Good day and thank you for standing by. Welcome to the Allegro MicroSystems Q3 Fiscal 2023 Financial Results Conference Call. At this time all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Jalene Hoover. Please go ahead..

Thank you, Tanya. Good morning and thank you for joining us today to discuss Allegro's third quarter fiscal 2023 results. I joined Allegro at the beginning of January and with more than two decades in semis, I'm thrilled to join at such an exciting time in Allegro's life cycle. I look forward to working with the team as well as with all of you.

I'm joined today by Allegro's President and Chief Executive Officer, Vineet Nargolwala; and Allegro's Chief Financial Officer, Derek D'Antilio. They will provide highlights of our business, review our quarterly financial performance and provide a summary of our outlook. We will follow our prepared remarks with a Q&A session.

Our earnings release and the accompanying financial tables are available on the Investor Relations page of our website at www.allegromicro.com. This call is being webcast, and a replay will be available on our IR page shortly.

Please note that comments other than statements of historical fact made during this conference call including forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995.

These forward-looking statements may include projections and other statements about future events that are based on current expectations and assumptions and as a result, are subject to risks and uncertainties that could cause actual results to differ materially from anticipated results and projections.

Please refer to the earnings press release we issued today and other documents filed by us with the SEC including the risk factors discussed in detail in our most recent 10-K filed on May 18, 2022, as amended on Form 10-K/A filed on August 29, 2022, and subsequent 10-Qs.

While we may elect to update forward-looking statements at some point in the future, the company assumes no obligation to update any forward-looking information presented even if our estimates or assumptions change.

Unless otherwise noted during the call, all references to income statement-related financial measures other than sales will be to financial measures not prepared in accordance with generally accepted accounting principles, or GAAP.

Please refer to the press release posted to our website for information regarding our non-GAAP financial results and a reconciliation of our GAAP to non-GAAP financial measures.

The non-GAAP financial measures that are discussed today are not intended to replace or be a substitute for the presentation of Allegro's GAAP financial results and may be calculated differently than similar measures used by other companies.

We are providing this information because it may enable investors to make meaningful comparisons of core operating results and more clearly highlight the results of our core ongoing operations. It is now my pleasure to turn the call over to Allegro's President and CEO, Vineet Nargolwala.

Vineet?.

Thank you, Jalene, and welcome to the Allegro team, and good morning and thank you all for joining us this morning for our fiscal third quarter conference call. I'm pleased to report that Allegro had another record quarter with sales increasing 5% sequentially and 33% year-over-year to $249 million and near the high end of our guidance range.

Our growth continues to be driven by ongoing momentum in our e-mobility and industrial markets with sales in these strategic focus areas, increasing 11% sequentially and 56% year-over-year. Gross margin also expanded in the quarter due to higher sales of feature-rich products as well as continued favorable foreign exchange.

This allowed us to deliver record operating margins of 30% in the quarter. Further highlighting our operating leverage, earnings per share increased more than 80% year-over-year on revenue growth of 33%. Coming off the strong quarter, along with the fourth quarter guidance, we're increasing full year sales growth expectations to 26% over fiscal 2022.

In support of this growth, we are also making progress in alleviating the supply constraints that have limited our ability to serve our customers over the past several quarters. Let me expand on this with some proof points.

First, while our overall backlog remains strong, our past due backlog is beginning to decline as we ship more products to fulfill a portion of prior outstanding orders. We view this as a positive step as it improves order lead times for our customers.

We have also continued to work with our customers to allow for reschedules and cancellations within certain parameters. Second, channel inventory has begun to normalize with certain distributors approaching historical levels. Finally, we've been able to grow our internal supply of wafers and die banks during the quarter to support anticipated growth.

An another positive and very important step in down last week, our U.S. based fab partner, Polar Semiconductor is expected to receive $150 million equity investment to expand its 200-millimeter wafer fabrication capacity, which positions Polar and Allegro to support anticipated growth in customer demand.

Shifting to key business highlights for the quarter. Sales in our automotive business increased 8% sequentially to a new quarterly record and represented year-over-year growth of 80%.

Our focus on the secular mega trend of e-Mobility, which includes the increasing electrification of vehicles and the higher adoption of ADAS feature sets, continues to drive Allegro's growth above market.

In fact, e-Mobility applications expanded to a record 43% of Allegro's third quarter automotive sales, reflecting the combined contribution from our sensing and power products. In addition, the majority of third quarter automotive design wins were in e-Mobility. We continue to focus efforts across the company on the strategic fast-growing opportunity.

Notable design wins included a large ADAS application for our power products in a steering system for a North American OEM as well as multiple wins with the Chinese EV manufacturer. We also achieved another record in our Industrial business with sales growing 6% sequentially and 60% year-over-year.

Continued growth of Clean Energy and Industrial Automation end markets drove our performance in the third quarter. Overall design win traction has remained strong and well balanced across target markets as well as on magnetic sensors and power IC product portfolios. I'm equally pleased with our performance from a product line perspective.

We continue to reinforce our market leadership in magnetic sensors, which grew 25% year-over-year. Our Power IC portfolio continue to see very robust sales growing 50% on a year-over-year basis.

These results underscore our core value of innovation with purpose, the strong alignment of our R&D investments and portfolio with our strategic focus areas as well as our initiatives to accelerate new product velocity.

And finally, punctuating our continued investments and innovation, last week we announced plans to open our newest R&D center in Richardson, Texas, which will expand Allegro's research and development efforts. I'll now turn the call over to Derek to review the financial results and provide guidance for our fiscal fourth quarter.

Derek?.

Thank you, Vineet. Good morning everyone. Before we discuss the financial results, I'll again provide an update on what we are seeing in our business environment. As Vineet mentioned, demand and order patterns remain robust across our focus areas. We again exited Q3 with more than a year of backlog and extended visibility based on design wins.

However, we acknowledge the macroeconomic uncertainty and as business conditions continue to evolve, we are continuing to monitor leading indicators for changes in our markets and sales channels. Looking at our end markets and beginning with auto, which represents nearly 70% of our sales, we continue to see significant opportunities for growth.

According to recent third-party reports and adjusted to align to our fiscal year, global auto production is projected to be 83 million units, an increase of 8% compared to fiscal 2022 and is projected to increase by another 4% in fiscal 2024.

Further, in highlighting the significant e-Mobility opportunity, EV production is projected to increase by 50% in our fiscal 2023 and by another 30% in fiscal 2024. We also continue to see growth in our targeted industrial markets, while demand in our other markets, which include consumer applications, has continued to soften as expected.

Moving on to the supply environment, in Q3, we began to see additional wafer capacity, and towards the end of the quarter we started to rebuild our wafer and die banks. We expect to continue to build wafer and die bank in Q4 and believe this will allow us to improve lead times and further reduce our past due backlog.

In addition, our supply chain team continues to make progress on securing capacity for fiscal 2024 and beyond considering technology, cost and fab location. Now turning to Q3 results, sales were $249 million; gross margins were 58%; operating income was 30.3%; and adjusted EBITDA was 35.4%.

Record sales, combined with strong gross margin performance, contributed to EPS of $0.35 per share, an 84% increase year-over-year. Sales to our automotive customers were $170 million or 68% of Q3 sales, an increase of 8% sequentially and 30% year-over-year. Within automotive, e-Mobility sales increased 15% sequentially and 54% year-over-year.

Highlighting the transition to EV and ADAS features are e-Mobility sales were 43% of Q3 auto sales, up from 37% a year ago. Industrial sales were $51 million, an increase of 6% sequentially and 60% year-over-year. And other sales were $28 million, a decrease of 14% sequentially, but an increase of 15% year-over-year.

From a product line perspective, magnetic sensor sales were $154 million, an increase of 10% sequentially and 25% year-over-year. Sales of power products were $95 million, a decline of 3% sequentially and an increase of 50% year-over-year.

The sequential decline was driven by data center where we allocated wafers to other areas of our business as we see some near term inventory consumption.

Sales through our distribution remains strong with 39% of Q3 sales, and we continue to work with our partners to restock inventories to more normalized levels versus the trough levels we saw earlier this year. Once again, no single customer represented more than 10% of sales.

And sales by geography were again well-balanced with 26% of sales in China, 24% of sales in the rest of Asia, 18% in Japan, and 16% in both Europe and North America.

Turning to profitability, gross margin was 58%, an increase of 180 basis points compared to Q2, driven by favorable mix, continued positive foreign exchange and leverage at our assembly and test facility.

Foreign exchange contributed an incremental 50 basis points compared to Q2, and 180 basis points compared to rates at the beginning of our fiscal year. Operating expenses increased by 2% sequentially on a dollar basis and declined as a percentage of sales to 27.7% compared to 28.3% of sales in Q2 and 31.7% in Q3 of fiscal 2022.

Third quarter research and development expenses were 15% of sales. And SG&A expenses were 13% down sequentially and contributing to strong operating leverage. Operating income was 30.3% of sales, up from 27.9% in Q2 and 23.1% a year ago. Operating income increased by 14% sequentially on a comparable sales increase of 5%.

The effective tax rate in the quarter was 9% lower than our guidance due to a change in the treatment of certain foreign R&D credits. We now expect our full year fiscal non-GAAP tax rate to be approximately 11%. The Q3 share count was 193.9 million shares.

And net income was $68.8 million or $0.35 per diluted share, an increase of 13% sequentially in 84% year-over-year. Moving to the balance sheet and cash flow, we ended Q3 with cash and equivalents of $344 million. In terms of working capital, DSO was 47 days consistent with Q2. And in days of inventory were 102 days up from 85 days in Q2.

Cash flow from operations was $54 million. Capital expenditures primarily for wafer probe and test equipment were $14 million, and free cash flow was $40 million.

Finally, turning to our Q4 outlook, we expect sales in the fourth quarter to be in the range of $260 million to $270 million, and at the midpoint of this range, we are projecting a full year sales increase of 26%. We expect Q4 gross margins to be approximately 57%. And expect operating expenses to be between 27% and 28% of sales.

Based upon current tax legislation, we expect our non-GAAP tax rate to be approximately 11% and our diluted share account to be approximately 194 million shares. Using these assumptions, we anticipate non-GAAP earnings per share to be in the range of $0.35 to $0.37. As a reminder, our fiscal 2023 fourth quarter includes 14 weeks and ends on March 31.

I will now turn the call back to Vineet.

Vineet?.

Thank you, Derek. We are pleased to have delivered another quarter of record performance. These results are a testament to our market focus, as well as our innovative product portfolio and considerable engineering talent. I want to thank our teams across the world for their hard work, and dedication and going above and beyond to serve our customers.

The markets and applications that we serve are underpinned by strong secular trends, which we believe will continue to expand and drive growth for Allegro in both the near term and through the next decade.

Our continuous innovation and differentiated solutions for our strategic focus areas gives us confidence in Allegro’s ability to outperform the markets we serve. I will close on a very positive and satisfying note.

As evidence of her emphasis on customer intimacy and push to cultivate more direct OEM engagement, Allegro was recently awarded the Best Cooperation Supplier of 2022 by Wodeer, a Tier 1, and Geely, a major Chinese OEM.

We are pleased with this recognition and will continue to find ways to get even closer to our customers as we help them tackle challenging problems. With that, we will be glad to take your questions.

Jalene?.

Thank you, Vineet. This concludes management's prepared remarks. We will now open the call for questions. Tanya, please review Q&A instructions..

Certainly. [Operator Instructions] And our first question will come from Gary Mobley of Wells Fargo. Your line is open..

Good morning, everybody, and welcome Jalene. It’ll be good to work with you again. I wanted to start out by probing a little bit deeper into a comment Derek made with respect to backlog, still at a year’s worth of backlog.

Earlier this summer or I guess in the summer you stress tested the backlog, giving customers an opportunity to cancel or defer some of those orders.

Have you stress tested more recently that backlog and what was the outcome if so?.

Yes, Gary. This is Derek. Thank you. We’ve continued to work with our customers throughout Q2 and throughout Q3 and continue to work with them to better align our lead times to deliver what the customers want and quite frankly to work down our past due backlog. As a result of that, we have continued to allow cancellations here into Q3.

Cancellations in Q3 were slightly higher than Q2. And backlog is coming down as we expect it to come down but it’s not getting to normalize levels. We’ll continue to work with our customers on that. We still have well over a year’s worth of backlog, and approximately 20% of that is still past due..

Thanks for that color, Derek. I wanted to ask about gross margin in the outperformance there. I know in the first half of the year, there was a tailwind from foreign exchange, but if I’m not mistaken.

Foreign exchange wasn’t as favorable throughout the third quarter or was it, and with 57% gross margin guidance for the fourth quarter, obviously, 200 basis points or a little bit less above your targeted range, is there a new view on the long-term targeted range there? Thank you..

Yes. So foreign exchange continue to be a pervasive tailwind in Q3. And if I look at our gross margins in Q2, there were 56.2%. And if I took out foreign exchange, Q2 was about 55%. Q3 had about 180 basis points of foreign exchange if I compare that to rates at the beginning of the year.

So excluding the complete foreign exchange compared to the beginning of this year, it was about 56.2%. So the mix did contribute an extra 120 basis points in Q3 here. Q4 still has some foreign exchange in there, Gary. So if I take out the foreign exchange in Q4, it’s probably somewhere between 55% and 56% gross margin on an operational basis..

Thank you..

One moment. And our next question comes from Joshua Buchalter of Cowen. Your line is open..

Hey, team. Thanks for taking my questions and congrats on another stellar quarter. I wanted to ask about the Polar investment. I know you’re working with UMC and TSMC to expand your capacity.

What’s sort of a – I guess a realistic timeline where this incremental investment at Polar could start meaningfully contributing to your total output potential? And I guess, I assume it’s going to be a little bit. So could you update us on how you’re feeling about your ability to get more output out of TSMC and UMC in the shorter term? Thank you..

Yes. Hi, Josh. Thanks for the question. So first on Polar. We are really excited about this new development. We believe that it’s going to be really important.

It’s a really important development for us and for our customers as we will be able to make the necessary technology investments and capacity enhancements to serve our customers for many years to come. The timeline in terms of getting the new capacity and technology online, we are still probably two to three years out.

It’s largely based on lead time for equipment and qualification of those lines. So we don’t expect it to be a meaningful contribution to our wafer capacity for at least the next two to three years. In the meantime, we are working with our other foundry partners to get increased allocation for the coming fiscal year.

And as we get into the guidance for the upcoming year, we’ll shed more light on that..

Appreciate the color. Thank you. For my follow-up, I wanted to ask about inventories. I think in the past, you’d spoken to sort of a 100 to 110 day target. It sounds like you’re making good progress on building up the die bank and slowly lowering lead times. But there’s still work to do.

So I guess, is it a fair assumption that at least for the near or medium term that a 100 to 110 day target is I guess too low? Thank you..

Yes, Josh. Good question. This is Derek. We’re going to continue to build wafer bank in particular here in Q4. And that’s really an area that during sort of the pandemic and coming out of the pandemic, we struggled with being able to build any wafer and die bank. As a result, our lead times went up, our passed due backlog went up.

So we have a real focus on trying to reduce that past due backlog, improve lead times. We’re making allocation decisions to put product in the right place. So we’re not building inventory at customers. But I’d expected our wafer bank in particular will continue to build here over the next the short term..

Got it. Thanks..

One moment. And our next question comes from Blayne Curtis of Barclays. Your line is open..

Hey, good morning. Thanks for taking the question. I had two. I just want to ask one on the data center. You mentioned a bit of a pause and reallocating those wafers.

Maybe you can just elaborate on where you’re seeing that? And then, the second one and just kind of you’re hearing more about 48-volt servers and some changes of data center plans, if any thoughts for that data center business as you look to the calendar year?.

Yes, Blayne, thank you for the question. So data center continues to be a really important growth vector for us. And we see some really strong momentum – continued momentum with our design wins. Having said that and we’ve alluded to this before, we do see a little bit of an inventory digestion in data center.

And so we’ve made some very proactive and conscious efforts to allocate our wafer supply to areas where we have been stressed for a while. And as Derek pointed out earlier, full – we still have a significant amount of past due backlog that we are trying to serve. So that’s really what went into making those decisions.

When we think about the 48 volts trajectory in data centers, we don’t really see any change in momentum there. And that’s actually underpinned by the design wins we are seeing in that segment..

Got you. And then, I just wanted to follow up on the prior question on the Polar investment. I think the prior arrangement kind of ensured you guys kind of positive transfer payments. So i.e., [ph] if Polar had lower utilizations, it wasn’t really impactful to you.

I’m kind of curious with this new investment, would you be kind of sharing in the utilization and kind of, is the cost structure any different or is it similar to what you had in place before?.

Yes, Blayne, this is Derek. The cost structure we have, I would say market-based competitive pricing with Polar right now. It’s probably in between the pricing of our other partners. And that’s part of the reason why we’re excited about this. I think the investment will allow them actually over time to reduce the cost with scale with that fab.

We have not been paying transfer pricing. The larger owner pays transfer pricing for Polar. And in fact, as a result of this transaction, we'll go from owning about 30% of Polar right now to around 14%, so it will be some slight benefits in accounting. And there won't be any transfer pricing.

It's largely market-based pricing with a long-term wafer agreement that's market-based.

Thanks..

One moment. Our next question comes from Quinn Bolton from Needham & Company. Your line is open..

Hey guys, congratulations on the 30% op margin.

Just one quick follow up on the Polar investment as, as a minority shareholder are you guys required to contribute any CapEx to this expansion or is that all handled separately by, by Polar?.

Quinn, this is Derek. No, we're not required to contribute any CapEx. We'll own about 14% of Polar. We've owned 30% right now and have not been required to contribute any CapEx.

And that's really one of the wonderful things about this is the Polar Fab will get the investment they need to improve their technology from both One Equity Partners coupled with some proposed CHIPS Act funding..

Got it. My question is with your lead time starting to compress as you build die-bank and you said in the near-term it sounds like you're going to be rebuilding some channel inventories.

Can you just, I know you're not giving guidance beyond the March quarter, but how are you thinking about the next several quarters? Do you – as you see lead times compress, do you expect a period of, sort of a pause in sales? Or do you think you can continue to grow through this period of compression in lead times and the backlog normalizing over the next several quarters?.

Yes. Quinn, that's a really great question. I would say what we are trying to do with building wafer and die-bank is really about improving lead times for our customers. It's a customer service issue for us; having said that we would expect no real pause in our sales growth. As Derek pointed out, we have over year's worth of backlog.

Our mission right now is to continue to improve lead times for our customers, keep reducing the past due and make sure that we are servicing customers the way we want to service them, and so that's really what the wafer and the die-bank is about..

Understood. Thank you..

One moment. And our next question will come from Vijay Rakesh and Mizuho Group. Your line is open. And Vijay, your line is open..

Yes. Hi. Good quarter and guide here. Just a question on the EV side.

I think you guys mentioned EV growing 30% in fiscal 2024, is that right? I'm just wondering if that's conservative, if you start to see the EV side start to expand faster given all the price cuts in the channel?.

Yes, Vijay, that's a great question. We're just using third-party data at this point. So I think it remains to be seen if the price cuts actually accelerate the EV penetration. We think there's potential elasticity there. So at this point we're just relying on the third-party data here with the 30%..

Got it. And in terms of applications, and I think you had talked about how your content is much higher on the EV side with the sensors. You talked about $90 per unit on the EV side.

Do you see broadly that driving your market share higher as you go into calendar 2023 fiscal 2024? I guess the question is; do you see that application space expanding in EVs?.

Yes. Vijay, just to be clear, so the $90 is our content opportunity, and that includes our newest acquisition, Heyday, which brings to us isolated high-voltage gate drivers. I would say that broadly and directionally, our content opportunity on EVs is 1.6 to twice that of what we have in our standard ICE vehicle.

And certainly, as you look at the application set, we believe that we have leadership in the applications that are specific to an EV, around current sensing, around motor drivers and then isolated gate drivers. And so we would expect to see share expansion as we – as EVs take off. The Heyday revenue is probably two to three years out at this point.

So that's just the nuance there..

Got it. And just a quick last question; I think in the past you've mentioned your foundry capacity has been one of the gating factors on your – in your top line.

Are you seeing better capacity allocation now from your foundries?.

Yes. So it is incrementally getting better, Vijay, and I would say the long term looks really good. We have to work through the near term here as the increased allocation starts to make its way through our back end but that's the dynamic we are dealing with..

Got it. Great. Thanks a lot..

Thank you..

One moment. And our next question will come from Alessandra Vecchi of William Blair. Your line is open..

I asked for the congratulations on the strong quarter, and Vijay took a couple of my questions on EV. So maybe, Derek, just one for you, a housekeeping question more so.

Just on OpEx, you guys have done a tremendous job kind of getting OpEx down to that 27% to 28% of sales that you guys had alluded to at the beginning of the year, even with inflationary pressures.

How should we think about that as we look forward to next year and maybe walk us through some of the puts and takes?.

Yes. Thanks Aless. Good morning. The way to look at it is that 27% to 28% that we had in both Q3 and going into Q4 still includes some elevated variable compensation as well, which will reset at the beginning of our fiscal year on April 1st. So that will be a natural decrease in that, at the beginning of the year.

And as I said before we expect to invest significantly in research and development particularly in these focus areas where we have leadership and want to maintain that leadership so the target is to invest about 15% of sales in research and development, and we were about there in Q3.

SG&A came down to about 13% of sales, and I'd expect that as a percentage of sales to continue to come down as that won't grow any more than inflation. What I mean by inflation is sort of normalized inflation. So that's the way to look at OpEx..

Perfect. That was very helpful. Thank you..

[Operator Instructions] And I'm showing no further questions. I would now like to hand the conference back to Jalene Hoover for closing remarks..

Thank you, Tanya. Before closing out the call, we are excited to announce that Allegro plans to host its inaugural Analyst Day event on March 14th at Convene Rockefeller Plaza in New York with virtual accessibility. Please stay tuned for additional information for this invitation-only event. We appreciate you taking the time to join us today.

This concludes this morning's conference call..

This concludes today's conference call. Thank you for your participation. You may now disconnect..