Allegro Microsystems at Morgan Stanley Conference: Strategic Growth Amid Challenges

On Tuesday, 04 March 2025, Allegro Microsystems (NASDAQ: ALGM) participated in the Morgan Stanley Technology, Media & Telecom Conference. The call highlighted Allegro’s strategic focus on innovation and market expansion, set against the backdrop of current financial pressures. While the company reaffirmed its revenue guidance, challenges such as gross margin pressures and regional market dynamics were also discussed.

Key Takeaways

• Allegro reconfirmed its Q4 revenue guidance between $180 million and $190 million, marking a 4% increase at the midpoint.
• Gross margin pressures are attributed to pricing negotiations and production adjustments, with a rebound expected by June.
• The company is prioritizing investments in R&D and debt reduction, with a long-term gross margin target of 58%.
• Allegro’s strategic focus includes innovation in automotive and industrial sectors, with emphasis on e-mobility and ADAS.
• Management expressed confidence in navigating challenges such as customer inventory behavior and potential tariffs.

Financial Results

• Revenue: Q4 guidance stands at $180 million to $190 million. December sales saw a 5% decline, notably with an 8% drop in automotive revenue.
• Gross Margin: Guidance for March is between 46% and 48%, the lowest in recent years. December’s non-GAAP gross margin was 49.1%. A rebound is anticipated by June.
• Debt: Allegro holds $345 million in debt, with recent refinancing to SOFR plus $200 million.

Operational Updates

• Automotive Sector: December marked a revenue trough in North America, but signs of recovery are evident. Asia continues to perform well.
• Lead Times and Visibility: Bookings have increased by 50% from the previous year, with cancellations decreasing significantly.
• Geographical Balance: China, Japan, and other Asian regions contribute significantly to revenue, providing resilience against market fluctuations.
• Inventory: Inventory days are currently at two quarters’ worth, with a target of 110-120 days.

Future Outlook

• E-Mobility and ADAS: Allegro targets an $8 billion automotive SAM, with significant growth in e-mobility. Increased semiconductor content in EVs is a key driver.
• Industrial Market: The company is focusing on high-growth areas such as data centers and robotics, driven by AI and high-voltage technologies.

Q&A Highlights

• Customer Behavior: Inventory levels vary, with incentives for automotive suppliers to maintain higher stock.
• Pricing Trends: Distribution channel pricing has stabilized, with automotive pricing expected to normalize.
• Tariffs: While concerns about potential tariffs exist, no significant customer behavior changes have been observed.

For a detailed understanding of Allegro Microsystems’ strategic direction and financial performance, refer to the full transcript below.

Full transcript - Morgan Stanley Technology, Media & Telecom Conference:

Joe Moore, Semiconductor Analyst, Morgan Stanley: If you have any questions, please reach out to your Morgan Stanley sales rep. So with that out of the way, I’m Joe Moore, Semiconductor Analyst for North America and Morgan Stanley and happy to have with us today the management team of Allegro, Mike Duke, newly President and CEO and Derek Dentillo, 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 and A rumors, 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 give a few moments to speak about your background and your priorities for the company.

Mike Duke, President and CEO, Allegro: 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 twenty seven years, if you can believe that. I started as a chip designer and 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 a 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, etcetera. 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 sew 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.

Joe Moore, Semiconductor Analyst, Morgan Stanley: Great. Well, congratulations on the job and it’s a great background. It’s a lot of loyalty to Allegro over this year. So congrats. I guess under other situations of CEO transitions, companies have reiterated guidance.

If it hasn’t changed, fair to say that

Derek Dentillo, EVP and CFO, Allegro: you’re still comfortable with the guidance that you’ve given? Yes, Joe. We’re reconfirming guidance this morning. So revenue of $180,000,000 to $190,000,000 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. And we’re reiterating the gross margin guidance and EPS guidance as well for this quarter.

Joe Moore, Semiconductor Analyst, Morgan Stanley: 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.

It’s kind of first in, first out. Is that what’s happening here?

Derek Dentillo, EVP and CFO, Allegro: Yes, a little bit. So let me correct the December a little bit. For the December, our sales were down 5%, which is actually seasonal for the last fifteen years. Typically sales are down about 5%. The only quarter that has actual seasonality in totality is the December 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 here of auto revenue about $130,000,000 And what really drove that down was we expected that we expected North American and European auto to be down significantly in the December 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. And that’s the law of small numbers because it was up $5,000,000 But we’re seeing things like life in data center, medical returning. So as we go into the March, we do expect that right now this December was the trough in auto and we’re seeing some life in North American auto. And we’re seeing continued good things in places like Asia, China, Korea in auto for us.

Joe Moore, Semiconductor Analyst, Morgan Stanley: 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?

Derek Dentillo, EVP and CFO, Allegro: Sure. So the gross margin guidance for the March was 46% to 48%. It’s the lowest we’ve been in a couple of years. And there were really three things driving that down. It’s about 200 basis points, which for context is about 3,800,000 And those three things are, one is pricing is typically negotiated in the March 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 and L. What I mean by that is it takes about two quarters to cycle through inventory. And if you look back to January of twenty twenty three, 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, we continue to adjust our production levels. So we’ve been building some inventory, 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 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 of gross margins, all else being equal. And so, I expect the March the June of gross margins to rebound from there.

Joe Moore, Semiconductor Analyst, Morgan Stanley: 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 I think you mentioned last quarter turns orders had picked up. Just how much visibility are you getting from the customers right now?

Derek Dentillo, EVP and CFO, Allegro: 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 two quarters worth of backlog. It doesn’t mean we had the next two quarters booked, but there would have been about 80% of that next quarter actually booked and then there’d be within quarter returns business of about 20%. That did not exist in 2022, ’20 ’20 ’3 and 2024 during the wafer shortages and during the chip crisis.

So, now coming into the September, 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 are the most positive they’ve been in the year. Bookings were 50% up from a year ago above one to one. And one month or one quarter 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 aside their 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 $280,000,000 you see those negative things. You see cancellations coming fast and furious push outs. And to touch on your last question, Joe, 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 thirty plus years. And in the June, we were down quite significantly in 2024. It was down 30%.

China was down 54%. But we’ve seen a lot of inventory clear in the channel and we got a lot of credit from that from our customers.

Joe Moore, Semiconductor Analyst, Morgan Stanley: Great. And maybe you could also talk to customer behavior, maybe starting with autos. 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 these shortages happen again. Feels like it’s pretty much the same this time. Like 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?

Mike Duke, President and CEO, Allegro: 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 inventories. 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 seat in front of many of our customers doing negotiations during 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?

Joe Moore, Semiconductor Analyst, Morgan Stanley: 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 maybe people are still having the same behavior.

Mike Duke, President and CEO, Allegro: I mean, on a positive point, as Allegro, we now have a 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.

Derek Dentillo, EVP and CFO, Allegro: Okay. 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. Five years ago, interest rates were the lowest they’ve been in eighty years, right? And those two 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 six or nine 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.

Joe Moore, Semiconductor Analyst, Morgan Stanley: 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?

Mike Duke, President and CEO, Allegro: Yes, it’s a good story in terms of our automotive SIEM. We put it in the neighborhood of around $8,000,000,000 for Allegro. Of that $5,000,000,000 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 $8,000,000,000 Sam, you have this $5,000,000,000 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 five or seven of our chips. Now you see it getting up to 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 a 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 $2,000,000,000 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.

Joe Moore, Semiconductor Analyst, Morgan Stanley: And I guess maybe in bigger picture, what are you seeing from automotive investment in those two 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 there’s still steering wheels. So the ADAS is kind of slowed.

Do you see that changing a little bit? I mean, it seems like FSD from Tesla’s really made some great strides. China is making great strides. Do you see the Western automakers start to replicate some that?

Mike Duke, President and CEO, Allegro: Yes. So, look, I think the sweet spot for Allegro where our dollar content really starts to rise, you don’t need FSD. Yes. 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.

So I do love it because of what it means inside the car. I do know which car you’re wearing. 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. Yes.

And it’s a strong dynamic and certainly we continue to benefit as you go to full self driving. Yes. But I wouldn’t correlate full self driving adoption too heavily to our ADAS growth story. Yes. There is more going on well before full self driving.

Derek Dentillo, EVP and CFO, Allegro: 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 we 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, ’20 ’20 ’9 is 65% better today than it was five years ago during sort of the EV hype.

So the data is still really, really good and that’s across the globe of course.

Joe Moore, Semiconductor Analyst, Morgan Stanley: 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 five years ago. Can you talk about your positioning there? And it seems like even in China, your competition is largely coming from Western companies.

Mike Duke, President and CEO, Allegro: 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, 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 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 And what’s interesting is when you look at what is most likely to happen, we have good business in China today.

They’re 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, etcetera, have become even more important. So, we’re feeling good about our position in EVs in China.

Joe Moore, Semiconductor Analyst, Morgan Stanley: And when you talk about the domestic part of the market, is it still Infini and Alexis are the main competition for those sockets?

Mike Duke, President and CEO, Allegro: Yes. Those are two of our biggest competitors at the marketplace. On the sensing side, especially, they also compete on the power side as well. So those would be two primary names.

Joe Moore, Semiconductor Analyst, Morgan Stanley: 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?

Derek Dentillo, EVP and CFO, Allegro: 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 re exported out of China. So the actual China exposure is probably 12%, thirteen % 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 Percent is North America and Europe. So it’s fairly well geographically balanced. So when you have Lunar New Year where there’s clearly a weaker week and a half 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 timeframe. Japan’s 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 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 when clearly North American auto was actually up 1% to 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.

Joe Moore, Semiconductor Analyst, Morgan Stanley: 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?

Mike Duke, President and CEO, Allegro: Yes. So, when you look at the target markets, right, we focus within auto and industrial. There is a good distribution of both, let’s take automotive, Tier one and Tier two players for Allegro to participate with. 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 one suppliers and automotive Tier two and sometimes Tier three. 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 1s names in automotive and you might think, well, surely you would have a bigger position with a company like company X, Y or Z, a lot of times you do, but you actually accumulate that revenue through selling through the Tier two’s and the Tier three’s. 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.

Joe Moore, Semiconductor Analyst, Morgan Stanley: Okay, great. And then with regards to pricing, Derek, you mentioned a little bit of a normal decline. I guess, can you give us a sense for what’s been happening for like for like pricing over the last two, three years? And where we’re going from here? And I guess, is that different geographically?

Is China different than

Derek Dentillo, EVP and CFO, Allegro: Yes. I’ll start. Maybe Mike can add some customer color. But what we’ve said publicly is that essentially there’s sort of two dynamics in pricing. One is the distribution channel, which is about 50 of our sales go through distribution, which is all of our industrial sales go through distribution, some of the auto in certain regions.

That’s real time. That’s market based pricing. And I started talking about November of twenty twenty three starting to see pricing decline in that distribution channel and that’s always the case. And that’s kind of, I would say, stabilized in the distribution channel. It’s come down quite a bit since November, but that’s stabilized.

And their goal is to move inventory, of course. And usually, that’s the good news is that’s where you start to see that rebound when inventories get a bit tighter, pricing starts to become healthier in the distribution channels. That’s also a tailwind to gross margin going forward. In auto, as we talked about for a couple of traditionally, there’s been low single digit declines in auto every year. You lease a part for $1 it’s $0.96 in year two, $0.92 here, etcetera.

So, the goal is to really to continue to release new products that Mike will talk about. But what we’ve seen in the last couple of years that dynamic went away for a couple of years and we actually had price increases and we haven’t talked about what those were. But they haven’t been outsized because these are customers we’ve had for a long time. But this year there’s certainly more friction in negotiating the prices as people want to get back to pricing a couple of years ago, we’re not going to get there. I think there’s going to be some friction.

And so that coupled with capacity, there’s certainly more pricing friction. I think going forward, we will be back to what I would call normal in automotive.

Joe Moore, Semiconductor Analyst, Morgan Stanley: And I mean, you guys have you said you were sort of working with customers to get their inventories down. I assume the same thing is true on pricing. You don’t have long term agreements that have locked people into above market pricing or anything like that. You’ve taken your medicine earlier.

Derek Dentillo, EVP and CFO, Allegro: That’s correct. Yes. That’s absolutely right.

Joe Moore, Semiconductor Analyst, Morgan Stanley: Okay. And then last automotive question, tariffs. Do you see obviously, we haven’t I don’t know what happened today, but we haven’t actually implemented Mexican Canada tariffs to my knowledge, but there’s been the threats of doing so. Has that changed customer behavior at all? Are you seeing people trying to move the footprint by ahead of tariffs, anything like that?

Mike Duke, President and CEO, Allegro: Yes. I think it as you kind of noted in the beginning, there’s such an air of uncertainty that there’s been lots of conversations with customers. There’s concern amongst the customer base. When we look at the order patterns of our customers, we’re not seeing anything too anomalous. If we see anything that looks abnormal, we start a conversation with customers and just try to understand what’s happening.

But I would say there’s a lot of nervousness, but we haven’t seen too many changes in behavior.

Joe Moore, Semiconductor Analyst, Morgan Stanley: Great. That’s helpful. So industrial, you sort of mentioned starting to seek some growth there. Can you give us a sense for what parts of the industrial market are growing? And I mean, have you seen the same general inventory behaviors that everybody now has seen, which is pretty it’d be hard to imagine that we don’t start improving just given how much it’s been down?

Mike Duke, President and CEO, Allegro: Yes. Let me start with just a brief overview of our industrial strategy. So, we talk publicly about how we’re an automotive first company when it comes to our technology. So, we develop these maybe high voltage or highly ruggedized technologies, mostly with an automotive market in mind, and then we go out and we try to find those markets that really appreciate those technologies. I’ll give you an example.

Throughout the powertrain of an electric car, you have high voltage batteries, you’re converting to AC voltage. Well, the same thing happens in solar farm or a photovoltaic system, where you’re converting DC from the panel to AC for the grid. Additionally, there’s lots of systems in the industrial market, which are now going to the 48 volt rail. We developed 48 volt technology, which we’ve been releasing more and more parts recently with an automotive system in mind and we’re starting to see pickup in those areas, both be it in the data center or robotics, etcetera. So, it’s important to just frame the question to talk about where we’re playing in the industrial space.

The targeted areas that really value our technology tend to be higher growth areas of the industrial market as well. And it’s really the lens that we’re looking through as we look for green shoots of growth in the industrial market. As we mentioned publicly, we’ve started to see some of those green shoots in the data center market.

Derek Dentillo, EVP and CFO, Allegro: We

Mike Duke, President and CEO, Allegro: definitely have been working with our customers on an inventory pocket in the data center space. It’s a consolidated number of customers. We’re working with them closely. And as AI data center build outs started to accelerate, we’re starting to see an increased pickup at new orders, not only for some of the older parts, but for some of our newer parts, which are targeted in that space. Additionally, we’re seeing some good momentum for our electrical current centers and some of our high voltage gate drivers in terms of design and activity for the power supplies in the data center space.

So, we definitely see that as a general trend accelerating. There’s a tailwind in data center. And then on top of that, we’ve talked about the medical business that we have using some of the new TMR sensors that we’ve developed and released. And certainly within pockets of the medical market, it looks a bit more like a high volume consumer driven patient to patient sale type of business and we’re seeing good growth there.

Joe Moore, Semiconductor Analyst, Morgan Stanley: That’s great. And I don’t have a long history with you guys, so maybe bear with me. But the decline you’ve seen in data center from peak to trough is pretty significant. And it’s pretty clear now that you have growth drivers that you’re focused on AI. Can you characterize the decline that you saw?

Was that more traditional servers or what caused the business?

Mike Duke, President and CEO, Allegro: Yes. The primary business we’ve had, let’s say, over the last five years was selling fan drivers. They’re part of our motor driver business into three phase fans. There’s so many fans cooling different elements of the electronics in the data center. What do our customers value?

Efficiency, we bring higher efficiency to the market and electricity costs are such a huge driver of the operating cost of the data center. And they’re also more audibly quiet. There’s so many of those fans inside the data center. So, we had good growth in that business during the chip crisis. Customer inventories inflated a bit, and that’s where we’ve been working closely with those customers to just manage through that.

Great. Okay.

Joe Moore, Semiconductor Analyst, Morgan Stanley: And then as you mentioned, we saw

Derek Dentillo, EVP and CFO, Allegro: the same dynamics in inventory within it’s all through distribution, right? And a lot of it’s general industrial to a large swath of customers. So we saw the same dynamics that many of our peers are seeing in industrial inventories. But as Mike mentioned, we’re seeing some of these green shoots and there’s some new forward looking areas as well that we’re getting involved in, which are kind of interesting like robotics, right, a little way down the line, but very interesting opportunity for us.

Joe Moore, Semiconductor Analyst, Morgan Stanley: Yes. I wanted to ask you about that. I mean, it’s obviously we don’t want to get ahead of ourselves on science fiction stuff, but like doing motion sensing things like that are really important when you start talking about industrial robots, military drones, humanoid robots. You’re on a list of humanoid robot beneficiaries, I believe. So maybe just talk a little bit to obviously early, but like the applicability of your technology.

Mike Duke, President and CEO, Allegro: Yes. No, that’s I’m glad you asked, because I’m glad you said it’s obviously early as well. It’s early, but it’s exciting because so we have a lot of our sensor and power solutions already entrenched in advanced robotic solutions. And now they’re running at fairly low volume today. What is Allegro really good at with our products?

We can spin motors reliably, quietly without vibration, and we can also sense the position of a moving object. That is the creation of a motor control system that you can control very precisely and that is exactly what robots want. When you start to think about a robot that’s actually walking or standing up, the ability to control it precisely is of utmost importance. So customers are coming to us really liking the TMR magnetic sensors we have for their increased position sensor resolution, the inductive sensors that we have. A lot of these advanced humanoid robots are working on 48 volt or 60 volt rails.

That’s a sweet spot for Allegro’s wafer process technology. And when you start to think of a robotic system or let’s say many robotic systems at scale with multiple joints, like you start to think about having hands, the number of actuators and sensors goes up significantly. So this is the a bit of a double growth effect where as we look ahead and think of things like humanoid robots taking off and as they start to have more sockets, no pun intended, for joints and actuators, it could become a significant opportunity. And we do have the right tech. We’re talking to some of the most advanced companies in the space about forward looking solutions and we’re monitoring it closely.

Joe Moore, Semiconductor Analyst, Morgan Stanley: Main markets can be under hyped and over hyped at the same time and this has that kind of feel like this is such a huge opportunity long term and you don’t want to get ahead of yourself in terms of thinking about it. But if you have all these technologies going into the automotive market that for safety and regulatory reasons just take years to get deployed, you could get a much quicker time to market in other areas at some point.

Mike Duke, President and CEO, Allegro: Yes. And agreed into the first order, the solutions that the companies we’re talking to that they’re looking for, many of them are solutions we generally already have in place and there will be some bigger R and D developments to really make a splash as the market develops. But to get into the game in a more meaningful way, it’s not a ton of investment either.

Joe Moore, Semiconductor Analyst, Morgan Stanley: Okay, great. Maybe you just touch on the financials a little bit and I’ll open up for questions. But gross margin, I think you’ve talked about a path back to the high 58% level if I’m not mistaken. Can you walk us through where you are now, where you’re going to get tactically and where you’re going to get long term?

Derek Dentillo, EVP and CFO, Allegro: Sure. So we finished the December at 49.1% on a non GAAP basis. As I mentioned, we expect a trough here in the our guidance is to trough here in the March between 4648%. I do expect it to rebound from there based on the reasons I talked about. We reiterate our long term model of 58%.

We were there two years ago at 58.3% for a couple of quarters. There’s work to get back there. Revenue is going to be the first driver. So, we have about a 65% drop through or variable contribution margin that’s held true since we’ve been public. Not every quarter, but if you look at it year to year, it’s held about true.

So, revenue helps quite a bit as we have an underutilized facility in The Philippines. We’ve made significant investments in our back end facility. And like most folks, revenue helps quite a bit. The other tailwinds to get back there are new product introductions that Mike talked about. Those generally have a higher gross margin for us.

The tailwinds as industrial comes back through the distribution channel generally has a higher gross margin. And then, we’re doing a number of efficiency things. And we’re very, very I’m actually flying to The Philippines tomorrow night. We’re very focused on the near term getting back to 50% very, very quickly, getting back to that mid-50s and 58% is the long term target. But there’s very tactical things to get us back to the 50% here in the near term.

Joe Moore, Semiconductor Analyst, Morgan Stanley: Great. And I guess, I mean, you mentioned that price isn’t likely to be a major factor other than there’s maybe tactically that cost and price move at different times.

Derek Dentillo, EVP and CFO, Allegro: That’s correct. And right now inventory days for us and many of our peers are at two quarters worth of inventory days, right? So it takes about two quarters to cycle those cost benefits back into your P and L. In a typical time, our inventory days target is probably one hundred and ten or one hundred and twenty days, So, it would take a lot less time to cycle into the P and L. So, right now, there’s that little bit of disjointedness in addition to the time lag.

Joe Moore, Semiconductor Analyst, Morgan Stanley: Great. And then, last question for me. Free cash flow priorities as free cash flow starts to Yes.

Derek Dentillo, EVP and CFO, Allegro: That hasn’t changed. So, we’ve continued to use our excess free cash flow to invest in the business, invest in research and development, invest in the business. We’ve taped out twice as many products in the last two years we ever have in the past. So, we’re investing in research and development. But you’ve noticed OpEx hasn’t gone up in three years.

So, we’re managing our SG and A. We’ve moved a number of things to our shared services in The Philippines. So we’re going to use excess free cash flow to pay off our debt. We have about 300 as of Friday, we have $345,000,000 of debt, pretty modest levels. But I think that’s the best thing we can do for shareholders in the near term, continue to make accelerated voluntary payments on our debt.

We made one in the fall. We just made another $30,000,000 voluntary payment last Friday. We refinanced our debt to SOFR plus $200,000,000 So, we’ll continue to manage across the entire balance sheet and continue to bring down that leverage level.

Joe Moore, Semiconductor Analyst, Morgan Stanley: Do we have any questions from the audience? If not, maybe we could just wrap up, I mean, where we started. So you’re the new CEO stepping into this role, but you’ve been with the company almost thirty years. It seems like you’re going to keep doing things pretty much the way they’ve been doing. I mean, any changes we should think about from that transition that you’re thinking about?

Mike Duke, President and CEO, Allegro: Yes. So I have been there a long time and I want to point out that just before this appointment, I was in charge of corporate strategy, right? So I believe and I ran all three segments in the past. So I believe in the products. I really believe in the people of Allegro.

I believe in the strategies. What will be different? I think we can lean in on the innovation front a little bit to accelerate some of the strategies. And in doing so, I think we can unlock more value a bit faster as well. But I don’t foresee any major changes, but definitely the advancement and acceleration of some innovative work and some work getting closer to customers and to try to unlock value by figuring out how to tie together those innovations to solve the problems that they have.

That’s always been a winning formula.

Joe Moore, Semiconductor Analyst, Morgan Stanley: Great. Well, congratulations on the role and congratulations for working your way through this automotive correction and coming out really nicely on the other side of it.

Derek Dentillo, EVP and CFO, Allegro: Thank you. Thank you, Joe, for your time.

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