Earnings Call Transcript - ALGM Q1 2025

Operator, Operator

Good morning and welcome to the Allegro MicroSystems First Quarter Fiscal 2025 Earnings 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. 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, Allegro MicroSystems. Please go ahead.

Jalene Hoover, Vice President of Investor Relations and Corporate Communications

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 is included in our earnings release, which is available on 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 projections and assumptions as of today's date and as a result are subject to risks and uncertainties that could cause actual results or events 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 fourth quarter and fiscal year 2025 and in our most recent periodic 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, CEO

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 roadmap with some major new product introductions in Q1. During the quarter, we announced the launch of the third product in our high-voltage power through 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 roadmap 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 the 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 microinverters, 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 the board presence by one 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's ownership, combined with the departure of one equity partner from Allegro, enables us to be completely independent in our strategies and actions. I'm very thankful to our teams and advisors for the 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, CFO

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. Each total Q1 sales declined by 31% sequentially and by 40% compared to Q1 of fiscal 2024. Sales to automotive customers were $131 million, a decline of 28% sequentially and 29% year-over-year, representing 79% of our Q1 sales. E-mobility sales were $62 million, declining by 31% sequentially and 30% year-over-year, representing 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, representing 49% of our Q1 sales. We continue to monitor channel POS sell-through, which has been higher than sell-in to help manage distributor inventories to appropriate levels. From a product perspective, magnetic sensor sales were $115 million, declining 21% sequentially and 34% year-over-year. 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% and 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 40 million, largely in wafer, 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. 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 its ownership from 51% pre-transaction to approximately 33%, resulting in 30% more free flow and a net reduction of approximately $10 million or 5% fewer shares outstanding. As Vineet mentioned, it also brings with it significant governance benefits to Allegro 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 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 on a non-GAAP basis within fiscal year 2025. 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 plus to BB minus. 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 a range of $182 million to $192 million, implying 12% sequential growth at the midpoint of this range. We also project the following 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%. Our weighted average diluted share count is expected 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. 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 Hoover, Vice President of Investor Relations and Corporate Communications

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. For your attending Needham's 5th Annual Needham Virtual Semiconductor & SemiCap One-on-One Conference on August 22nd, Jefferies Semiconductors, IT Hardware & Communications Summit on August 27th at the Four Seasons Hotel in Chicago, and Evercore's ISI Semiconductor, IT Hardware & Networking Conference on August 28th at the Omni, Chicago. We will now open the call for your questions. Steve, please review Q&A instructions.

Operator, Operator

Thank you. At this time, we will conduct a question-and-answer session. Our first question comes from the line of Chris Caso of Wolfe Research. Your line is now open.

Chris Caso, Analyst

Yeah. Thank you. Good morning. I guess the first question is with regard to customer inventory levels and the progress in getting multi-channel all now your automotive customers in line. You expressed an intention last quarter to take down inventory pretty aggressively. We've heard from others in the space that the targets for those automotive inventories appear to be coming lower. Are some of what you're seeing and the progress that you've made in the quarter?

Vineet Nargolwala, CEO

Yeah, hi, Chris, this is Vineet. Thanks for the question. So I would categorize our progress on inventory as expected. As we highlighted in our last earnings call, we think on average within the automotive channel, which is largely derived through tiers and contract manufacturers, inventories have come down roughly four weeks. Now some tiers and contract manufacturers are ahead of that, while others are obviously behind. I would say that every customer and partner has differing goals, but broadly we have made substantial progress in bringing inventories down. Within the industrial business, which is largely sold through distribution, I would say it’s more of a regional lens, where some of the regions would stay with slightly higher levels, which is typical, for example, in Japan. But in places like China and North America, we've made 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 under shipped in Q1 to help our distributor partners and our channel partners and tiers work down their inventory very aggressively. We think that this is largely done, though some inventory adjustments may continue into the next quarter. We believe we’ve made substantial progress here on inventory balancing.

Chris 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 under shipping demand? What kind of view can you give us on the December quarter on that basis?

Vineet Nargolwala, CEO

So, Chris, we are 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. We’re pleased that we are able to get back to sequential growth here in the coming quarter.

Chris Caso, Analyst

Thank you.

Operator, Operator

Thank you. The next question comes from the line of Blayne Curtis at Jefferies. Your line is open.

Blayne Curtis, Analyst

Good morning. Thanks for letting me ask a question. 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 your two segments, where you're seeing the most recovery.

Derek D'Antilio, CFO

So Blayne, this is Derek. I'll start with it by 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 areas like data center and other areas that haven't had enough inventory to digest are looking positive.

Blayne Curtis, Analyst

Got you. And then..

Vineet Nargolwala, CEO

And Blayne, I would just add that this is as expected, where we expected 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

Thanks, guys.

Operator, Operator

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

Quinn Bolton, Analyst

Hey, guys. I just wanted to follow up on the previous 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, CEO

Quinn, this is Vineet, thanks for the question. So maybe there are two parts to this. We don't really see the impact of tariffs in Europe really affecting how our Chinese customers are behaving or driving growth for the overall business. I think I've shared earlier, in earlier calls that we are really exposed to every Chinese OEM, every one of the top 10 Chinese OEMs, and we have great geographical diversity in our business as well. So we feel 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 records that will be produced and shipped from China. Chinese OEMs are also setting up manufacturing in Eastern Europe. So we think that they will navigate around this issue. But to the second part of your question, our guide is really reflected right now on what we believe is shown in our order patterns and our backlog. We don't think that the tariffs will have a material impact on how we see things playing out.

Quinn Bolton, Analyst

Great. And then maybe just to sort of the accounting question for you, Derek, can you walk me through the dynamics of the share repurchase, the $35 million, I think you called it, the facilitation fee? And wondering how that’s accounted? Is that sort of intended to help offset some of the higher interest expense from the term loan? Is it agreed to help offset some of the higher interest expense from the term loan? Can you clarify how we should be thinking about accounting for that payment?

Derek D'Antilio, CFO

Yes, sure. So it's a one-time payment to help facilitate this transaction so that no one shareholder receives a benefit at the expense of all other Allegro shareholders. In addition to that, the facilitation fee will cover all of the transaction costs, including the underwriter's spread and interest on the debt. Our intent is to use that payment of cash to pay interest and principal on our debt. In a way, it’s being accounted globally, and quite frankly, it won’t impact our P&L. And it's nontaxable that way as well.

Quinn Bolton, Analyst

Got it. Okay. Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Vijay Rakesh from Mizuho. Your line is now open.

Vijay Rakesh, Analyst

Yes. Thanks, Vineet and Derek. Just a quick question. I know you mentioned Grade three magnetic sensor share up and a leading question there. The one question that isn't getting to investors during the debt is down 40% year-on-year. Could you give us some clarity on how your market share is standing here in the EV and ADAS space and how the design pipeline looks, especially in orders and XTV?

Vineet Nargolwala, CEO

Yes, Vijay. Just so I understand your question. You're asking about how our design pipeline is faring?

Vijay Rakesh, Analyst

Yes. And some more confidence around the market share here post-reset.

Vineet Nargolwala, CEO

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. This is a testament to the hard work our team does every day to serve our customers and really deliver innovation. I would say that, while we've been intentionally under shipping to our distributors and tiers, that demand is still being met by Allegro products from inventory, so it should have zero impact on share position. The second part of your question, which is on our design pipeline, continues to grow really well. We continue to win more than our fair share in the market and the applications we serve in the markets we serve. By giving some qualitative information around some of the key wins we had in the fourth quarter, I can 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, indicating how our customers trust us to continue to support them in this transition to a more electric and advanced feature.

Vijay Rakesh, Analyst

Got it. And then on the gross margin slide, Derek, how do you see the T-cell shipments improving? And how do you see those gross margin progressing first in a 50%, 55%, 58% that you’ve seen historically?

Derek D'Antilio, CFO

Yeah, Vijay, so you're 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 historical drop through our 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 for whatever revenue numbers you put into the next couple of quarters. You're absolutely right. On the mix side of things, we have sort of two mix things; one is product mix, which was a little bit weaker in Q1, but just these new mix also was lower in Q1 at 49% of sales, which was the lowest number it's been in the last three years, because we were obviously under shipping the distribution channel. The biggest piece of 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. Positive product mix and distribution mix will help enhance gross margin again between now and the end of the year. We're still committed to getting to that 58% level over time, which will require focusing on those three things as well as leveraging our back-end facility in the Philippines, leveraging our suppliers as we get back to scale, and continuing to release new products that Vineet talked about, which include some exciting new current sensors that start with a higher ASP.

Vijay Rakesh, Analyst

Got it. Okay. Thanks a lot.

Operator, Operator

Thank you. Our next question comes from the line of Thomas O'Malley at Barclays.

Thomas O'Malley, Analyst

Thank you. 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 how e-mobility and your other auto business have been tracking. E-mobility has been doing a lot better just from both 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 the e-mobility side to track a little bit better in the recovery for the remainder of the year; would you expect one to grow faster than the other? Any color would be helpful.

Vineet Nargolwala, CEO

Yeah. Hey, 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 under shipping. I wouldn't read too much into the product trends there. I would say broadly speaking, when we look at our design pipeline, more than three-quarters of that within automotive is tied to e-mobility. So it's natural to expect that e-mobility will have a faster acceleration as we come out of this trough during the inventory rebalancing period. Certainly, as we look to the future, we would expect 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. Thank you.

Vineet Nargolwala, CEO

Yeah. Tom, it's related to what I just said earlier. It's an artifact of us under shipping 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 gets served for distribution. And that's where we really wanted to inflect a significant inventory rebalancing, if you will. I think China bore the brunt of that inventory correction in Q1; 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 now sets up really well as we look to the coming quarters. Hopefully, that answers your question.

Operator, Operator

Thank you. Our next question comes from the line of Joshua Buchalter at TD Cowen. Joshua, your line is now open.

Joshua Buchalter, Analyst

Hey, guys. Thank you for taking my question. I wanted to follow up on the earlier comments about gross margins. I understand that underutilization is driving the headwinds now. But how should we think about that unwinding over the next few quarters? Is there any lingering impact? Can you remind us on how Crocus' margins should start to layer in over the next several quarters? Do you still feel confident you can get back to that mid-50s level by the end of the fiscal year? Thank you.

Derek D'Antilio, CFO

Yeah, Joshua. As I just talked about a few minutes ago, really the way to think about the utilization is that over the last two years, we've put in place a significant amount of capacity at our facility in the Philippines. CapEx was running at about 12% to 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 additional capacity. The majority of the decline in gross margin from Q4 to Q1, the 400 basis points, was primarily due to utilization. If you look at the change in revenue versus the change in margin, there’s about a 65% drop-through. If you extrapolate that forward, you look at it for Q2, that's about in line with our Q2 guidance at the midpoint. Mix will play a factor; to the extent that you have positive product mix and distribution mix, it will enhance gross margin in the coming quarters. 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. Thank you for that color, Derek. Maybe you have a bigger picture one. I don't think it has the lockup and the Board seats thresholds that are still below the 33% level. Is there any change long-term? Do you expect Sanken to continue to monetize our position? Or do you think that it's important to them to keep the strategic relationship with Allegro longer and beyond the lockup period? Thank you.

Vineet Nargolwala, CEO

Thank you. 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. They've taken a significant chunk of their value in Allegro and monetized it in this transaction. The reason for that large transaction was to ensure they had enough capital to meet all of their needs for some time to come. Having said that, obviously things are dynamic and they can change, and they'll have to make their determination once they get out of the lockup period. But from our perspective, we are pleased with this transaction and what it means for Allegro shareholders.

Joshua Buchalter, Analyst

Understood. Thank you, Vineet. I appreciate the color there.

Operator, Operator

Thank you. Our next question comes from the line of Mark Lipacis at Evercore ISI. Mark, your line is now open.

Mark Lipacis, Analyst

Great. Thanks for taking my question. Two questions, actually, if I may. The auto business is now pushing about 80% of revenues, I think, and historically it's been in the 70% range. Is this just an artifact of inventory and what's going on in inventories in the supply chain? Would you expect 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, CEO

Yes, Mark, this is Vineet. You're exactly right; I think we shouldn't read too much into product or segment trends for this quarter because we've been working hard with our customers and partners to draw down inventory. That's obviously been very different for each customer and partner. I would expect that as things normalize, we should get back to more of a traditional mix. However, from quarter to quarter, things do vary right, depending on the order pattern as opposed to any strategic intent to grow one 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, and now you’re destocking. How do you think about going forward? Is there like a steady state level that you'd like to have on a days basis in this channel? Or do you think about different times of the cycle where you want to have different levels there? Can you just help us think about longer-term how you think about distribution inventories and the right levels?

Derek D'Antilio, CFO

Yes. Mark, in the past, we've talked about ideally having 8 to 12 weeks in a distribution channel. That will vary by region; some regions like Japan like to carry more inventory. We're still stocking that channel, quite frankly, as we've moved away from saying things were low over the last year-and-a-half. Other regions, as you remember, going back two years, the trough was at about four weeks, which was very difficult for everybody. As often happens, we’re above those levels right now, and we expect to get back into that range over the next couple of quarters.

Vineet Nargolwala, CEO

Yes. I would just add, Mark, that distribution serves two purposes for us. One is fulfillment for some auto customers largely in Asia, and the second is serving our very fragmented, broad, but high-growth industrial verticals. The dynamics are very different. One of the key things we focus on through distribution is parts availability. We never want inventory to come down below the 8 to 10 weeks that Derek mentioned. So that's really the sweet spot for us. We need to ensure we guide each partner to the right level of inventory depending on fulfillment versus organic demand creation.

Derek D'Antilio, CFO

This is Derek. I'd be remiss if I didn't answer the second part of Joshua's question with respect to progress margins. Progress has been largely integrated into Allegro. We’re focusing on R&D in that business. I know their variable contribution margins are really acceptable above our existing variable contribution margins, and we've fully absorbed their OpEx. If you look at our OpEx, it's actually down 5% year-over-year inclusive of fully absorbing progress, and we’re making investments in 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, 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, Vice President of Investor Relations and Corporate Communications

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

Operator, Operator

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