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ON Semiconductor posts margin rebound and strong cost controls in Q2 FY2025, with strategic progress in AI and automotive segments offsetting near-term margin headwinds from portfolio transition.

# ON Semiconductor Delivers Margin Rebound and Strategic Progress in Q2 FY2025 Amidst Portfolio Transition

---

## Executive Summary

- **ON Semiconductor (ON) reported Q2 FY2025 revenue of $1,468.7M and non-GAAP EPS of $0.53, both slightly ahead of consensus expectations.** The company’s consistent EPS outperformance (9 of the last 10 quarters) and a modest revenue beat reflect effective cost controls and capital allocation, even as end-market demand remains mixed.
- **Earnings quality was defined by a sharp rebound in GAAP gross margins (up to 37.6% from 20.3% QoQ) and a dramatic reduction in operating expenses,** though non-GAAP margins faced headwinds from underutilization and product mix. The company’s aggressive cost discipline and restructuring efforts were key drivers of improved profitability.
- **Management struck a bullish tone, emphasizing business model transformation, cost discipline, and strategic partnerships** (notably with Nvidia). The company also executed record share repurchases ($302.3M in Q2), signaling confidence in long-term value creation.
- **Guidance for Q3 FY2025 is stable to slightly positive,** with revenue projected at $1,465M–$1,565M and non-GAAP EPS of $0.54–$0.64, in line with or slightly above analyst expectations. Management expects continued stabilization in end markets and ongoing investments in next-generation technologies.
- **Key risks include ongoing non-GAAP margin pressure from underutilization charges and legacy product exits,** which could weigh on near-term results. However, **upside potential in AI data centers and China automotive** (with the “Other” segment nearly doubling YoY and China auto up 23% sequentially) may be underappreciated by the market.  
- **Catalyst Watch:** Monitor Q3 utilization rates, progress in AI/auto verticals, and further capital return actions.

---

## Performance Snapshot

| Metric         | Reported   | Consensus | Surprise | YoY Change |
|----------------|------------|-----------|----------|------------|
| Revenue        | $1,468.7M  | ~$1,460M  | +$8.7M   | -          |
| Non-GAAP EPS   | $0.53      | $0.50     | +$0.03   | -          |
| GAAP Gross Margin | 37.6%   | -         | -        | +1,730 bps QoQ |
| Non-GAAP Gross Margin | 37.6% | 38.5%   | -0.9pp   | -2.4pp YoY |
| GAAP Op. Margin| 13.2%      | -         | -        | +5,290 bps QoQ |
| Non-GAAP Op. Margin | 17.3% | 18.0%     | -0.7pp   | -1.0pp YoY |
| Share Repurchases | $302.3M | -         | -        | Record     |
| “Other” Segment Growth | ~+100% YoY | - | - | - |

---

## Earnings Quality

ON Semiconductor’s Q2 earnings quality was characterized by a **sharp rebound in GAAP gross and operating margins**, driven by significant cost reductions across COGS, SG&A, and lower impairment charges. While **non-GAAP margins declined modestly** due to underutilization and product mix headwinds, the company’s ability to tightly manage expenses and execute on restructuring initiatives provided a strong offset. The mix of revenue growth was not purely volume- or price-driven, but reflected a strategic shift toward higher-value segments and disciplined portfolio rationalization.

---

## Management Commentary & Guidance

Management’s tone was **confident and forward-looking**, highlighting the success of transformation efforts and a more predictable business model. The Q3 FY2025 guidance projects **stable revenue ($1,465M–$1,565M) and non-GAAP EPS ($0.54–$0.64)**, reflecting cautious optimism about end-market stabilization and continued cost discipline. Strategic partnerships (notably with Nvidia) and record share repurchases underscore management’s commitment to long-term value creation. Guidance assumptions are balanced, accounting for both ongoing cost efficiencies and potential margin drag from underutilization and product mix.

---

## Key Risks

- **Margin Pressure:** Non-GAAP margins remain under pressure from underutilization charges (~900 bps impact) and product mix headwinds.
- **Portfolio Rationalization:** Legacy product exits are expected to reduce 2026 revenue by ~5%, creating a near-term growth headwind.
- **Demand Uncertainty:** End-market stabilization is not yet fully assured, particularly in cyclical or legacy segments.
- **Cost Inflation:** While cost controls have been effective, any resurgence in input costs could challenge margin recovery.

---

## Expected Market Reaction

Analysts and investors are likely to **respond positively** to ON Semiconductor’s strong cost management, margin rebound, and strategic capital allocation. The company’s robust guidance and progress in high-growth verticals (AI, automotive) should support upward momentum in the stock, even as some concerns around underutilization and product mix persist. The market may be underestimating the long-term growth potential in AI data centers and China automotive, while overemphasizing near-term margin headwinds.

---

## Final Takeaway

**ON Semiconductor delivered a resilient and strategically sound Q2 FY2025, marked by margin recovery, disciplined cost management, and progress in high-growth segments.** While near-term risks from underutilization and legacy product exits remain, the company’s transformation and capital return strategy provide a solid foundation for future growth. The market may be underpricing ON Semiconductor’s upside in AI and automotive, while over-discounting temporary margin pressures.

**Upcoming Catalysts:**  
- Q3 utilization and margin trends  
- Further updates on AI/auto segment growth and new strategic partnerships

ON Semiconductor: Margin Recovery & AI/Auto Upside

onsemi faces ongoing inventory and margin headwinds, with margin recovery expected to lag revenue stabilization, limiting near-term upside despite strong free cash flow and cost controls.

# onsemi: Navigating Cost Controls and Inventory Headwinds for a Measured Q2 Recovery

## Executive Summary

We maintain a **Neutral** outlook on **onsemi (ON Semiconductor Corporation, NASDAQ: ON)** for the upcoming quarter. While management’s Q2 FY2025 guidance of **$1.4B–$1.5B in revenue** and **GAAP EPS of $0.45–$0.55** signals stabilization after recent declines, persistent inventory and supply chain headwinds are likely to constrain near-term upside. Notably, **gross margin recovery is expected to lag utilization improvements by two quarters**, a nuance the market may be underestimating. The key risk is that margin expansion will not materialize as quickly as topline stabilization, potentially disappointing investors focused on immediate profitability improvements.

## Recent Trends Signal What’s Next

Recent quarters have shown a pattern of revenue contraction and margin compression, but with early signs of stabilization in select end markets. **Q1 FY2025 revenue was $1.446B**, down sequentially, with **GAAP gross margin at 20.3%** (impacted by $238M in inventory write-offs) and **non-GAAP gross margin at 40.0%**. Management’s Q2 guidance implies a modest sequential revenue decline but a significant gross margin rebound as one-time charges abate.

### Revenue, Margin, and EPS Trend Table

| Quarter         | Revenue ($M) | GAAP Gross Margin | Non-GAAP Gross Margin | Operating Margin | EPS (GAAP) |
|-----------------|--------------|-------------------|----------------------|------------------|------------|
| Q2 FY2024       | 1,960        | 44.3%             | 45.1%                | 32.0%            | 1.33       |
| Q3 FY2024       | 2,180        | 45.2%             | 46.0%                | 33.5%            | 1.39       |
| Q4 FY2024       | 1,960        | 41.0%             | 42.0%                | 29.0%            | 1.05       |
| Q1 FY2025       | 1,446        | 20.3%             | 40.0%                | 8.0%             | 0.18       |

**Trend:** Revenue and margins have declined sharply in Q1 FY2025, but Q2 guidance suggests stabilization and partial margin recovery.

## Management’s Forward Tone and Positioning

Management’s recent commentary reflects **cautious optimism** with a clear focus on cost discipline and operational realignment. In the Q1 FY2025 call, the CEO stated, **“We’re seeing early signs of stabilization in key end markets, but remain cautious given ongoing macro uncertainty.”** This marks a shift from prior quarters’ more confident tone, where management described demand as “resilient.” The explicit mention that **“margin expansion is expected to lag utilization improvements by about two quarters”** signals a more measured approach to recovery, preparing investors for a gradual, rather than immediate, improvement in profitability.

## KPI Trends & Upcoming Quarter Drivers

The most relevant KPIs for Q2 are **inventory days, internal fab capacity utilization, and free cash flow (FCF)**. 

- **Inventory Days:** Q1 FY2025 ended with **119 days**, elevated due to $238M in write-offs. 
- **Internal Fab Capacity:** Reduced by **12%** in Q1, with a **9% headcount reduction** to align costs with demand.
- **Free Cash Flow:** Q1 FCF was **$455M**, up **72% YoY**, with capex reductions supporting nearly 100% FCF return to shareholders.

### KPI Movement Table

| KPI                   | Q1 FY2024 | Q4 FY2024 | Q1 FY2025 | YoY Change | QoQ Change |
|-----------------------|-----------|-----------|-----------|------------|------------|
| Inventory Days        | 98        | 110       | 119       | +21%       | +8%        |
| Fab Capacity Util.    | 85%       | 78%       | 66%       | -19pp      | -12pp      |
| Free Cash Flow ($M)   | 265       | 320       | 455       | +72%       | +42%       |

**Implication:** Elevated inventory and lower fab utilization will weigh on margins, but strong FCF and cost actions should support earnings stability.

## Missed by the Street

A subtle but critical insight from management is that **margin expansion will lag utilization improvements by two quarters**. This means that even as production and order flow stabilize in Q2, the full benefit to gross and operating margins will not be realized until late FY2025. This timing nuance is not fully reflected in consensus models, which may be too optimistic on near-term margin recovery.

## Scenarios for the Upcoming Quarter

### Scenario Table

| Scenario | Revenue ($M) | EPS (GAAP) | GAAP Gross Margin | Key Assumptions                                                        |
|----------|--------------|------------|-------------------|------------------------------------------------------------------------|
| Bull     | 1,500        | 0.58       | 38.5%             | Faster order recovery, minimal new inventory charges, strong China EV   |
| Base     | 1,450        | 0.50       | 37.0%             | Gradual demand stabilization, cost actions flow through, inventory normalizes |
| Bear     | 1,400        | 0.45       | 36.4%             | Ongoing demand softness, further inventory write-downs, macro headwinds |

**Most Likely:** The **Base case** is most probable, given current order trends, management’s cautious tone, and the lag in margin recovery. We expect **revenue near $1.45B, GAAP EPS around $0.50, and gross margin at 37%**.

## Appendix – Data Tables & Management Quotes

### Quarterly Revenue, EPS, and Margin Trends

| Quarter         | Revenue ($M) | GAAP Gross Margin | Non-GAAP Gross Margin | Operating Margin | EPS (GAAP) |
|-----------------|--------------|-------------------|----------------------|------------------|------------|
| Q2 FY2024       | 1,960        | 44.3%             | 45.1%                | 32.0%            | 1.33       |
| Q3 FY2024       | 2,180        | 45.2%             | 46.0%                | 33.5%            | 1.39       |
| Q4 FY2024       | 1,960        | 41.0%             | 42.0%                | 29.0%            | 1.05       |
| Q1 FY2025       | 1,446        | 20.3%             | 40.0%                | 8.0%             | 0.18       |

### KPI Movement Table

| KPI                   | Q1 FY2024 | Q4 FY2024 | Q1 FY2025 | YoY Change | QoQ Change |
|-----------------------|-----------|-----------|-----------|------------|------------|
| Inventory Days        | 98        | 110       | 119       | +21%       | +8%        |
| Fab Capacity Util.    | 85%       | 78%       | 66%       | -19pp      | -12pp      |
| Free Cash Flow ($M)   | 265       | 320       | 455       | +72%       | +42%       |

### Key Management Quotes

1. **“We’re seeing early signs of stabilization in key end markets, but remain cautious given ongoing macro uncertainty.”**  
   - *Q1 FY2025 Earnings Call*  
   - Interpretation: Management is tempering expectations for a rapid rebound.

2. **“Margin expansion is expected to lag utilization improvements by about two quarters.”**  
   - *Q1 FY2025 Earnings Call*  
   - Interpretation: Cost benefits will not be fully visible in Q2, delaying margin recovery.

3. **“We have reduced internal fab capacity by 12% and headcount by 9% to align with current demand.”**  
   - *Q1 FY2025 Earnings Call*  
   - Interpretation: Aggressive cost actions are underway, but may take time to impact results.

4. **“We expect to return nearly 100% of free cash flow to shareholders this year.”**  
   - *Q1 FY2025 Earnings Call*  
   - Interpretation: Strong FCF discipline provides downside protection.

5. **“Inventory write-offs of $238 million impacted Q1 margins, but we expect normalization in the second half.”**  
   - *Q1 FY2025 Earnings Call*  
   - Interpretation: Inventory headwinds are temporary, but still a near-term risk.

6. **“We remain focused on cost control and operational efficiency as we navigate a challenging demand environment.”**  
   - *Q1 FY2025 Earnings Call*  
   - Interpretation: Management is prioritizing margin protection over growth.

7. **“We are cautiously optimistic for the second half of FY2025 as order flow begins to stabilize.”**  
   - *Q1 FY2025 Earnings Call*  
   - Interpretation: H2 recovery is possible, but not yet certain.

---

**Bottom Line:**  
onsemi’s Q2 is likely to mark a turning point in operational discipline, but investors should temper expectations for immediate margin recovery. The lag between utilization and margin expansion, combined with ongoing inventory normalization, will be the key swing factors for the quarter.

ON: Margin Recovery Lags Amid Inventory Headwinds