Allegro Microsystems Inc

NASDAQ:ALGM

Earnings Call Analysis

Key Takeaways from Allegro MicroSystems' Q1 Earnings Call

Allegro MicroSystems reported Q1 sales of $167 million, with a gross margin of 48.8% and non-GAAP EPS of $0.03. The company is navigating inventory rebalancing, especially in automotive and industrial markets. Despite a downturn, they expect low double-digit growth in Q2 sales, projected between $182 million and $192 million. Notably, Allegro has repurchased shares from its largest shareholder, Sanken, reducing their ownership to about 33%. This move aims to boost governance and independence. The company remains optimistic about its design pipeline and market position, particularly in e-mobility and renewable energy applications.

Introduction

Allegro Microsystems has recently presented its earnings for the first quarter of fiscal year 2025. Despite declining sales, the company has managed to stay at the high end of its EPS guidance and navigate several strategic changes, including a significant share repurchase from its largest shareholder, Sanken.

Financial Performance

In the first quarter, Allegro reported sales of $167 million, which represents a sharp decline of 31% sequentially and 40% year-over-year. The gross margin was 48.8%, a drop from previous quarters. Operating income was 6% of sales, a significant decrease from 23.8% in the prior quarter. The adjusted EBITDA stood at 13% of sales. Net income came in at $6 million, translating to earnings of $0.03 per share【4:0†source】【4:1†source】.

Strategic Initiatives and Share Repurchase

One of the major moves for Allegro this quarter was the share repurchase agreement with Sanken. This transaction reduced Sanken's ownership from 51% to approximately 33%, bringing increased liquidity and governance improvements. Allegro repurchased 39 million shares from Sanken and will retire them. The repurchase was funded through a combination of equity issuance, an incremental term loan of $200 million, and cash on hand. Additionally, Sanken agreed to reimburse Allegro for all transaction expenses and pay a $35 million facilitation fee【4:17†source】.

Product and Market Innovations

Allegro introduced several new products this quarter, including its third high-voltage Power-Thru product and new sensor solutions to replace traditional shunt resistors. The company highlighted significant wins in automotive and industrial sectors, such as a multi-portfolio win with a North American OEM for a steering system.【4:18†source】.

Market Conditions and Outlook

The automotive sector continues to be a major part of Allegro's business, accounting for 79% of Q1 sales. However, e-mobility sales have declined. The industrial and other sales categories have also seen significant drops. Despite this, the company remains optimistic about a recovery driven by the automotive sector, particularly the xEV segment, and is cautiously optimistic about the industrial sector recovering in the second half of the fiscal year.【4:0†source】【4:2†source】.

Guidance for Q2 2025

Looking ahead, Allegro expects Q2 sales to range between $182 million and $192 million, implying a sequential growth of 12% at the midpoint. The Q2 gross margin is projected to be between 49% and 51%. On a non-GAAP basis, the expected EPS is in the range of $0.04 to $0.08 per share. This guidance reflects improvements in profitability and operational efficiency measures implemented by the company【4:17†source】.

Conclusion

Despite facing several challenges in the first quarter, Allegro Microsystems has proactively managed its operations and strategic initiatives to position itself for future growth. The share repurchase from Sanken marks a new chapter for the company, providing it more strategic and operational flexibility. Going forward, the company remains optimistic about its growth prospects, particularly in the automotive and industrial sectors.

Earnings Call Transcript 2025-Q1

[Operator]

Good morning, and welcome to the Allegro MicroSystems First Quarter Fiscal 2025 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to Jalene Hoover, Vice President of Investor Relations and Corporate Communications at Allegro MicroSystems. Please go ahead.

[Jalene Hoover, executive]

Thank you, Steve. Good morning, and thank you for joining us today to discuss Allegro's first fiscal quarter 2025 results. 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 share our second quarter outlook. We will follow our prepared remarks with a Q&A session.

Our earnings release and prepared remarks include certain non-GAAP financial measures. The non-GAAP financial measures that are discussed today are not intended to replace or be a substitute for our GAAP financial results. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release, which is available in the Investor Relations page of our website at www.allegromicro.com. This call is also being webcast, and a replay will be available in the Events and Presentations section of our IR page shortly.

During the course of this conference call, we will make projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution that such statements are based on current expectations and assumptions as of today's date and, as a result, are subject to risks and uncertainties that could cause actual results to differ materially from projections.

Important factors that can affect our business, including factors that could cause actual results to differ from our forward-looking statements are described in detail in our earnings release for the first quarter of fiscal 2025 and in our most recent periodic and other filings with the Securities and Exchange Commission. Our estimates, expectations or other forward-looking statements may change, and the company assumes no obligation to update forward-looking statements to reflect actual results, changes to assumptions or other events that may occur, except as required by law. It is now my pleasure to turn the call over to Allegro's President and CEO, Vineet Nargolwala. Vineet?

[Vineet Nargolwala, executive]

Thank you, Jalene, and good morning, everyone. Thank you for joining our first quarter fiscal year 2025 conference call. We delivered results towards the higher end of our commitments while making progress on inventory rebalancing across automotive and industrial markets. Q1 sales were $167 million, above the midpoint of guidance, and non-GAAP EPS was $0.03, at the high end of guidance. During the first quarter, we made progress reducing inventory in direct and distribution channels. We believe that inventory rebalancing in automotive will continue into our second quarter, and customers are returning to a more normal ordering pattern, which we expect to drive low double-digit growth in the second quarter sales.

While industry estimates project a slight decline in calendar year 2024 automotive production, we remain encouraged with the estimates for continued double-digit growth in xEVs, which includes battery electric vehicles and full hybrids. Our industrial outlook reflects the impact of higher interest rates and ongoing inventory digestion. We believe that our industrial and other sales are hovering at the bottom and remain cautiously optimistic about a potential recovery in the second half of our fiscal year, though a return to normal could be well into fiscal year 2026.

As we manage Allegro through the recovery, we remain excited about the fundamentals that are driving our end markets and the opportunities that are available to us. We continue to invest for growth and remain focused on those aspects of the business that we control. To that point, we continue to execute a product and technology road map with some major new product introductions in Q1. During the quarter, we announced the launch of the third product in our high-voltage Power-Thru portfolio. Allegro's two-chip isolated gate-driver IC solution works with external transformers to provide the freedom to design and maximize power efficiency for clean energy applications such as solar inverters, xEV charging infrastructures, energy storage systems, and data center power supply units.

In our sensor portfolio, we launched new sensor solutions to replace traditional shunt resistors. Our newest plug-and-play sensors provide customers with smaller designs, cooler operation, a lower bill of materials, and simplified implementation to reduce design cycle time. This resonates strongly with customers in fast-growing applications like ADAS, renewable energy, and industrial automation, positioning Allegro for continued success in these markets.

We also highlighted our market-leading 48 Volt portfolio, which continues to gain traction in automotive and industrial applications, enabling more efficient power supply. Allegro's 48 Volt solutions are used today by the leading North American xEV OEM, and we are finding increasing application in the data center market. Our road map calls for continued expansion with more 48-volt products expected to hit the market in fiscal 2025.

Based on third-party 2023 data, we increased our leadership position in magnetic sensing. The increase in our leadership position is a direct result of our relentless drive to innovate. At Allegro, we take great pride in our market-leading magnetic sensing position. As our solutions continue to build momentum across strategic growth areas, I will share a few highlights from our first quarter design wins.

In automotive, we had a multi-portfolio win with a North American OEM for a steering system using our power and magnetic sensor IC solutions. In industrial, our high-voltage power portfolio was awarded its first win with a European solar manufacturer for micro-inverters, and we secured a large design win using our TMR technology for blood glucose monitoring. During the quarter, we released our second ESG report where we highlighted ambitious 2030 goals that align with global sustainability trends and focus on renewable energy, gender diversity, and global pay equity.

Before closing, I'd like to say a few words about the recently announced transaction to repurchase shares from our largest shareholder, Sanken, who had owned a majority of Allegro since 1990. This event marks the first time in nearly 35 years that Allegro has not been controlled by another company and opens a new chapter in our journey of growth and transformation.

The transaction also brings significant governance improvements. Sanken reduced their Board presence by 1 seat immediately after falling below majority ownership, and no Sanken-appointed director can chair any of our Board committees. Our updated shareholder agreement also lays out a transition path for Sanken's presence on our Board commensurate with their ownership. The reduction in Sanken ownership, combined with the departure of 1 equity partner for Allegro, enables us to be completely independent in our strategies and actions.

I'm very thankful to our teams and advisers for their hard work over the past few months to plan and execute this transaction. We believe the increased liquidity, improved governance, and clarity and certainty about our future will act as a catalyst for further value creation. And the timing couldn't have been better. With an improving cycle on the horizon, we are poised for reacceleration towards the goals outlined in our target financial model. I'll now turn the call over to Derek to review the Q1 financial results and provide our outlook for the second quarter. Derek?

[Derek D'Antilio, executive]

Thank you, Vineet, and good morning, everyone. I'll start with a summary of our Q1 financial results. Sales were $167 million, gross margin was 48.8%, operating income was 6%, and adjusted EBITDA was 13% of sales. As a result, earnings were $0.03 per share, at the high end of our outlook range. Total Q1 sales declined by 31% sequentially and by 40% compared to Q1 of fiscal '24. Sales to our automotive customers were $131 million, a decline of 28% sequentially and 29% year-over-year and represented 79% of our Q1 sales. E-mobility sales were $62 million and declined by 31% sequentially and 30% year-over-year to represent 48% of first quarter auto sales.

Effective in the first quarter of fiscal year 2025, we are combining what we historically referred to as other sales into industrial and other sales. Industrial and other sales were $36 million in the quarter, declining 39% sequentially and 62% year-over-year. Sales through our distribution channel were $81 million, a decline of 36% sequentially and 48% year-over-year and represented 49% of our Q1 sales. We continue to monitor channel POS sell-through, which has been higher than sell-in to help manage distributed inventories to appropriate levels.

From a product perspective, magnetic sensor sales were $115 million, declining 21% sequentially and 34% year-over-year. And sales of our power products were $52 million, declining 45% sequentially and 50% year-over-year. Sales by geography were again well balanced, with 24% of sales in Japan as well as the rest of Asia, 19% of sales in China, 17% in the Americas and 16% of sales in Europe.

Now turning to Q1 profitability. Throughout Q1, we continued to manage the inventory reductions in both channels carefully while focusing on profitability and cash flow. Gross margin was 48.8% and operating expenses were $71 million. Operating margin was 6% of sales compared to 23.8% in Q4 and 31% a year ago. The effective tax rate in the quarter was 10%. In the first quarter, diluted share count was 194.7 million shares, net income was $6 million and $0.03 per diluted share.

Moving to the balance sheet and cash flow. We ended Q1 with cash of $184 million. Cash flow from operations was $34 million, and free cash flow was $23 million or 14% of sales in a trough quarter. From a working capital perspective, DSO was 35 days compared to 45 in Q4. Inventory dollars increased by $14 million, largely in wafer and die bank, and days of inventory were 174 days compared to 126 days in Q4, increasing largely as a function of the decline in sales. Capital expenditures in Q1 were $11 million.

And before I discuss our Q2 2025 outlook, I'd like to take a few minutes to provide some more details about the recent share repurchase from our largest shareholder. This is an important transaction for Allegro and its shareholders. It will reduce Sanken's ownership from 51% pre-transactions to approximately 33%, resulting in 30% more free float and a net reduction of approximately [ 10 million ] or 5% fewer shares outstanding. And as Vineet mentioned, it also brings with it significant governance benefits to Allegro's shareholders.

I'll now highlight a few key details of the transaction. Post transaction, Allegro's outstanding share count will have decreased from 194 million shares to 184 million shares. In terms of transaction mechanics, we will have repurchased 39 million shares from Sanken and retire those shares. The repurchase was funded with a combination of an equity issuance of almost 29 million shares and an incremental term loan of $200 million as well as cash on hand. Our pro forma gross and net leverage on a trailing 12-month basis is 1.4x and [ 0.0x ] respectively. Sanken has agreed to reimburse Allegro and Allegro shareholders for all transaction expenses and pay Allegro a $35 million facilitation fee. We also expect this to be accretive to -- on a non-GAAP basis within fiscal year '25.

We also reiterate our commitment to continue to make accelerated and voluntary debt payments with excess free cash flow as demonstrated by the $50 million voluntary payment made in Q1. In addition, we are taking this opportunity to reprice the entire term loan balance of $400 million from SOFR plus 275 basis points to SOFR plus 225 basis points. Finally, in connection with this transaction, Allegro's S&P corporate rating has been upgraded from B+ to BB-. We believe the favorable debt repricing and the ratings upgrade are reflective of the strength and resilience of our business model and our conservative balance sheet management.

Now I'll turn to our Q2 2025 outlook. We expect second quarter sales to be in the range of $182 million to $192 million, implying 12% sequential growth at the midpoint of this range. We also project the following, all on a non-GAAP basis: We expect Q2 gross margin to be between 49% and 51%, reflecting a sequential increase of 120 basis points at the midpoint. We expect interest expense in the second quarter to be approximately $7 million. We expect our tax rate to be approximately 10% and our weighted average diluted share count to be approximately 191 million shares, reflecting the repurchase transactions.

The weighted average share count reflects the timing of these transactions within Q2. And we expect the diluted share count to reduce further to approximately 184 million shares in Q3. As a result, we expect non-GAAP EPS to be between $0.04 and $0.08 per share, and exclusive of the incremental interest expense associated with the recent share repurchase, estimated non-GAAP EPS at the midpoint of our outlook range would be $0.08 per share. Now I'll turn the call back over to Jalene for questions. Jalene?

[Jalene Hoover, executive]

Thank you, Derek. This concludes management's prepared remarks. Before we open the call for your questions, I'd like to share our second fiscal quarter conference lineup with you. We are attending Needham's Fifth Annual Virtual Semiconductor and Semi-cap 1x1 Conference on August 2; Jefferies Semiconductor, IT, Hardware and Communications Summit on August 27 at the Four Seasons Hotel in Chicago; and Evercore's ISI Semiconductor IT Hardware and Networking Conference on August 28 at The Omni, Chicago. We will now open the call for your questions. Steve, please review Q&A instructions.

[Operator]

[Operator Instructions] Our first question comes from the line of Chris Caso at Wolfe Research.

[Christopher Caso, analyst]

I guess the first question is with regard to customer inventory levels and sort of the progress in getting both the channel and your automotive customers in line. You expressed some intentions last quarter to take down that inventory pretty aggressively. We've heard from some others in the space that the targets for those automotive inventories appear to be coming lower, at least for some. Could you give us some sense of what you're seeing and the progress that you've made in the quarter?

[Vineet Nargolwala, executive]

Chris, this is Vineet. Thanks for the question. So I would categorize our progress on inventory is as expected, okay? And as we highlighted in our last first quarter -- or the last earnings call, we think on average, within the automotive channel, which is largely direct through tiers and contract manufacturers, inventories have come down roughly 4 weeks. Now some tiers and contract manufacturers are ahead of that. Some are obviously behind. And I would say that every customer, every partner has differing goals. But I would say broadly, we've made substantial progress in bringing the inventories down.

Within the industrial business, which is largely distribution, I would say it's more of a regional lens, where some of the regions would stay with a slightly higher level, which is what is typical, for example, in Japan. But in places like China, in North America, we've made some substantial progress in bringing the inventory down. So overall, I would say I'm really pleased with the progress that's been made.

As you remember, we intentionally undershipped in Q1 with the aim of helping our distributor partners and our channel partners and tiers really work down the inventory very aggressively. And so we think that that's largely done. Some of this is going to, as I said in my prepared remarks, will continue into Q2 obviously, but we believe that we've made substantial progress here on the inventory balancing.

[Christopher Caso, analyst]

Got it. Just as a follow-on to that, given the fact that you expect that there's still some inventory that needs to be worked down in the September quarter, what does that imply for the December quarter with the assumption that you're still burning through inventory, you're still undershipping demand? What kind of view can you give us on the December quarter on that basis?

[Vineet Nargolwala, executive]

So Chris, we're obviously not guiding for the December quarter, right? But if you go back to our comments that we made in the prior earnings call, there has really been no change to our assumptions that underpin those comments. And we're pleased that we are able to get back to sequential growth here in this coming quarter.

[Operator]

Our next question comes from the line of Blayne Curtis at Jefferies.

[Blayne Curtis, analyst]

I just was curious when we're looking at the recovery here if you can just help us for the September quarter. I'm just kind of curious between now your 2 segments, where you're seeing the most recovery.

[Derek D'Antilio, executive]

So Blayne, this is Derek. I'll start with it by sort of market or application, which is the way we look at it. The majority of that recovery or sort of increase from Q1 to Q2 is automotive. We still see industrial and some consumer markets or other markets being relatively muted, but things like data center and other areas that have had some more inventory to be digested over the next couple of quarters.

[Vineet Nargolwala, executive]

And Blayne, I would just add that this is as expected, where we expected that once the automotive tiers and contract manufacturers would be done with their digestion, we would get back to normal ordering patterns. The end market in automotive continues to be pretty stable, whereas in industrial, and we've said this before, the inventory digestion has been coupled with muted demand in certain pockets, while there are other smaller areas of industrial that continue to show some growth. And so that's what's reflected in our guide for Q2.

[Blayne Curtis, analyst]

And then maybe just following up on the prior question. I wanted to ask just in terms of the automotive market. You've seen outlooks for demand kind of tick down a bit. So it seems like for others, the correction is taking a bit longer. You had a very extreme correction in June and you're always very confident on some sort of recovery in September. So you're seeing a little bit different trends maybe because of the depths of that correction. But I'm just kind of curious how your kind of outlook for auto has changed over the quarter.

[Vineet Nargolwala, executive]

Yes. Blayne, you'll remember that we stay focused on the mid- to long term. And for us, whether automotive production or SAAR goes up a couple of percent or it goes down a couple of percent, it really doesn't change what we do and how we invest. We remain encouraged by the continued double-digit growth in xEV production and sales. And when we look at the latest estimates, they're still calling for more than doubling of xEV production and sales by 2030.

And the programs we work on, the programs we're getting awarded by our customers that our customers trust us and our products to support their platforms, they're still all very much focused on significant growth in xEV platforms. So that's really what underpins our business fundamentals. And the quarter-to-quarter perturbations, frankly, aren't as important to us.

[Derek D'Antilio, executive]

And Blayne, this is Derek. You're absolutely right that there's going to be differences between companies in the market, right? We took a severe downturn in Q1. A lot of that is us working with our customers directly to help manage those inventory levels down and undershipping. Some of our partners have managed it differently throughout the last couple of years, so the trajectory up and down is a bit different for people.

[Operator]

Our next question comes from the line of Quinn Bolton at Needham.

[Quinn Bolton, analyst]

I just wanted to follow up on Blayne's question there. One of your peers at Mobileye this morning talked about lower volumes in the second half in part due to the recent EU tariffs on Chinese vehicle manufacturers. Just wondering if you're seeing that as something that has been a recent change or whether that's incorporated in your sort of outlook for a modest low single-digit reduction in auto production globally this year.

[Vineet Nargolwala, executive]

Quinn, this is Vineet. Thanks for the question. So maybe there are 2 parts to this, right? So we don't really see the impact of tariffs in Europe really impacting how our Chinese customers are behaving or driving growth for their overall business. I think I've shared earlier in earlier calls that we are really well exposed to every Chinese OEM, every one of the top 10 Chinese OEMs, top 10, 15 Chinese OEMs.

And we have great geographical diversity in our business as well. And so we feel really well positioned to get secular growth as it happens with the Chinese OEMs across the world. And let's keep in mind that the tariffs only apply to vehicles that will be produced and shipped from China. Chinese OEMs are also setting up manufacturing in Eastern Europe. So we think there are ways they will get around it. But to the second part of your question, our guide is really reflected right now on what we believe is reflected in our order pattern in our backlog. So we don't really think that's got a material impact on how we see things playing out.

[Quinn Bolton, analyst]

Great. And then maybe just a sort of accounting question for you, Derek. You walked through the dynamics of the share repurchase, but you mentioned that $35 million, I think you called it a facilitization fee. I'm wondering how is that accounted? Is that sort of intended to help offset some of the higher interest expense from the term loan? Is that accounted for as just a onetime payment? Just any help on how we should be thinking about accounting for that payment would be helpful.

[Derek D'Antilio, executive]

Yes, sure. So it's a onetime payment to help facilitate this transaction so that not 1 shareholder received a benefit at the expense of all other Allegro shareholders. So in addition to that facilitation fees, Sanken is paying all other transaction costs, including underwriter spread, arrangement fees on the debt. But our intent is to use that payment or the cash for that to pay interest and principal on our debt. And the way it's being accounted for, Blayne, quite frankly, is a reduction of [ ApEx ] so it won't even hit our P&L, and it's nontaxable that way as well.

[Operator]

Our next question comes from the line of Vijay Rakesh of Mizuho.

[Vijay Rakesh, analyst]

Just a quick question. I know you mentioned 2023 magnetic sensor share up and a leading position there. One question that we've been getting from investors is given the [indiscernible] down 40% year-on-year, let's say, if you can give us some clarity on how your market share is trending here in EV and ADAS and how the design pipeline looks, especially in autos and xEV?

[Vineet Nargolwala, executive]

Yes, Vijay, just so I understand your question, you're asking about how is our design pipeline faring?

[Vijay Rakesh, analyst]

Yes. And some more confidence around the market share here for [indiscernible] yes.

[Vineet Nargolwala, executive]

So Vijay, as I referenced in my prepared remarks, third-party data shows we've extended our market share. We're really pleased with that. And really, it's a testament to the hard work our teams do every single day to serve our customers and really deliver innovation.

I would say that let's keep in mind, while we've been intentionally undershipping to our distributors and to the tiers, that demand is still being met by Allegro product from inventory, right? So it should have 0 impact on share position. The second part of your question, which is around our design pipeline, it continues to grow really well. We continue to win more than our fair share in the market and the applications we serve and the markets we serve.

And I gave some qualitative information around some of the key wins we had in the first quarter. And we'll continue to provide visibility into how our backlog is growing at regular intervals. I provided some visibility in the last earnings call. But we continue to be pleased with our design pipeline and how it's growing, and it's a significant -- it's an indication of how our customers trust us to continue to support them in this transition to a more electric and more autonomous future.

[Vijay Rakesh, analyst]

Got it. And then on the gross margin side, Derek, obviously, a lot of it has to do with the disti side. How do you -- can you talk to how the disti shipments are improving? And how do you see those gross margins progressing towards that [ 55, 58 ] that you have seen historically?

[Derek D'Antilio, executive]

Yes, Vijay. So going from Q4 to Q1, gross margins declined by about 400 basis points. The majority of that was actually utilization. So if you look at our sort of historical drop-through or variable contribution margin, just taking the change in sales and the change in gross margin, that's between 60% and 65%. If you project that forward, you get to our guidance gross margin midpoint for Q2, and you can kind of extrapolate that forward to whatever revenue numbers you put in for the next couple of quarters.

And you're absolutely right. On the mix side of things, we have sort of 2 mix things. One is product mix, which is a little bit weaker in Q1, but disti mix also was lower in Q1. It was 49% of sales, which was actually the lowest number it's been in the last 3 years because we're obviously undershipping the distribution channel. So the biggest piece in the short term of growing our gross margins back will be the utilization. You can use that gross margin drop-through number and apply it to your sales projections.

But also both product mix and distribution mix will help enhance gross margin again in the [ mid ] between now and the end of the year. And then getting to that 58% model we're still committed to over time, that's going to require the 3 things we just talked about, plus we continue to leverage our back-end facility in the Philippines, leverage our suppliers as we get back to scale, and continue to release new products that Vineet talked about. We released some really exciting new current sensors, TMR products that start with a higher ASP.

[Operator]

[Operator Instructions] Our next question comes from the line of Thomas O'Malley at Barclays.

[Thomas O'Malley, analyst]

So my first question is around some of the numbers you gave. I think you said e-mobility was 48% of auto, which is about $62 million. If you look at kind of how e-mobility and your "other" auto business have been tracking, e-mobility has been doing a lot better just from both a -- just really a year-over-year perspective. And now kind of into the June quarter, both are kind of down around 30% year-over-year. Could you talk about what you're seeing there as to why those are tracking the same? I would expect kind of the e-mobility side to track a little bit better. In the recovery for the remainder of the year, would you expect 1 to kind of grow faster than the other? But just any color there would be helpful.

[Vineet Nargolwala, executive]

Tom, this is Vineet. I'll take that question. So keep in mind that the product ups and downs you see here in our Q1 results are really a function of what we are shipping or undershipping. And so I wouldn't read too much into the product trends there. I would say, broadly speaking, when we talk about -- we look at our design pipeline, more than 3/4 of that within automotive is tied to e-mobility. And so it's natural to expect that e-mobility will have a faster acceleration as we come out of this trough, as we come out of this inventory rebalancing period. And certainly, as we look to the future, we would expect the e-mobility sales to continue to trend higher.

[Thomas O'Malley, analyst]

Helpful. And then if I look at the geos you gave as well, I think I caught that China was 19% of revenue. That looks like it's down about 50% sequentially. In terms of your China revenue, is that mostly auto or industrial? And I just wanted to make sure that there wasn't a correlation between the drop in China and potentially the weakening EV side. Any kind of color on where that China weakness came from would be helpful.

[Vineet Nargolwala, executive]

Yes, Tom, it's related to what I just said earlier. It's an artifact of us undershipping very significantly into the China market. China is largely served for distribution. Both our automotive from a fulfillment standpoint as well as our industrial business in China get served through distribution. And that's where we really want to inflect a significant inventory rebalancing, if you will.

And so I think China bore a brunt of that inventory correction in Q1. And so I wouldn't read too much into it other than we have successfully taken out a big chunk of inventory in the China region. And that sets up really well as we look to the coming quarters.

[Operator]

Our next question comes from the line of Josh Buchalter at TD Cowen.

[Joshua Buchalter, analyst]

I wanted to follow up on the earlier comments about gross margins. So I totally understand that underutilization is sort of driving the headwinds now. But how should we think about that unwinding over the next few quarters? And also, is there any lingering impact? And can you remind us on how Crocus's margins should start to layer in over the next several quarters? And do you still feel confident you can get back to that mid-50s levels by the end of the fiscal year?

[Derek D'Antilio, executive]

Yes, Josh. So as I just talked about a few minutes ago, really the way to think about the utilization is the last 2 years, we've put in place a significant amount of capacity, our Philippines facility and CapEx was running 12%, 13% of sales. That's down to 7% in Q1, and it's expected to revert towards our model of about 6% as we don't need the capacity CapEx, there'll be some unique things.

But we have a significant amount of capacity and the majority of the decline in gross margin from Q4 to Q1, the 400 basis points, the majority of that was utilization. And if you kind of look at the change in revenue versus the change in margin, it was about a 65% drop-through, and that's historically been around the number of 60% to 65%. So if you extrapolate that forward and you look at that for Q2, that's how -- that's about on our Q2 guidance at the midpoint. Mix will play a fact that to the extent that you have positive product mix, positive distribution mix, will all start to work its way back. So yes, that gets us back to that kind of Q4 level of gross margin by the end of this fiscal year.

[Joshua Buchalter, analyst]

Got it. And then maybe a bigger picture one. I know Sanken has the lockup and the Board seats thresholds that are still below the 33% level. But is there any change long term? I mean, once we get through this lockup, do you expect Sanken to continue to want to monetize their position? Or do you think that it's important to them to keep the strategic relationship with Allegro longer and beyond the lockup period?

[Vineet Nargolwala, executive]

Josh, this is Vineet. Thanks for the question. Obviously, this question is best posed to Sanken. I can relay what our conversations have been around, which is they continue to really enjoy the strategic relationship. And they've taken a really big chunk of their value in Allegro and monetized it in this transaction. And the reason for that large transaction here was to make sure that they had enough capital to meet all of their needs for some time to come. Having said that, obviously, things are dynamic, they can change. And they'll have to make their determination once they get out of the lockup period. But certainly, from our perspective, we're pleased with this transaction and what it means for Allegro shareholders.

[Operator]

Our next question comes from the line of Mark Lipacis, Evercore ISI.

[Mark Lipacis, analyst]

Two questions actually, if I may. The auto business is now pushing about 80% of revenues. I think historically, it's been in the 70% range. Is this just an artifact of an inventory, of what's going on in inventories in the supply chain? Would you expect kind of steady state to be in the 70% range? Or should we think differently about that mix? And then I had a follow-up, if I may.

[Vineet Nargolwala, executive]

Yes, Mark, this is Vineet. You're exactly right. I think we shouldn't read too much into product or segment trends just for this quarter because we've been working very hard with our customers and partners to really draw down inventory. And that's obviously been very different for each customer, each partner. I would expect that as things sort of normalize, we should get back to more traditional mix. However, from quarter-to-quarter, things do vary, right? And it depends on really a function of the order pattern as opposed to a strategic intent to grow 1 area over the other.

[Mark Lipacis, analyst]

Got you. That makes sense. And then the second question on distribution inventories. How should we think about -- or how do you think about what the right level should be? I think if I remember correctly, you had taken them down and then you started to restock the channel. Now you're destocking. Like how do you think about going forward? Is there like a steady state level that you like to have on a days basis in the channel? Or do you think about different times of the cycle, you want to have different levels there? Can you just help us think about longer term how you think about distribution inventories in the right levels?

[Derek D'Antilio, executive]

Yes, Mark, in the past, we've talked about ideally having 8 to 12 weeks in the distribution channel at any given time, and that will vary by region. Some regions like Japan like to carry more inventory. We're still stocking that channel, quite frankly, as we moved away from Sanken in the last 1.5 years. Other regions, if you remember going back 2 years, sort of troughed in about 4 weeks, 3 weeks, which is very difficult for everybody. And as often happens, we're above those levels right now. We expect to get back into those levels over the next couple of quarters.

[Vineet Nargolwala, executive]

Yes, I would just add, Mark, that distribution serves 2 purposes for us. One is fulfillment for some auto customers, largely in Asia. And the second is serving a very fragmented broad but high-growth industrial verticals. And so the dynamics there are very different. One of the key things that we focus on through distribution is part availability. And so we never want the inventory to come down below the 8 to 10 weeks that Derek has mentioned.

So that's really the sweet spot for us. And we need to make sure that we get our partners back into that range. We've said this before, I'd say it again, we get really good data in terms of point of sale as well as the days of inventory on hand. So we're able to really guide each partner to the right level of inventory depending on the mix of fulfillment versus organic demand creation.

[Derek D'Antilio, executive]

And I -- this is Derek. I'd be remiss if I didn't answer the second part of Josh's question with respect to Crocus margins. So Crocus has been largely almost entirely integrated into Allegro. And so we're focusing on R&D in that business, and their variable contribution margins are really quite acceptable, above our existing variable contribution margins. And we've fully absorbed their OpEx. And if you look at our OpEx, it's actually down 5% year-over-year, inclusive of fully absorbing Crocus. And we're making investments in the research and development. They're expected to release more parts this year than they ever have, and the variable contribution margins are really healthy.

[Operator]

At this time, I'm showing no further questions in the queue. I would now like to hand it back to Jalene for closing remarks.

[Jalene Hoover, executive]

Thank you, Steve. This concludes this morning's conference call. We appreciate you taking the time to join us.

[Operator]

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.