Allegro Microsystems Inc

NASDAQ:ALGM

Q2-2026 Earnings Call

[Operator]

Good morning, and welcome to Allegro Microsystems Second Quarter Fiscal Year 2026 Earnings Conference Call. 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.

[Jalene Hoover, executive]

Thank you, Kathy. Good morning, and thank you for joining us today to discuss Allegro's Fiscal Second Quarter 2026 Results. I'm joined today by Allegro's President and Chief Executive Officer, Mike Doogue; and Allegro's Chief Financial Officer, Derek D'Antilio. They will provide highlights of our business, review our quarterly financial performance and share our third 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 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 second quarter of fiscal 2026 and in our most recent periodic and other filings with the Securities and Exchange Commission. Our estimates, expectations and 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, Mike Doogue. Mike?

[Michael Doogue, executive]

Thank you very much, Jalene, and good morning, and thank you all for joining our second quarter earnings conference call. We remain encouraged by the positive momentum we continue to see across the business, achieving multiyear highs and second quarter bookings and backlog and delivering strong design win activity in our strategic focus areas, particularly in e-mobility and data center. This momentum has enabled us to deliver strong second quarter results with sales, gross margin and EPS above the midpoint of our guidance ranges at $214 million, 49.6% and $0.13, respectively.

In the second quarter, we saw broad strength in our automotive sales with growth in e-mobility and other auto. Our automotive sensor business grew through increased adoption of our ICs and xEV powertrain systems. And motor driver IC sales also grew in electronic power steering systems in ADAS and in applications and other auto.

In our industrial and other end markets, sales growth was led by data center, establishing a new quarterly record. Data center momentum was fueled by a broad server power architecture upgrade supporting next-generation AI workloads as systems move toward higher voltage and power levels. As a result, the demand for our data center fan driver ICs continues to increase, and additionally, our market-leading high-speed current sensor ICs are ramping in data center power supply applications where they enable crucial efficiency and power density improvements.

Looking ahead, we are building another growth vector in this market. Within the quarter, we sampled our new high-voltage gate drivers for silicon carbide with market leaders in the data center power supply space. Collectively, this strong market pull is reflected in our design win activity, where data center continued to lead Q2 industrial design wins with revenue from any of these wins ramping within the next year.

Shifting to automotive design wins. E-mobility continued to lead second quarter activity. We secured a multi-portfolio ADAS win for a steering system using our current sensors and motor drivers with Chinese OEM.

Additionally, our current sensors won multiple designs with an onboard charger and high-voltage traction inverter systems with a North American XEV OEM. As I've said in the past, relentless innovation that drives performance leadership is a priority for Allegro. During the quarter, we released the industry's first 10 megahertz TMR current sensor, a disruptive IC that further extends our competitive advantage.

We believe our 10 megahertz sensor, the highest bandwidth magnetic current sensor in the market by a significant margin will help accelerate our sales growth. These ultrafast sensors reduce the size of inductors and other components in high-voltage power systems. Within the quarter, I also traveled to China where I spent time with our teams, our customers and our suppliers. This time on the road reinforced my excitement about our opportunity and positioning in this important geography.

Our sales to China have grown every quarter since Q1 FY '25 when we launched a strategy to quickly correct an over-inventory situation. Today, China inventory levels are lean, design win activity remains strong and we have no indication of any material pull-in activity from our customers in response to tariffs.

We continue to navigate geopolitical challenges. Therefore, it was encouraging to see China lead our second quarter automotive design win activity for Allegro led by ADAS and xEV applications. While in China, I was also pleased to confirm new design-ins and wins for our sensor ICs in nascent quadruped and hematoid robotics programs.

In summary, we continue to execute on our strategic priorities. We are seeing positive momentum across the business, especially in auto and data center markets. and recent design wins confirm our increasing dollar content opportunity in high-growth auto, data center and robotics applications.

I'll now turn the call over to Derek to review the Q2 2026 financial results and to provide our outlook for the third quarter.

[Derek D'Antilio, executive]

Thank you, Mike, and good morning, everyone. Starting with our second quarter results. Net sales were $214 million and non-GAAP earnings per share were $0.13. Gross margin was 49.6%, operating margin was 13.9% and adjusted EBITDA was 19% of sales. Total Q2 sales increased by 5% sequentially and 14% year-over-year. Sales to our automotive customers increased by 8% sequentially and 12% year-over-year, while e-mobility sales increased by 21% year-over-year.

Industrial and other sales declined by 1% sequentially and grew 23% year-over-year. We saw continued strong performance in data center, offset by a decline in consumer and broad-based industrial where we continue to see some remaining inventory burn. Distribution sales increased by 22% sequentially and 23% year-over-year. Sell-in was still below POS, which remained near the highest levels it's been in 6 quarters.

From a product perspective, magnetic sensor sales increased by 1% sequentially and 2% year-over-year. Magnetic Sensor sales increased by 13% in the first half of fiscal '26 compared to the second half of fiscal '25. And sales of our power products increased by 13% sequentially and 42% year-over-year. Sales by geography were as follows: 29% of sales in China, 24% in the rest of Asia, 17% in Japan, 17% in the Americas and 13% of sales in Europe.

Sales grew in all geographies, except for Europe, where we saw seasonal declines. Now turning to Q2 profitability. Gross margin was 49.6%, an increase of another 140 basis points sequentially. Operating expenses were $76 million approximately $3 million above our outlook due to an increase in variable compensation expense and a further weakening of the U.S. dollar.

Operating margin was 13.9% of sales, compared to 11.1% in Q1 and 11.7% a year ago. The effective tax rate for the quarter was 6%, driven lower by tax planning and elections made within the one Big Beautiful Bill. Second quarter interest expense was $5.1 million, and the second quarter diluted share count was 186 million shares. Net income was $24 million or $0.13 per diluted share.

Non-GAAP EPS increased by 44% sequentially and 63% year-over-year, demonstrating the significant operating leverage in the business model.

Moving to the balance sheet and cash flow. We ended Q2 with cash of $127 million. Cash flow from operations was $20 million was $6 million and free cash flow was $14 million. From a working capital perspective, DSO was 45 days, compared to 40 days in Q1 and inventory days were 135 days compared to 141 days exiting Q1.

During the quarter, we made another voluntary debt repayment of $25 million bringing our total debt balance to $285 million and net debt to $168 million. Finally, I'll now turn to our Q3 2026 outlook. We expect third quarter sales to be in the range of $215 million to $225 million. The midpoint of this range equates to a 24% year-over-year increase and above seasonal for the December quarter.

Additionally, we expect all the following on a non-GAAP basis. Gross margin to be between 49% and 51%. Interest expense is projected to be $5 million reflecting a 25 basis point reduction in SOFR. We expect our tax rate for the quarter and full year FY '26 to now be 8%, a decline from prior estimates of 10%. We estimate that our weighted average diluted share count will be 186 million shares. And as a result, we expect our non-GAAP EPS to be between $0.12 and $0.16 per share.

Now I'll turn the call back over to Jalene for your questions.

[Jalene Hoover, executive]

Thank you, Derek. This concludes management's prepared remarks. Before we open the call to your questions, I'd like to share our third fiscal quarter conference line up with you. We will attend Wells Fargo's Ninth Annual TMT Summit on November 19 in Rancho Palos Verdes, UBS's Global Technology Conference on December 2 and 3 in Scottsdale. Nasdaq's Investor Conference held in association with Morgan Stanley on December 10 in London and Barclays 23rd Annual Global Technology Conference on December 11 in San Francisco.

And finally, we are excited to announce that we will be hosting our next Investor Day on February 3, 2026 in Boston. We'll send a save the date announcement soon, providing additional details. We will now open the call to your questions. Cathy, please review Q&A instructions.

[Operator]

[Operator Instructions] Our first question comes from the line of Joe Quatrochi with Wells Fargo.

[Joseph Quatrochi, analyst]

Congrats on the results. maybe just kind of try to understand a little bit inside the automotive business, I think mobility was up a little bit sequentially, but non-e-mobility was up a lot more. Any sort of color on just how do we think about what's driving that? Is it inventory replenishment? And what -- how do you think about that going forward?

[Michael Doogue, executive]

Joe, thanks. This is Mike. So yes, just to kind of reiterate some of the stats on auto, up 8% quarter-over-quarter and up 12% year-over-year, but e-mobility was up 21% year-over-year. So we are seeing growth in the e-mobility space, as we would expect based on the strong activity we have through design wins in the e-mobility space. When we look at the overall growth of the auto business in this quarter that we're reporting on, we did have some growth in our motors business for what I would call more in-cabin and chassis-related applications.

These are sort of the powertrain agnostic applications where there are an increasing number of loaders and we're getting an increasing number of design wins in that area. So we were actually quite pleased to see some of those wins flow through within the quarter.

[Joseph Quatrochi, analyst]

And then as a follow-up, I think your slide deck has referenced an opportunity like $425 million per rack of revenue for AI servers. Any help on just kind of understanding what you're capturing today? And how do you see that trending over the next couple of years?

[Michael Doogue, executive]

Yes, absolutely, and it's an exciting story. So what we're seeing is that as the data center or, let's say, new data centers start to pivot more towards an AI architecture not only are the power levels consumed by the servers going up enormously, but in a commensurate basis, you need lots of cooling within those high-power data centers, they get hot. So we are seeing strong pull-through for our 3-phase fans that we've been selling into the data center market for many years now. What's happening, the fans are moving into new areas within the rack. Most notably, we're seeing the fans move over into the power supplies, which are now getting so hot that they need to be cooled directly.

So that's 1 tailwind for us in the data center space. Another positive sign, which I talked about in my prepared remarks, our current centers are now being adopted and ramping within the power supplies as well. Measuring current is essential to having efficient power management in those power supplies. We offer a smaller form factor solution that also has reduced heating or reduced OMIC losses to offer a greater efficiency in those power supplies.

That business started to ramp roughly a year ago, and we're in the middle of the ramp now. We have differentiated ICs. Today, we talked about a 10 megahertz current sensor using our TMR technology. Within the last year, we released a 5 megahertz device. These higher speed current sensors help shrink the size and help optimize the control of those power supplies. So it is a new growth vector that is ramping right now within the data center as well.

[Operator]

The next question comes from the line of Vivek Arya with Bank of America Securities.

[Vivek Arya, analyst]

On the first one, just on the demand side, very near term. I was wondering if you are noticing any direct or indirect effects because of the next year situation that is going on and it's constraining output at some of the large auto OEMs. And in general, Mike, how would you describe kind of the regional demand environment? I think you mentioned Europe is still a little bit below trend. But just in general, how would you describe what the kind of the broader regional demand situation is and where you see inventory kind of being on the better versus worse side.

[Michael Doogue, executive]

Yes. Thanks, Vivek. So on the first question, we read in the press, the potential impact of the Nexperia situation personally, we have not seen any changes in demand from our end customers that attribute to that situation. So I don't have much more to say on that situation.

In terms of the regional trends that we see coming into this quarter, we were pleased to see an uptick in sales in the Americas. We also saw growth in all regions other than Europe. So we continue to see pockets of weakness and pockets of inventory within the European market. And there are still some pockets of inventory in the North American market, but that's why we are encouraged to see it grow a bit more in this quarter.

[Vivek Arya, analyst]

And from my follow-up on just a sequential trend. So you are guiding to growth in the December quarter, right, which tends to be usually flat to down or so. So I'm curious what's driving that above seasonal growth and for extra credit, if you could give us a sense for how should we think about seasonality going into March?

[Derek D'Antilio, executive]

Yes, Vivek, this is Derek. Typically, you're right. The December quarter over the course of almost 2 decades, we saw about a 5% decline in that quarter, usually led by industrial. Last year, we had a 5% decline in that quarter. Interestingly, it was auto in North America and other places. But in the years where there's been a cyclical upturn in those previous years were cyclical upturn has happened, we've performed above seasonal in the December quarter.

So we're guiding up this December quarter, largely led by continuing strength in auto and in data center. The 2 areas we've seen a lot of strength in the past several quarters. I'm not going to guide for March, but we've typically not seen seasonality in the March quarter other than Chinese New Year shutdowns in China and other parts of Asia, which typically is a little bit lower for those. But that's the beauty of our business being pretty well geographically diversified, and that's a quarter we usually see a rebound in the Americas Japan and Europe that's typically offset those things.

[Operator]

The next question comes to the line of Gary Mobley with Loop Capital.

[Gary Mobley, analyst]

Derek, I'm having a little bit of a difficult time reconciling the 60 basis points of gross margin upside you delivered for the quarter. Seemingly, there were some headwinds like foreign exchange also automotive was a higher percentage of mix. You delivered right on with that $0.75 of gross profit drop-through. So what drove that gross margin upside for the quarter?

[Derek D'Antilio, executive]

Yes. I would say, Gary, it came in as we expected, right? I expect it to have about 75% drop-through and having the revenue at $214 million above the midpoint, that's the extra 60 basis points. You're absolutely right. There are certainly headwinds with the cost of some commodities continuing to go up. Foreign exchange, at least for the Philippine peso did moderate from a decline in the second quarter here, and we expect it to moderate going forward.

So that's good. That's a tailwind. And we continue to do things in our factory to be far more efficient. So our target is to have that 60% to 65% drop-through the guide for Q3 equates to exactly 65% at the midpoint of that guidance. So I feel like it came in as we expected, offsetting some of the headwinds with continuing to look at PPV from our vendors and also factory efficiencies.

[Gary Mobley, analyst]

Just my follow-up, I want to ask about the shipment into the channel is embedded in your third quarter revenue guide that $220 million midpoint, does that assume that you're still under shipping to end demand? And maybe you can give us a sense if so, by how much?

[Derek D'Antilio, executive]

So I'll give the statistics on Q3 -- sorry, in Q2, we were still shipping below POS. Our sell-in was still a couple of percentage points below POS we still did burn some inventory came down by a couple of million dollars, distributed inventory in the second quarter. I would describe it as the curve is slowing because we've burned a lot of inventory last year. It's been going on for the better part of 5 quarters now. I would say we're in the late eighth inning right now. There may be some additional burn in the December quarter in the long tail of consumer and broad-based industrial in certain pockets.

[Operator]

The next question comes from the line of Tom O'Malley with Barclays.

[Thomas O'Malley, analyst]

Really nice results. The first is just on the mix of business in the quarter. It looks like your no mobility business was very strong. We've seen a bit of slowing on the e-mobility side. Could you just maybe give us the breakdown of what you expect between e-mobility and non-e-mobility in your guidance for the third quarter?

[Michael Doogue, executive]

Yes. So thanks for the question. I mentioned earlier, with E-Mobility being up 5% quarter-over-quarter, but also, let's remember that it's up 21% year-over-year and I mentioned these motor driver design wins throughout the cabin or the chassis in the car. These are these powertrain agnostic applications that we continue to pursue because that's where some of our motor driver technology shines. I've talked many times in the past that we are exceptionally skilled at spinning motors, more quietly, more efficiently, et cetera.

So we did pick up some wins in those areas and they're ramping within the quarter, and that added to the growth of the automotive market within the quarter. Obviously, again, the E-Mobility up 5%; auto overall up 8%. These motor applications driving most of the delta between the 5% growth and the 8% growth.

[Derek D'Antilio, executive]

And Tom, some of this is geographical. For example, the Americas grew 11% in the quarter, while China grew 7.5%. And as you might imagine, it's more of the traditional auto in the Americas.

[Thomas O'Malley, analyst]

Anything on the guidance between those 2 just into the out quarter on what you're expecting between those 2 segments?

[Derek D'Antilio, executive]

No. We're not going to guide to that level of granularity. I will say that the growth in Q3 from a macro market standpoint will be led by automotive, Tom.

[Michael Doogue, executive]

And maybe the other thing I'd add...

[Thomas O'Malley, analyst]

Go ahead.

[Michael Doogue, executive]

I was going to say, the only other thing I'd add is part of the reason we talk about our design wins being so strong in the e-mobility space is just to highlight the fact that most of the growth that we're seeing most of the dollar content gains that we're seeing continue to be in the e-mobility space.

[Thomas O'Malley, analyst]

Helpful. And then just as a follow-up, into the out year, I think more broadly, auto estimates for just market growth have come down a little bit, but you guys have shown an ability to grow really despite the broader market kind of slowing or really being kind of flattish. Can you remind us again is there a way or a framework to think about your growth versus what the broad market looks like into 2026? And any kind of puts and takes that we can to apply kind of your growth trajectory versus what we think is kind of more of a flattish market for next year.

[Michael Doogue, executive]

So there's a couple of different ways to answer that one. I'll first go back to the model that we've shared many times where we say that our total content opportunity in an internal combustion engine car is roughly $40. When you look at either hybrids or EVs, it doesn't matter which one, right? It's the dollar content is the same, roughly in hybrid and full EVs that dollar content for Allegro today is at $60. And as we roll out some of our new products like our isolated gate drivers, that number goes up to $100.

So you can see within those statistics, that is the dollar content story that underpins our ability to far outgrow the vehicle production market.

[Operator]

The next question comes from the line of Chris Caso with Wolfe Research.

[Christopher Caso, analyst]

Yes. The first question is related to gross margins as we go into next year. And in the past -- this past year, you've seen a seasonal decline in gross margins in the March quarter as annual price reductions kind of take hold. Should we expect similar this year? And then perhaps with that, could you talk a bit about what your pricing expectations are into next year? Or are you still expecting a fairly normal pricing environment?

[Derek D'Antilio, executive]

Yes, Chris, what's interesting is that 60% to 65% gross margin drop-through, it's held pretty true since we've been public on an annual basis, but there are quarter-to-quarter perturbations, meaning that in that March quarter, typically, when pricing is negotiated with customers and they're down, the pricing is down, that hits that quarter immediately like it did this past year. The cost cycle back into our P&L over the next 2 quarters, which you did here, so we have a better drop through in those 2 quarters and then it normalizes out.

2 or 3 years ago when prices were increasing, we had the opposite effect, where we had higher gross margin in that March quarter. So it certainly depends on the pricing environment. What I did say this past year in March of 2025 quarter was the friction on the pricing was a bit more than it had been because we had price increases for the past several years. And that was also on a lower revenue number. So the amount of basis points is higher and now our inventory days have gone from 185 days on balance sheet to 135. So the turns of the cost into the P&L will be quicker. So all else being equal, I expect the impact to be less and maybe Mike could talk a little bit about the pricing environment.

[Michael Doogue, executive]

Yes. From a pricing perspective, there are competitors in the market right now that have been publicly stated as raising prices. I don't think there's a broad appetite from our customer base for price increases nor am I saying that's part of our strategy, but our expectation heading into the new calendar year is that we can hold pricing more favorably for Allegro than we might have been able to do in other periods.

[Christopher Caso, analyst]

Got it. That's helpful. I guess going forward, you made some comments, Derek, this was sort of in the late eighth inning with regard to inventory reduction and such. Is that a comment for both the distribution channel as well as the direct customers? And if that's the case, how do we think about that with respect to revenue growth and seasonality as we get over the next few quarters? I mean is it if we start to get some restocking, if demand stabilizes here, does that suggest above seasonal quarters once the inventory burn is complete?

[Derek D'Antilio, executive]

Yes. So I'll start, Chris. What we saw in Q2 was continued inventory burn a small amount. Distributor inventory came down by about another $5 million our sell-in was mid-single digits below POS. POS remained pretty strong. I expect to see a little bit more and that's all on the distributor side where we get data from our distributors on a regular basis. I expect to see a little bit more inventory burn in the very long tail of consumer and broad-based industrial here in the December quarter.

So I feel like we're getting to the end of that on the distributor side. On the automotive side, it's a little harder to see the actual inventory with our customers but we're getting more in-quarter lead time orders. So that tells us that, that coupled with forecast tells us that, that's also getting near the end of the inventory burn as well.

[Michael Doogue, executive]

And I could just add to that, that I mentioned I was in China within the quarter. One nice piece of learning within that trip, our internal teams did a nice job pulling our Tier 1s in the China market for their inventory levels of Allegro products. And we were seeing very healthy, if not in some cases, slightly low levels of inventory in the China market space. I bring that up for a couple of reasons. Number one, we're getting the obvious and insightful questions being asked, do you see any evidence of stocking in China? We weren't seeing that, but it also shows that we could be poised for growing to end demand in China in the coming quarters.

[Derek D'Antilio, executive]

And Chris, to answer the second part of your question, as we've laid out in our financial model, we expect that end demand for us is growing at low double digits going forward. If there was a restocking cycle, which we don't really see evidence of that right now, that could be above that number.

[Operator]

The next question comes from Blayne Curtis with Jefferies.

[Blayne Curtis, analyst]

Nice results. 2 questions. I just wanted to ask, obviously, data center has been all over the news. And I'm just kind of curious how you've seen the outlook for data center improved over the last quarter. And then I don't know if you're able to kind of frame how big it is within industrial I'd also be curious, just commentary as to -- obviously, there's a 3x increase in content to AI, but how much is AI today versus general-purpose servers.

[Michael Doogue, executive]

Yes. Thanks, Blayne. I'll talk generically, you can poke at the answer, I didn't answer your questions. But as I mentioned earlier, what we're seeing is just the incredible levels of power that are being consumed in these newer data center architectures. We're starting to see transition to 48-volt discussion of 800-volt. And if I could summarize that at the highest level, all those trends align very nicely with some of the competitive advantages of our products that would include our motor or fan drivers our current sensors and increasingly, we're getting some uptick in activity in the data center landscape from our isolated gate drivers.

Everything we're seeing is related to the higher power levels, getting the heat out of these power supplies, getting the heat out of the cabinet or the rack itself is becoming more important, and we have numerous technologies now that help achieve these higher levels of cooling and higher levels of performance in the data center. We are not experts in data center or server architectures, although we're putting more time and energy and to studying trends for the future.

We do see trends that should increase the number of fans for Allegro interact within an AI data center should increase the numbers of current sensors and eventually the isolated gate drivers and that's an encouraging sign.

[Blayne Curtis, analyst]

Got you. And then I wanted to ask -- I guess if I did the math right, the Disty sales were up 22% sequentially. So I think that's a high number vers historically. I guess I'm just curious you just described that you said inventories are down in that channel? I guess, why the jump? And is it more end market related? If you can just provide any color would be great.

[Derek D'Antilio, executive]

Yes, Blayne, that's exactly right. So distributor sales for us, sell-in was up 22%. We continue to see -- it continue to shift below POS by about mid-single digits, and we also burned about $5 million in inventory in the distribution channel. So distribute our sales into the distributors have been pretty low for the past 6 quarters. So it's back to what it was about 6 quarters ago. And really, I think we're going to continue to see that increase. The way I distribute the sales work is all of our industrial products go through distribution and then we have fulfillment done through distribution for both auto and industrial in places like Japan and most of China as well.

[Operator]

The next question comes from the line of Quinn Bolton with Needham & Company.

[Quinn Bolton, analyst]

Nice job on the results and outlook. I guess I just wanted to come back. I think last quarter, you had sort of put consumption at the end of '24, somewhere in the level of $220 million to $230 million. And I think you sort of felt that, that was probably a good level to think about through this year, given some of the annual price declines. Just wanted to make sure you guys hadn't changed your outlook for where you think sort of end consumption is. And then looking forward, when do you think you get back to that sort of low double-digit growth rate in that TAM? Do you think that's something you're looking for in 2026?

[Derek D'Antilio, executive]

Yes, Quinn, that's exactly right. We talked about getting to about $225 million. In the fourth quarter of 2024, that $225 million number was the number I gave in consumption at that point. That number has continued to grow organically just from the markets that we serve, offset it by some of the price declines that have happened in the market over 2 years. So we still think that number is in that range. It may have moved up a little bit from there. Now that pricing has largely stabilized, that number should continue to move up at the rate of our content opportunity in the market, so called out the 10% per year.

So that number will continue to increase. And as I mentioned, as we get through I think we're in the late innings of this inventory burn for us. I don't expect to continue to see material inventory burns. And beyond that, as I call a previously asked, if there is a restocking cycle, we could even see growth above that content opportunity growth.

[Quinn Bolton, analyst]

Great. And then I wanted to follow up, Mike, you sort of addressed some of the applications in the data center, but I was wondering if you could specifically talk about 800-volt given a number of the hyperscalers talking about moving to 800-volt rack power distribution rails in next-generation racks, I think you've kind of gone through where you play in 48-volt, but do you have specific applications at that 800-volt rail on top of what you've kind of previously highlighted on the 48-volt rail?

[Michael Doogue, executive]

Yes. Great question, Quinn, and we have a great 800-volt story. And part of the reason is that a lot of the technologies we developed for the EV space were all developed around 800-volt batteries and EVs. So whether you look at our current sensors or our isolated gate drivers, they were all designed specifically to offer efficiency gains, power density gains, size benefits in 800-volt systems. So we are actually excited about becoming transition to an 800-volt architecture at data center.

[Operator]

Thank you. The next question comes from Joshua Buchalter with TD Cowen.

[Joshua Buchalter, analyst]

Congrats on the results and guide. I'm sensing a lot of optimism on the current sensing side. Really, it seems like it's been building all year. Is this because of the TMR portfolio maturing and potentially being applicable and ready for autos. Maybe you could just speak to how much of the current sensing piece is current and ready on TMR across your applications?

[Michael Doogue, executive]

Yes. Thanks, Josh. It's Mike. So we're excited about current sensors for lots of reasons. One of them is just the growth potential the current sensors offer both in electrified vehicles and really in the electrification of everything, which would include the data center. So the team has done a really nice job increasing the number of package offerings that we deliver to customers that help them solve some of the size problems they have, some of the power density problems that they have. And the packaging technologies create a great platform for them what becomes circuit innovations.

I talked about this new 10 megahertz TMR current sensor. And this is a great example of us taking a market-leading TMR tech, combining it with our market-leading packages and creating a product that is highly sought after, both in the EV space, like in the onboard charger part of the EV world, but also in these data center power supplies. And once again, these faster current sensors help protect against short circuit conditions with gallium nitride and silicon carbide. But when you switch these power supplies faster, not only can you make them more efficient, but you can also shrink the size of some expensive inductors and other components in the power supply. So TMR is helping out quite a bit in the world of current centers and in our sensor business as a whole.

[Joshua Buchalter, analyst]

As my follow-up, it sounds like you have incremental confidence in the pricing environment. Obviously, maybe I was hoping you could expand on what's changed in the market that's driving that confidence? And then also when you talked about being able to hold pricing better into I think you said stable. Are you expecting flat pricing into 2026? Or is that just relative to the step down that happened at the beginning of this year that it's more stable.

[Michael Doogue, executive]

Yes, it won't be flat pricing. It will just be more stable. I think what we're seeing is that some of the larger players in the market who had been very aggressive on pricing to try to fill factories they're starting to take their foot off the gas. Some of them are even talking about price increases. And we just think it creates a more stable environment for pricing, but we're not saying pricing will be flat entering next year.

[Operator]

The next question comes from the line of Vijay Rakesh with Mizuho.

[Vijay Rakesh, analyst]

Mike and Derek, just a quick clarification on the e-mobility and magnetic sensors. I saw e-mobility growing 21% year-on-year, and the magnetic sensor was growing only 2% year-on-year. Is that because a lot of the traction is on the motor driver side here? And do you see a pull-through for the Magnit sensors with the motor trials like the position speed or find sensing alongside those motor drives, as you look out?

[Michael Doogue, executive]

Thanks, Vijay. I'm actually glad you asked this question. So as Derek stated in his prepared remarks, in the first half of fiscal year '26, mag sensors were up 13% relative to the second half of FY '25. And what you're seeing in the stats in the second quarter of last year of FY '25. It was a bit of an anomalous spike up in revenues for magnetic sensors, which are making the numbers this quarter on a year-over-year basis.

Just a bit anomalous based on some lumpiness within the quarters. We feel great about our magnetic sensor performance, very strong wins in the EV space and the ADAS space. As I mentioned, we're ramping the current sensors and data center. We're seeing robotics wins. We actually had a record quarter for TMR sales within this quarter. So there's a little bit of a timing dynamic in the numbers in terms of year-over-year growth, but the story for magnetic sensors remains quite strong.

[Vijay Rakesh, analyst]

Got it. And then, Derek, on the longer-term 58% gross margin target, just wondering in how we should look at that the progression to that, whether it's product mix or foundry or loading pricing, et cetera, again, just walk us through that.

[Derek D'Antilio, executive]

Yes. So 50% is our long-term target. We're taking it sort of piece by piece, right? The first goal was to get back to 50%. The guide for our midpoint in the December quarter was 50% coming off some troughs kind of at the 46% range. So we continue to grind our way back to 50%. And the biggest piece of that continues to be leverage. We have a significant amount of capacity both at our wafer suppliers and in our back-end facility in the Philippines, where we've invested heavily over the last 4 years.

So we get a lot of leverage. That's that 60% to 65% drop through, and that's really the biggest piece of it. Aside from that, mix will certainly help some of these newer products that Mike talks about with the TMR, the high-voltage gate drivers, this 10 megahertz current sensor we released, those inherently have more value to our customers and higher gross margins as they begin to ramp.

And we continue to do a lot of good things with efficiencies in our factory, which does 2 things: improves gross margin and allows us really to temper our CapEx. This quarter, our CapEx was $6 million or 3% of sales I expect that to remain below 5% of sales, our target model. So those are really the things that will drive gross margin. On the variable contribution margin side, I don't expect that to change considerably, because we'll be continuing to have cost down with our vendors, of course, and those hopefully will exceed the price downs we have with our customers. And that's kind of a netting that happens there.

[Operator]

The next question comes from the line of Joe Moore with Morgan Stanley.

[Joseph Moore, analyst]

I wanted to come back to the data center business. I think -- I want to make sure I have the right sizing that it's kind of mid-single-digit percentage of revenues? And can you kind of help us with how much of that currently is cooling versus power?

[Michael Doogue, executive]

Yes Joe, this is Mike. So we have said publicly in the past that data center had hit 7% of sales for Allegro. And in the -- here in Q2, the number was only slightly higher than that, but did set a record. And we are still seeing the majority of our revenue coming from cooling, but we're seeing a faster ramp on the power supply side of things. So I think the future is bright on both the cooling and the power supply side of the business.

[Joseph Moore, analyst]

Okay. That's helpful. And then with regards to the comment you made a few minutes ago that the rack content is quite a bit different. Can you expand on that a little bit just because of the market right now, there's a combination of kind of racks of way servers versus full rack scale. What's the difference in content for you guys?

[Michael Doogue, executive]

Yes, Joe, I am no expert on all the permutations of the configurations out there. But in our investor deck on our website, we talk about $150 of potential content in a more conventional high compute server going up to 425 for Allegro and more of a G&A type server configuration. That's not tied to any 1 hyper-specific server configuration. It's more related to the conversations we're having with our customers about the transition over to magnetic current sensors and the power supplies being a general trend and then also the need to have more fans in the server architectures.

We are seeing significant numbers of fans in certain architectures that rely on liquid cooling heavily as well. So I think there's some positive news in at least some of the architectures we've seen that even though there's liquid cooling, there tends to be quite a few fans. And then as we look ahead, becomes even more exciting when we can put high-voltage gate drivers into the power supplies. And as I said in my prepared remarks, we're working with customers on that right now.

[Joseph Moore, analyst]

Congratulations on the numbers.

[Operator]

The next question comes from the line of Timothy Arcuri with UBS.

[Timothy Arcuri, analyst]

I want to go back to this question on distribution. It was up 22%. It sounds like it's just shy of $120 million. But then you said that they burn $5 million worth of your part. So it sounds like sell-through was like $5 million, we've been higher than that. Yet the direct sales were down 10%. So it kind of seems like end customers are building inventory, and they're pulling from the disty. So I know that you don't have as much visibility as to what's kind of happening at the end customer. But does that make you a little concerned that maybe they are building inventory just out of disti.

[Derek D'Antilio, executive]

That's not what we're seeing right now. We don't have visibility further down the line, but a lot of that is geographical for us as well. We use distributors for both demand generation for the industrial side of the business, but also for fulfillment in auto in Japan and China. So Disney could be up to the extent that China is of Japan was up industrial in certain markets like data center we serve through distributors. So that really will drive some of that.

[Timothy Arcuri, analyst]

Okay. And then it sounds like based on the answer to a prior question, it sounds like data center you're kind of a mid- to high single-digit share of this $900 million TAM that you put in the deck. So how -- like how big do you think your share can get there? Is it -- I know that the story really is one that TAM is growing versus your share, but are you also going to gain share in that TAM? And kind of what do you think that your share can get to?

[Michael Doogue, executive]

Yes. So I'll take that one. This is Mike. I won't comment on absolute share numbers, but I would say the best trend that we want to make sure it's crystal clear is that we had a data center business that was largely built on fan drivers. We're now happily seeing current sensors ramp in the power supply. And then the third wave will be these isolated gate drivers that we talked about.

As we bring in current sensor and isolated gate driver technology, we're starting from a low base. So it inherently implies market share gains for Allegro. And I think in aggregate, it creates a strong story of growth in the data center. There's really so much going on in terms of the architectures of the data centers. When is it 800 volts or not, it's tough to give any tangible numbers regarding the future. But I'm confident in saying that we have a strong story on data center.

[Operator]

Our last question comes from the line of Mark Lipacis with Evercore ISI.

[Mark Lipacis, analyst]

Derek, you had mentioned that some -- you're seeing some of your customers trying to order within lead times. So I'm hoping you could just review some of the cycle signals? Are you seeing expedites, are you seeing pull-ins? Or are any of these things changing quarter-to-quarter? And is any of what's going on with your own company lead times? Or any changes there or lead times from your suppliers? And then I had a follow-up.

[Derek D'Antilio, executive]

We continue to see book-to-bill be above one. We haven't given the absolute numbers. That continues to be pervasively above one, all of calendar 25 years. That's good. Our backlog continues to build. We are seeing orders within lead time, and we're having a typical sort of up-cycle constraint in the sense that we're also building some delinquency, meaning we're having challenges building products and getting it through our back-end factory. We're putting more capacity online to service things like data center in the future as we move forward.

So I would say those are the types of metrics you usually see when you come into this environment after a prolonged inventory clearing period.

[Mark Lipacis, analyst]

Got you. Very helpful. And then a follow-up. There's in the news concerns around rare earth metals or do you guys use those? And if so, what's your strategy for building inventory here?

[Michael Doogue, executive]

Yes. Thanks, Mark. This is Mike. So rare earth is used throughout so many industries, as you know, I would say the first signs we saw in terms of rare of tightness were from some of our customers that were putting rare earth materials into things like motors they've done a bunch of work starting in the spring and seem to have been navigating that carefully. Additionally, we're looking at a vendor that we used to buy some magnets from.

We spoke to them a few months ago when they assured us they had multiple years worth of supply of rare earth materials and we continue to work with them. And then finally, obviously, today was a big day for announcements about potential U.S.-China relations and the lifting of some potential restrictions. Net-net, I think lots of companies have their head on a swivel and are doing all the right things to make sure they have continuity of supply and people have been navigating that successfully at least from our seat to date.

[Operator]

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

[Jalene Hoover, executive]

Thank you, Kathy, and thank you all online for taking the time to join us. This concludes this morning's conference call.

[Operator]

Again, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect.