ONTO INNOVATION INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements Certain statements in this Quarterly Report on Form 10-Q (this “Form 10-Q”) of Onto Innovation Inc. (referred to in this Form 10-Q, together with its consolidated subsidiaries, unless otherwise specified or suggested by the context, as the “Company,” “Onto Innovation,” “we,” “our” or “us”) may be considered “forward-looking statements,” including, but not limited to, those concerning: • anticipated effects of, and future actions to be taken in response to the COVID-19 pandemic, • our business momentum and future growth, • acceptance of our products and services, • our ability to deliver both products and services consistent with our customers’ demands and expectations and to strengthen our market position, • our expectations of the semiconductor market outlook, • future revenue, gross profits, research and development and engineering expenses, selling, general and administrative expenses, • product introductions, • technology development, • manufacturing practices, • cash requirements, • our dependence on certain significant customers and anticipated trends and developments in and management plans for our business and the markets in which we operate, • our anticipated revenue as a result of acquisitions, and • our ability to be successful in managing our cost structure and cash expenditures and results of litigation. The statements contained in this Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by words such as, but not limited to, “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “plan,” “should,” “may,” “could,” “will,” “would,” “forecast,” “project” and words or phrases of similar meaning, as they relate to our management or us. The forward-looking statements contained herein reflect our expectations with respect to future events and are subject to certain risks, uncertainties and assumptions. Actual results may differ materially from those included in such forward-looking statements for a number of reasons including, but not limited to, the following: • effects of the COVID-19 pandemic and the measures being taken to limit the spread of COVID-19, including impact on demand for our products, reduction in production levels, R&D activities, and qualification activities with our customers, increased costs, disruptions to our supply chain and a decrease in availability under our credit agreement; • the severity of newly identified strains of COVID-19 and the timing, availability and efficacy of vaccines for COVID-19; • variations in the level of orders which can be affected by general economic conditions; • seasonality and growth rates in the semiconductor manufacturing industry and in the markets served by our customers; • the global economic and political climates; • difficulties or delays in product functionality or performance; • the delivery performance of sole source vendors; • the shortage of semiconductor chips or other key components; • the timing of future product releases; • failure to respond adequately to either changes in technology or customer preferences; • changes in pricing by us or our competitors; • our ability to manage growth; changes in management; • risk of nonpayment of accounts receivable; • changes in budgeted costs; • our ability to leverage our resources to improve our position in our core markets, to weather difficult economic environments, to open new market opportunities and to target high-margin markets; • the strength/weakness of the back-end and/or front-end semiconductor market segments; • the imposition of tariffs or trade restrictions and costs, burdens and restrictions associated with other governmental actions; 18 Table of Contents • the ability to successfully complete the integration of the businesses of Rudolph Technologies, Inc. (“Rudolph”) and Nanometrics Incorporated (“Nanometrics”) within the expected time frame and to maintain the anticipated synergies and value-creation contemplated by the merger of Rudolph and Nanometrics (the “2019 Merger”); • unanticipated difficulties or expenditures relating to the completion of the integration of the Rudolph and Nanometrics businesses; • the response of business partners and retention as a result of the 2019 Merger; • the diversion of management time in connection with the integration; and • the “Risk Factors” set forth in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 26, 2020 (the “2020 Form 10-K”) and in Part II, Item 1A of this Form 10-Q. You should carefully review the cautionary statements and “Risk Factors” contained in the 2020 Form 10-K and in this Form 10-Q. You should also review any additional disclosures and cautionary statements and “Risk Factors” we include from time to time in our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other filings we make with the Securities and Exchange Commission (the “SEC”). The forward-looking statements reflect our position as of the date of this Form 10-Q and we undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Critical Accounting Policies The preparation of condensed consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make judgments, assumptions and estimates that affect the amounts reported. Certain of these significant accounting policies are considered to be critical accounting policies, as defined below. A critical accounting policy is defined as one that is both material to the presentation of our condensed consolidated financial statements and requires management to make difficult, subjective or complex judgments that could have a material effect on our financial condition or results of operations. Specifically, these policies have the following attributes: (1) we are required to make judgments and assumptions about matters that are highly uncertain at the time of the estimate; and (2) different estimates we could reasonably have used, or changes in the estimate that are reasonably likely to occur, could have a material effect on our financial position and results of operations. Estimates and assumptions about future events and their effects cannot be determined with certainty. We base our estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances. These estimates may change as new events occur, as additional information is obtained and as our operating environment changes. In addition, management is periodically faced with uncertainties, the outcomes of which are not within our control and will not be known for prolonged periods of time. Certain of these uncertainties are discussed in our 2020 Form 10-K in the Items entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Based on a critical assessment of our accounting policies and the underlying judgments and uncertainties affecting the application of those policies, we believe that our condensed consolidated financial statements are fairly stated in accordance with U.S. GAAP and provide a fair presentation of our financial position and results of operations. For more information, please see our critical accounting policies as previously disclosed in our 2020 Form 10-K and recent accounting pronouncements discussed in Note 1 to the Condensed Consolidated Financial Statements. Executive Summary We are a worldwide leader in the design, development, manufacture and support of process control tools that perform macro-defect inspection and metrology, lithography systems, and process control analytical software used by semiconductor and advanced packaging device manufacturers . We deliver comprehensive solutions throughout the semiconductor fabrication process with our families of proprietary products that provide critical yield-enhancing information, enabling microelectronic device manufacturers to drive down costs and time to market of their devices. We provide process and yield management solutions used in both wafer processing facilities, often referred to as “front-end,” and in device packaging and test facilities, commonly referred to as “back-end” manufacturing. Our advanced process control software portfolio includes powerful solutions for standalone tools, groups of tools, or factory-wide suites to enhance productivity and achieve significant cost savings. 19 Table of Contents The following table summarizes certain key financial information for the periods indicated below (in thousands, except per share and percent data): Three Months Ended March 27, December 26, March 28, 2021 2020 2020 Revenue $ 169,279 $ 155,128 $ 139,928 Gross profit $ 90,469 $ 75,349 $ 62,631 Gross profit as a percent of revenue 53 % 49 % 45 % Total operating expenses $ 62,984 $ 60,638 $ 67,877 Net income (loss) $ 24,113 $ 19,914 $ (4,404 ) Diluted earnings (loss) per share $ 0.49 $ 0.40 $ (0.09 ) • In the March 2021 quarter, revenue increased 9% compared to the December 2020 quarter, primarily due to an increase in sales to foundry customers for advanced nodes applications . • The increase in gross margin as a percentage of revenue in the March 2021 quarter compared to the December 2020 quarter was primarily driven by lower charges for excess and obsolete inventory related to an older product line. • The increase in operating expenses in the March 2021 quarter compared to the December 2020 quarter was mainly driven by the Inspectrology, LLC (“Inspectrology”) acquisition and an increase in employee-related expenses. Our cash, cash equivalents and marketable securities balance increased to $392.9 million at the end of the March 2021 quarter compared to $373.7 million at the end of the December 2020 quarter. This increase was primarily the result of $51.0 million of cash generated from operating activities. This source of cash was partially offset by net cash used to purchase Inspectrology of $26.8 million and $3.9 million of capital expenditures. Employee headcount as of March 27, 2021 was approximately 1,273. Key Events Trade Restriction and Emerging Regulation. The United States Department of Commerce has added certain China-based entities to the U.S. Entity List, restricting our ability to provide products and services to such entities without an export license. In addition, the U.S. Department of Commerce has imposed new export licensing requirements related to China-based customers engaged in military end uses, as well as requiring that an export license be obtained for the purchase and use of certain semiconductor capital equipment based on U.S. technology. As of March 27, 2021, we currently have purchase orders of approximately $25 million from customers in China which are affected by these restrictions. We have filed for licenses with the US government and are waiting for a response to ship these orders. In addition, companies in China are being considered as potential military suppliers and these new additions may have a material impact to our sales in China. We continue to monitor the trade related actions governments may take during 2021. Impact of the COVID-19 Pandemic on Our Business . The spread of COVID-19 has caused an economic downturn on a global scale, as well as significant volatility in the financial markets. As of April 29, 2021, our operations have been impacted by our pandemic response, as described below, and the global nature of our workforce and our operations, but we have not experienced significant financial impact directly related to the pandemic. We have prioritized the health and safety of our employees and customers in our pandemic response. As governmental authorities implement restrictions on commercial operations, we have continued to ensure compliance with these directives while also maintaining business continuity for our essential operations. We have a global workforce. Although our manufacturing is conducted solely in the U.S., we maintain offices in the United States, South Korea, Japan, Taiwan, China, Singapore and Europe. Our operations at these offices are subject to various governmental directives and, as a result thereof, we have instituted a work-from-home policy for these employees to the extent practical. Where our essential employees are required to continue to report to work to perform their responsibilities, we have implemented staggered shifts or otherwise adjusted work schedules to maximize our operating capacity while adhering to applicable restrictions, including recommended distancing between persons. We have also provided our essential employees with appropriate protective equipment and have enhanced and increased cleanings at our facilities. At this time, we have not experienced any reduction in productivity, though we have incurred certain costs related to the implementation of these policies and practices. We may take further actions that we determine to be in the best interests of our employees or as may be required by federal, state, or local authorities. 20 Table of Contents We cannot at this time predict the impact that the COVID-19 pandemic will have on our financial condition and operations, although we are continuing to monitor our supply chain and orders from customers for COVID-19-related changes. Disruptions to our supply chain in connection with the sourcing of materials, equipment and engineering support, and services from geographic areas that have been impacted by COVID-19 may pose risks to our business, results of operations and financial condition. In this time of uncertainty as a result of the COVID-19 pandemic, we are continuing to serve our customers while taking every precaution to provide a safe work environment for our employees and customers. To date, the COVID-19 pandemic has disrupted the way that we conduct business, but has not had a material adverse impact on our operations. However, the extent of the pandemic’s effect on our operational and financial performance will depend in large part on future developments, which cannot be predicted with confidence at this time. Future developments include the duration, scope and severity of the pandemic, the severity of newly identified strains of COVID-19, the actions taken to contain or mitigate its impact, such as the extent of restrictions on gatherings and travel, the impact on governmental programs and budgets, the development, administration and efficacy of treatments and vaccines, and the resumption of widespread economic activity. Trade tensions between the United States and China may escalate as a result of COVID-19 or otherwise and could result in the imposition of additional tariffs, trade restrictions or policy changes, any of which could increase costs of our product components and pricing of, and consumer demand for, our products, which could have a negative effect on our results of operations. Although the inherent uncertainty of the unprecedented and rapidly evolving crisis makes it difficult to predict with any confidence the likely impact on our future operations, the COVID-19 pandemic could have a material adverse impact on our consolidated business, results of operations and financial condition. For a discussion of certain risks related to the international nature of our business and our operations and the COVID-19 pandemic, see Part II, Item 1A – Risk Factors of this Form 10-Q and Part I, Item 1A – Risk Factors of our 2020 Form 10-K. Results of Operations for the Three Months Ended March 27, 2021 and March 28, 2020 Revenue. Our revenue is primarily derived from the sale of our systems, services, spare parts and software licensing. Our revenue of $169.3 million increased 21.0% for the three months ended March 27, 2021 as compared to the three months ended March 28, 2020, in which revenue totaled $139.9 million. The following table lists, for the periods indicated, the different sources of our revenue in dollars (thousands) and as percentages of our total revenue: Three Months Ended March 27, March 28, 2021 2020 Systems and software $ 141,509 84 % $ 114,330 82 % Parts 17,418 10 % 13,575 10 % Services 10,352 6 % 12,023 8 % Total revenue $ 169,279 100 % $ 139,928 100 % Total systems and software revenue increased $27.2 million for the three months ended March 27, 2021 as compared to the three months ended March 28, 2020 primarily due to an increase of units shipped in our metrology and inspection product lines. The year-over-year increase in parts and services revenue in absolute dollars from the three months ended March 28, 2020 to the three months ended March 27, 2021 was primarily due to servicing a larger installed base. Parts and services revenue is generated from part sales, maintenance service contracts, system upgrades, as well as time and material billable service calls. Gross Profit. Our gross profit has been and will continue to be affected by a variety of factors, including inventory step-up from purchase accounting, manufacturing efficiencies, provision for excess and obsolete inventory, pricing by competitors or suppliers, new product introductions, production volume, customization and reconfiguration of systems, international and domestic sales mix, system and software product mix and parts and service margins. Our gross profit was $90.5 million and $62.6 million for the three months ended March 27, 2021 and March 28, 2020, respectively. Our gross profit represented 53.4% and 44.8% of our revenue for the three months ended March 27, 2021 and March 28, 2020, respectively. The increase in gross profit as a percentage of revenue for the three months ended March 27, 2021, as compared to the three months ended March 28, 2020, is primarily due to charges to cost of goods sold of $9.9 million in the 2020 period for the sale of inventory written-up to fair value upon the 2019 Merger and strengthening product margins across several product lines. 21 Table of Contents Operating Expenses. Our operating expenses consist of: • Research and Development . We believe that it is critical to continue to make substantial investments in research and development to ensure the availability of innovative technology that meets the current and projected requirements of our customers’ most advanced designs. We have maintained and intend to continue our commitment to investing in research and development in order to continue to offer new products and technologies. Accordingly, we devote a significant portion of our technical, management and financial resources to research and development programs. Research and development expenditures consist primarily of salaries and related expenses of employees engaged in research, design and development activities. They also include consulting fees, the cost of related supplies and legal costs to defend our patents. Our research and development expenses were $22.0 million and $20.9 million for the three months ended March 27, 2021 and March 28, 2020, respectively. The year-over-year dollar increase for the three month period ended March 27, 2021 as compared to the three month period ended March 28, 2020 was primarily due to an increase in new product initiatives. • Sales and Marketing . Sales and marketing expenses are primarily comprised of salaries and related costs for sales and marketing personnel, as well as commissions and other non-personnel related expenses. There was no change in our sales and marketing expenses which totaled $13.1 million for both the three months ended March 27, 2021 and March 28, 2020. • General and Administrative . General and administrative expenses are primarily comprised of salaries and related costs for administrative personnel, as well as other non-personnel related expenses. Our general and administrative expenses were $15.6 million and $20.1 million for the three months ended March 27, 2021 and March 28, 2020, respectively. The year-over-year dollar decrease in general and administrative expenses for the three month period ended March 27, 2021 as compared to the three month period ended March 28, 2020 was primarily due to higher compensation expense in the 2020 period related to restructuring charges as a result of the merger of Rudolph with Nanometrics. • Amortization of Identifiable Intangible Assets . Amortization of identifiable intangible assets was $12.4 million and $13.7 million for the three months ended March 27, 2021 and March 28, 2020, respectively. The year-over-year decrease in amortization expense for the three month period ended March 27, 2021 as compared to the three month period ended March 28, 2020 was due to certain intangible assets becoming fully amortized during this period, partially offset by amortization for the business acquired in fiscal 2021. Interest income, net . Net interest income was $0.4 million and $1.2 million for the three months ended March 27, 2021 and March 28, 2020, respectively. The decrease in net interest income for the three months ended March 27, 2021 as compared to the three months ended March 28, 2020 was due to lower interest rates during the 2021 period. Other (expense) income, net . Net other (expense) income was ($1.2) million and $0.0 million for the three months ended March 27, 2021 and March 28, 2020, respectively. The increase in other expense for the three months ended March 27, 2021 as compared to the three months ended March 28, 2020 was due to foreign exchange losses during the 2021 period. Income Taxes . We recorded an income tax provision of $2.5 million and $0.4 million for the three months ended March 27, 2021 and March 28, 2020 respectively. Our effective tax rate of 9% differs from the statutory rate of 21% for the three months ended March 27, 2021 primarily due to (i) research and development tax credits, (ii) the deduction related to foreign derived intangible income (FDII), and (iii) excess tax benefits associated with equity compensation. Our effective tax rate of (10%) differs from the statutory rate of 21% for the three months ended March 28, 2020, primarily due to (i) changes in mix of forecasted earnings by jurisdiction, (ii) computed research and development credits on forecasted earning levels, and (iii) a one-time provision for additional withholding tax related to a dividend distribution from the Company’s Korea subsidiary Our future effective income tax rate depends on various factors, such as possible further tax legislation, the geographic composition of our pre-tax income, the amount of our pre-tax income as business activities fluctuate, non-deductible expenses incurred in connection with business combinations, and research and development tax credits as a percentage of aggregate pre-tax income. We currently have a partial valuation allowance recorded for certain foreign and state loss and credit carryforwards where the realizability of such deferred tax assets is substantially in doubt. Each quarter we assess the likelihood that we will be able to recover our deferred tax assets primarily relating to state research and development credits. We consider available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. As a result of our analysis, we concluded that it is more likely than not that a portion of our net deferred tax assets will not be 22 Table of Contents realized. Therefore, we continue to provide a valuation allowance against certain net deferred tax assets. We continue to monitor available evidence and may reverse some or all of the valuation allowance in future periods, if appropriate. Liquidity and Capital Resources At March 27, 2021, we had $392.9 million of cash, cash equivalents and marketable securities and $628.4 million in working capital. At December 26, 2020, we had $373.7 million of cash, cash equivalents and marketable securities and $611.6 million in working capital. Net cash and cash equivalents provided by operating activities for the three months ended March 27, 2021 and March 26, 2020 was $51.0 million and $8.9 million, respectively. • The net cash and cash equivalents provided by operating activities during the three months ended March 27, 2021 resulted primarily from net income, adjusted to exclude the effect of non-cash operating charges, of $49.7 million and an increase in cash provided from operating assets and liabilities of $1.3 million. • The net cash and cash equivalents provided by operating activities during the three months ended March 28, 2020 resulted primarily from net loss, adjusted to exclude the effect of non-cash operating charges of $27.1 million, partially offset by a decrease in cash provided from operating assets and liabilities of $18.2 million. Net cash and cash equivalents used in investing activities for the three months ended March 27, 2021 and March 26, 2020 was $60.3 million and $2.6 million, respectively. • During the three months ended March 27, 2021, net cash used in investing activities included purchases of marketable securities of $83.7 million, purchase of a business of $26.8 million and capital expenditures of $3.9 million, partially offset by proceeds from sales of marketable securities of $54.0 million. • During the three months ended March 26, 2020, net cash used in investing activities included purchases of marketable securities of $76.5 million and capital expenditures of $1.0 million, partially offset by proceeds from sales of marketable securities of $74.9 million. Net cash provided by financing activities was $0.6 million and net cash used in financing activities was $35.0 for the three months ended March 27, 2021 and March 26, 2020, respectively. • During the three months ended March 27, 2021, financing activities provided cash from proceeds from sales of shares through share-based compensation plans of $3.0 million, partially offset by tax payments related to shares withheld for share-based compensation plans of $2.5 million. • During the three months ended March 28, 2020, financing activities used cash for the purchase of shares of our common stock under a share repurchase authorization of $33.6 million and tax payments related to shares withheld for share-based compensation plans of $1.6 million, partially offset by proceeds from sales of shares through share-based compensation plans of $0.2 million. From time to time, we evaluate whether to acquire new or complementary businesses, products and/or technologies. We may fund all of or a portion of the price of these investments or acquisitions in cash, stock, or a combination of cash and stock. On December 31, 2020, the Company acquired Inspectrology, a leading supplier of overlay metrology for controlling lithography and etch processes in the compound semiconductor market for $27,015 in cash and a potential earnout of $10,000, subject to the achievement of certain revenue targets earned for fiscal 2021 and 2022. I n November 2020, the Onto Innovation Board of Directors approved a new share repurchase authorization, which allows the Company to repurchase up to $100 million worth of shares of its common stock. Repurchases may be made through both public market and private transactions from time to time with shares purchased being subsequently retired. At March 27, 2021, there was $100,000 available for future share repurchases. We have a credit agreement with a bank that provides for a line of credit that is secured by the marketable securities we have with the bank. We are permitted to borrow up to 70% of the value of eligible securities held at the time the line of credit is accessed. As of March 27, 2021, the available line of credit was approximately $82.0 million with an available interest rate of 1.8%. The credit agreement is available to us until such time that either party terminates the arrangement at its discretion. To date, we have not utilized the line of credit. Our future capital requirements will depend on many factors, including the timing and amount of our revenue and our investment decisions, which will affect our ability to generate additional cash. In addition, a lthough the ultimate impact of the COVID-19 pandemic on our future results remains uncertain, we believe our business model and our current cash reserves 23 Table of Contents leave us well-positioned to manage our business through this crisis as it continues to unfold. We expect that our existing cash, cash equivalents, marketable securities and availability under our line of credit will be sufficient to meet our anticipated cash requirements for working capital, capital expenditures and other cash needs for the next 12 months following the filing of this Form 10-Q. Thereafter, if cash generated from operations and financing activities is insufficient to satisfy our working capital requirements, we may seek additional funding through bank borrowings, sales of securities or other means. Market conditions due to the COVID-19 pandemic may have an impact on our ability to access such additional funding. Our borrowing capacity under our existing line of credit is tied to the value of eligible securities held at the time of borrowing, which may be negatively impacted by market conditions due to COVID-19 and government responses thereto. In addition, a reduction in or volatility with respect to our stock price or the general market downturn could materially impact our ability to sell securities on favorable terms or at all. There can be no assurance that we will be able to raise any such capital on terms acceptable to us or at all. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes in market risk from the information presented in Part II, Item 7A. “Quantitative and Qualitative Disclosures About Market Risk,” in the 2020 Annual Report on Form 10-K.