal consumption, we should see growth. And then the tailwind for us is the continued electrification and the continued adoption of ADAS feature sets. And that for us is starting to -- you talked about xEV growth. We believe -- and this is not just us, various third parties have reported xEVs would still grow a healthy mid-20% range globally. Some regions faster than the others, right? China has been on a really, really strong growth trajectory. We think that, that continues, maybe moderates a little bit versus the target rate for the last couple of years. But there's so much more room to grow in Europe, North America and Southeast Asia. So we think that continues to grow. So we see a lot of tailwinds despite a flat production market.

And Quinn, we chatted about this, but in my last public fireside chat, we talked about how Allegro went through our strategic planning process in the fall. And it's kind of a constant process, but we do a full update in the fall time frame for our Board. And one of the outputs of that is I know investor presentation that we published with our earnings in November. And in there, there's a slide where we've really just updated our SAMs and our TAMs, which are slightly bigger than they were a couple of years ago, both in Industrial and Auto. But very importantly, it allowed us to reconfirm the growth in those areas of xEV and ADAS. And what we found very, very interesting was when the company went public a few years ago, that by 2028 or 2030, there were some projections for xEV, both hybrid and electric vehicles, which were quite good. Well, today, those projections are 65% better than they were by 2028 and that includes hybrids, which we have similar content on. So while sentiment, particularly in North America, on EVs has been a little down, I think the data shows otherwise, which is great for us and our peers.

You've talked about the e-mobility side of the business. Maybe just what are your thoughts on the growth rate looking forward over the next few years on e-mobility? And can you give us some sense how much of the e-mobility is largely xEV driven versus sort of the ADAS side of things?

So when roughly 50% of our sales are in e-mobility. The rest of it is a segment we call Safety, Comfort and Convenience, which is agnostic to the powertrain. So it grows slightly above SAAR. And then there's a smaller segment, which is purely ICE powertrain, which we've modeled at about, call it, high single-digit decline over the next few years, right? So that's what comprises our Automotive business. E-mobility continues to be our growth engine, right? And within that ADAS, and again, we're in sort of the real mission-critical part of it, which is your advanced power steering, your advanced braking systems with our -- with really a cross-section of our portfolio. It's our current sensors, it's our position sensors, it's our motor drivers, it's our auto-grade PMICs. So it's a really custom-built portfolio for -- which is automotive grade for these mission-critical applications. The fastest growth we are seeing is, of course, on our xEV portfolio, which is largely around current sensors, PMICs, motor drivers, all of it around efficiency and safety for electrical vehicles.

Perfect. And on the xEV side, I think there may be some misperception out there in the market with investors that your business is primarily driven by the battery electric vehicles. Can you maybe just sort of talk about your dollar content across the xEV landscape?

Sure. So let's start with high-level numbers. So our content opportunity on a pure ICE vehicle today is roughly around $40. That goes up to as much as $60 on a hybrid or what we would call a 400-volt battery electric vehicle. And then as battery electric vehicles move towards higher voltages, 800 volts and above, and you start to see more wide band-gap compound materials being used with our high-voltage gate drivers, that content opportunity goes up to as high as $100 a vehicle. So it's a very nice progression of content as there's increasing electrification in cars. On hybrids, I would remind everybody that we benefit from both conventional powertrain. And it's generally a lower powered engine but still needs transmission, still needs all the traditional sensors. And then you've got a smaller battery pack, but still a lot of the same electric powertrain considerations that you would have on a pure battery electric. So we get to benefit from both. And obviously our Safety, Comfort and Convenience, as people who seek more comfort, more tech in their cars, that content continues to grow nicely as well for us.

And Quinn, another way to spin it sort of is to say that more than half of our Auto business is powertrain agnostic between the Safety, Comfort, Convenience and the ADAS applications, which are Level 1 and Level 2.

Got it. Okay. I wanted to sort of switch, a couple of years ago or almost 2 years ago you terminated your distribution agreement with Sanken. What's your outlook now for the Japanese market now that you're sort of targeting that market more of a direct sales relationship?

Yes. So we are very fortunate to have a very enviable position in Japan as a U.S. company. And -- we all know how hard it is to break into the Japanese market. And our relationship with Sanken gave us that ringside view of what was happening in Japan and with Japanese OEMs, especially in automotive. And as Japanese OEMs became more serious about electrification, we wanted to have more of a direct relationship because we felt with our engineering talent and resources we could do -- we could serve them in a much better way than our partner Sanken could. So fast-forward to today, we've got our own team serving the customers directly. We are heavily engaged with the full force of our R&D team, our sales, our FAEs. And I'm really pleased to report that we've seen a great progress and a lot of momentum in design wins with the Japanese OEMs in Automotive, but also in the Industrial and a little bit on the consumer side as we've been able to make our value proposition crisper in the eyes of the customer. And so whether it's Automotive, especially in GMR in highly mission-critical applications or it's Industrial, in automation as well as in some gaming and consumer-related applications, we're seeing really good momentum. And I'm confident that as we look out the next year or 2, we'll start to see some pretty significant step change in our growth profile in Japan.

Great. Wanted to sort of move to the acquisition of Heyday, and you're move into the isolated gate drivers. I know you've announced your GaN gate driver already. Maybe give us a sense of what the customer feedback has been. I believe you also have announced your first design win with a Chinese customer for that. And then on the silicon carbide gate driver, is that still set to sample later this year?

That's correct. So really encouraged about the progress we're making with our high-voltage power business, which is really the isolated gate drivers. We have a very unique value proposition. We've continued to invest in that space. As you pointed out, we got our first wins on the GaN gate drivers. Really excited about our silicon carbide gate drivers, both for onboard chargers as well as for traction inverters, which we'd be sampling later this year. And we all know that silicon carbide is finding a lot of favor, not only in battery electric vehicles, but also in the data center space as power density becomes important and power efficiency becomes important. So we're seeing really good design win momentum and sampling momentum with these customers. And I'm bullish that over the course of the next 12, 18, 24 months, we'll start to rack up these design wins and really build a strong business there.

Yes. We definitely heard from some of the other folks presenting at the conference the idea that silicon carbide could start to move into the front ends of the data center power supplies as those racks go from 120 kilowatts to 400 to 500 kilowatts over the next couple of years. On those gate drivers, maybe just can you give us a sense of what the dollar content per auto would be as you -- as those designs ramp?

Yes. So as we talk about our content in battery electric vehicles going from $60 roughly on 400-volt battery architecture to close to $100 of content opportunity, that delta is largely driven by the gate drivers. We haven't really quantified the content opportunity yet in the Industrial side because that continues to be pretty fragmented. But certainly, the Automotive one, we believe is pretty real and we're excited about bringing those products to market.

Great. Moving to the China business. I believe it's roughly 25% of sales. Can you discuss your strategy to localize your China supply chain? When do you expect to have first production from OSATs? When do you expect to have local Chinese wafer manufacturers qualified and ramping?

Yes. So China is an incredibly important region for us. We're in about 25%, 26% of sales. This is where we've seen a continued strength even through sort of the inventory digestion period, if you will, first region out of it. And we have some really, really strong partnerships and relationships who have been urging us to think about local production for some time. And about 1.5 years ago, we saw the writing on the wall that if we didn't localize if that -- by localizing, we could be even more -- we would see even more meaningful growth in China. And so fast-forward today, we are qualifying and we've got more than 10 tape-outs at our foundry. We continue to make progress there. The foundry sourcing will probably take shape over the next 18, 24 months. But I'm pleased to say that from the OSATs, we'll start shipping this year. So we've already started shipping one part, but we'll start shipping more in earnest before the end of the year. So really pleased with the progress the team has made in a very short period.

And we've been, for a number of years, actually doing some assembly, about 10% of our assembly in China, Quinn. So the fact that we're now moving the rest of that portion of the supply chain for standard packaging and other things to the China market is not necessarily new and that's moving along quite well.

Derek, I wanted to just sort of follow up there. I think, in a recent fireside chat, you had mentioned that you're not necessarily moving everything for China to China. That what you'll outsource are more sort of standard process flows that some of the proprietary foundry processes, in particular, may stay offshore. But just talk about what will you sort of manufacture in China? What do you keep sort of more proprietary and perhaps with your current suppliers?

Go ahead, Vineet.

Yes, I would -- so we are very careful to make sure that we are protecting our IP while we localize in China. So we have -- one of our more standard processes, which we are localizing with our foundry partner and a lot of the standard packages will go to our OSAT partner in China. Everything else we will ship in from the outside into China, we believe that's the right balance for now. We obviously assess continuously and see if we need to adapt that strategy. But we believe that, that's going to satisfy the desire on the part of a lot of our Chinese customers and partners to have local production. And that will probably be roughly 50% of what we think is going to get shipped into China.

And Quinn, on the packaging side, it's a pretty similar strategy that we have today for the entire world, where we do a lot of the industry standard packaging, the high-volume packaging at OSATs where they can do it pretty efficiently. And then anything that's sort of custom packaging for both proprietary purposes and because we can just do it more cost effectively, we do that in our own facility in the Philippines.

Yes. Can you just spend a minute maybe just the China for China strategy, certainly very important, I think, for production that's consumed locally within China. But as the Chinese OEMs export more internationally, how much of that production needs to be locally produced in China? Or are they more willing to source parts from international manufacturing locations?

Yes. So it's a great question, Quinn. Right now, we are not really seeing a parsing of local production versus global production. I think there's just a desire to have more locally. Just like we're concerned about -- the U.S. government is concerned about technology advancements and supply continuity, the Chinese customers are concerned about their supply continuity. So I think the localization really speaks to their desire to maintain supply continuity and continue to source high-quality, high-performance parts from suppliers like us. I think as the -- we know that they've become net exporters. And as they expand globally, we believe that they are going to be very open to sourcing from our global supply base. It doesn't have to come from China.

And Quinn, you touched on that interesting point, right, where the majority, at least the expectations right now and the projections are, the majority of China auto growth -- production growth over the next several years is going to be net export. And that bodes well for Allegro and companies like Allegro because the standards still significantly matter, right? It's not just the cost equation. So the fact that our products have a technological moat, have significantly higher standards and those sort of things, that still matters a lot because of that net export growth.

I think many semiconductor companies will say, the best product still win in China, but there's a concern by investors about the threat from local competition in the China market. And so can you describe what you're seeing in terms of local competition in China? Do you see anyone locally in mag sensors or power ICs that could be a threat over the next couple of years?

Yes. So the time frame here is pretty important. I would say, over the next couple of years, our competitors are still going to be the big global players. And our strategy in China, Quinn, is we're not serving -- if you hear the reports, there's over 100 EV OEMs or automotive OEMs, right? We don't treat all of them equal, right? So we're really laser focused on the top 5, call it, 10 OEMs that have scale, that have global ambitions, that value quality and performance, and we believe our value proposition really resonates with them. And so there are probably local competitors that are serving the rest of the landscape, and we aren't too concerned about it. For the next couple of years, our competitors as we focus on those customers will continue to be the global players that we compete with in the rest of the world.

Got it. I wanted to shift over now to the Industrial and Other business. It looks like that business troughed in June and is starting to recover. I know earlier you said there's still pockets of inventory you have to get through in various industrial markets. But hopefully, it looks like the bottom was put in, in June. What do you see application-wise driving the recovery as we head into 2025 in the Industrial and Other business?

Yes. So very excited about our return to growth in industrial markets, and we're starting to see the green shoots. I think most of the inventory digestion there as well is behind us now. And I would say the applications we see leading the charge, excited about what we see in medical, excited about what we've seen in automation and robotics and then also the cloud infrastructure where -- these are the markets where we're starting to see an increasing percentage of orders coming within lead time, which says maybe the worst is behind us and now folks are starting to replenish and get ready for the build-out that is happening.