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”), or incorporated by reference in 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” or may be based on “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; • technology development, product introduction and acceptance of our products and services; • our manufacturing practices and ability to deliver both products and services consistent with our customers’ demands and expectations and to strengthen our market position, including our ability to source components, materials, and equipment due to supply chain delays or shortages; • our expectations of the semiconductor market outlook; • future revenue, gross profits, research and development and engineering expenses, selling, general and administrative expenses, and 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; and • our ability to be successful in managing our cost structure and cash expenditures and results of litigation. Statements contained or incorporated by reference in this Form 10-Q that are not purely historical are forward-looking statements and are subject to safe harbors under Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and 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. Forward-looking statements contained herein reflect our current expectations, assumptions and projections with respect to future events and are subject to certain risks, uncertainties and assumptions, such as those identified in Part II, Item 1A. “Risk Factors” and elsewhere in this Form 10-Q. Actual results may differ materially and adversely from those included in such forward-looking statements. 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 and Estimates 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 Annual Report on Form 10-K for the fiscal year ended January 1, 2022 (the “2021 Form 10-K”) filed with the Securities and Exchange Commission on February 25, 2022 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 17 Table of Contents of operations. There have been no material changes in our critical accounting policies and estimates from the information presented in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in the 2021 Form 10-K. For more information, please see our critical accounting policies and estimates as previously disclosed in our 2021 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” manufacturing, 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. Our principal market is semiconductor capital equipment. Semiconductors packaged as integrated circuits, or “chips,” are used in consumer electronics, server and enterprise systems, mobile computing (including smart phones and tablets), data storage devices, and embedded automotive and control systems. Our core focus is the measurement and control of the structure, composition, and geometry of semiconductor devices as they are fabricated on silicon wafers to improve device performance and manufacturing yields. Our products and services are used by our customers who manufacture many types of integrated circuits for a multitude of applications, each having unique manufacturing challenges. This includes integrated circuits to enable information processing and management (logic integrated circuits), memory storage (NAND, 3D-NAND, NOR, and DRAM), analog devices (e.g., Wi-Fi and 5G radio integrated circuits, power devices), MEMS sensor devices (accelerometers, pressure sensors, microphones), image sensors, and other end markets including components for hard disk drives, LEDs, and power management. The semiconductor and electronics industries have also been characterized by constant technological innovation. We believe that, over the long term, our customers will continue to invest in advanced technologies and new materials to enable smaller design rules and higher density applications that fuel demand for process control equipment. The following table summarizes certain key financial information for the periods indicated below (in thousands, except per share and percent data): Three Months Ended April 2, January 1, March 27, 2022 2022 2021 Revenue $ 241,350 $ 225,644 $ 169,279 Gross profit $ 131,023 $ 123,803 $ 90,469 Gross profit as a percent of revenue 54 % 55 % 53 % Total operating expenses $ 72,279 $ 73,948 $ 62,984 Net income $ 53,330 $ 46,737 $ 24,113 Diluted earnings per share $ 1.07 $ 0.94 $ 0.49 • In the fiscal quarter ended April 2, 2022 (the “April 2022 quarter”), revenue increased 7.0% compared to the fiscal quarter ended January 1, 2022 (the “January 2022 quarter”), primarily due to an increase in sales to memory customers for advanced nodes applications, partially offset by a decline in sales to specialty device advanced packaging customers. • Gross margin as a percentage of revenue in the April 2022 quarter compared to the January 2022 quarter decreased primarily due to higher freight and logistics costs in the April 2022 quarter. Our cash, cash equivalents and marketable securities balance increased to $541.9 million at the end of the April 2022 quarter compared to $511.3 million at the end of the January 2022 quarter. This increase was primarily the result of $43.2 million of cash generated from operating activities. This source of cash was partially offset by net cash of $2.5 million used for capital expenditures. Employee headcount as of April 2, 2022 was approximately 1,446. 18 Table of Contents Key Events Impact of the COVID-19 Pandemic on Our Business . As of May 3, 2022, our operations have been impacted by our pandemic response, as described below, given the global nature of our workforce and our operations. The ultimate extent to which COVID-19 will impact our business depends on future developments, which are highly uncertain and very difficult to predict, including the effectiveness and utilization of vaccines for COVID-19 and its variants, new information that may emerge concerning the severity of COVID-19 and its variants, and actions to contain or limit their spread. 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 facilities are in the United States, we maintain offices and have employees 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. In addition, we have enhanced our email screening and cyber monitoring of our devices to further support our work-from-home policy. As certain countries have relaxed restrictions over the past few months, we have restarted certain activities in accordance with local guidelines. 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. 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. We have not experienced significant delays in customer deliveries, but we are impacted by the global shortage in electronic components and our supply chain is strained in some cases as the availability of materials, logistics and freight options are challenging in many jurisdictions. Demand for our products was consistent with or exceeded our expectations for the first quarter of fiscal 2022. However, further 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 appropriate precautionary measures to provide a safe work environment for our employees and customers. The full 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, efficacy and public utilization of treatments and vaccines, and the resumption of widespread economic activity, and the pace of recovery, including with respect to supply chain shortage. 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 ongoing 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, Part I, Item 1A – Risk Factors of our 2021 Form 10-K. Results of Operations for the Three Months Ended April 2, 2022 and March 27, 2021 Revenue. Our revenue is primarily derived from the sale of our systems, services, spare parts and software licensing. Our revenue of $241.3 million increased 42.6% for the three months ended April 2, 2022 as compared to the same period in 2021, in which revenue totaled $169.3 million. 19 Table of Contents 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 April 2, March 27, 2022 2021 Systems and software $ 209,383 87 % $ 141,509 84 % Parts 19,857 8 % 17,418 10 % Services 12,110 5 % 10,352 6 % Total revenue $ 241,350 100 % $ 169,279 100 % Total systems and software revenue increased $67.9 million for the three months ended April 2, 2022 as compared to the three months ended March 27, 2021 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 April 2, 2022 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, and system upgrades, as well as time and material billable service calls. Gross Profit. Our gross profit has been and will likely continue to be affected by a variety of factors, 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 $131.0 million and $90.5 million for the three months ended April 2, 2022 and March 27, 2021, respectively. Our gross profit represented 54.3% and 53.4% of our revenue for the three months ended April 2, 2022 and March 27, 2021, respectively. The increase in gross profit as a percentage of revenue for the three months ended April 2, 2022, as compared to the three months ended March 27, 2021, is primarily due to an increase in sales volume and favorable changes in product mix, partially offset by higher freight and logistics costs, and higher personnel cost due to an increase in headcount to provide manufacturing capacity requirements. 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 $26.3 million and $22.0 million for the three months ended April 2, 2022 and March 27, 2021, respectively. The year-over-year dollar increase for the three-month period ended April 2, 2022 as compared to the three-month period ended March 27, 2021 was primarily due to increased compensation costs from additional headcount, as well as annual merit and promotion increases, and increased consulting, outside service and material expenses for new product initiatives. • Sales and Marketing . Sales and marketing expenses are primarily comprised of salaries, commissions and related costs for sales and marketing personnel, as well as other non-personnel related expenses. Our sales and marketing expenses were $15.6 million and $13.1 million for the three months ended April 2, 2022 and March 27, 2021, respectively. The year-over-year increase in sales and marketing expenses for the three-month period ended April 2, 2022 as compared to the three-month period ended March 27, 2021 was primarily due to increased compensation costs and increased travel related expenses as pandemic travel restrictions were lifted. • 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 $16.5 million and $15.6 million for the three months ended April 2, 2022 and March 27, 2021, respectively. The year-over-year increase in general and administrative expenses for the three-month period ended April 2, 2022 as compared to the three-month period ended March 27, 2021 was primarily due to increased compensation costs and increased litigation expenses. • Amortization of Identifiable Intangible Assets . Amortization of identifiable intangible assets was $13.8 million and $12.4 million for the three months ended April 2, 2022 and March 27, 2021, respectively. The year-over-year increase in amortization expense for the three-month period ended April 2, 2022 as compared to the three-month 20 Table of Contents period ended March 27, 2021 was primarily due to in-process research and development becoming classified as a finite-lived intangible asset and amortization commencing in the second half of 2021. Interest income, net . Net interest income was $0.4 million for both the three months ended April 2, 2022 and March 27, 2021. Other expense, net . Net other expense was $0.2 million and $1.2 million for the three months ended April 2, 2022 and March 27, 2021, respectively. The decrease in other expense, net for the three months ended April 2, 2022 as compared to the three months ended March 27, 2021 was primarily due to lower foreign exchange losses during the 2022 period. Income Taxes . We recorded an income tax provision of $5.6 million and $2.5 million for the three months ended April 2, 2022 and March 27, 2021, respectively. Our effective tax rate of 9% differs from the statutory rate of 21% for the three months ended April 2, 2022 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 9% differs from the statutory rate of 21% for the three months ended March 27, 2021, primarily due to (i) foreign and research and development tax credits, (ii) the deduction related to FDII, and (iii) excess tax benefits associated with equity compensation. Our future effective income tax rate depends on various factors, such as possible changes in 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 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. Beginning in 2022, the U.S. Tax Cuts and Jobs Act of 2017 (“TCJA”) eliminated the existing option to deduct research and development expenditures and requires taxpayers to amortize them over five years pursuant to IRC Section 174. While the capitalization requirement has a negative impact on our cash flows, there are offsetting benefits from the enactment of this provision that we have included in our estimated annual effective tax rate. Although Congress is considering legislation that would defer the amortization requirement to later years, we have no assurance that the provision will be repealed or otherwise modified. If it is delayed, these effective tax rate benefits will not be realized in the current year. Changes in our tax provisions or an increase in our tax liabilities, whether due to changes in applicable laws and regulations, the interpretation or application thereof, or a final determination of tax audits or litigation or agreements, could have a material adverse effect on our financial position, results of operations and/or cash flows. Liquidity and Capital Resources At April 2, 2022, we had $541.9 million of cash, cash equivalents and marketable securities and $847.6 million in working capital. At January 1, 2022, we had $511.3 million of cash, cash equivalents and marketable securities and $793.6 million in working capital. Net cash and cash equivalents provided by operating activities for the three months ended April 2, 2022 and March 27, 2021 were $45.5 million and $51.0 million, respectively. • The net cash and cash equivalents provided by operating activities during the three months ended April 2, 2022 resulted primarily from net income, adjusted to exclude the effect of non-cash operating charges of $70.8 million, partially offset by a decrease in cash provided from operating assets and liabilities of $25.4 million, primarily due to increases in inventories and accounts receivable. • 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. Net cash and cash equivalents used in investing activities for the three months ended April 2, 2022 and March 27, 2021 were $33.3 million and $60.3 million, respectively. 21 Table of Contents • During the three months ended April 2, 2022, net cash and cash equivalents used in investing activities included purchases of marketable securities of $97.5 million and capital expenditures of $2.5 million, partially offset by proceeds from sales of marketable securities of $66.7 million. • 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. Net cash and cash equivalents used in financing activities for the three months ended April 2, 2022 were $7.6 million. Financing activities provided net cash and cash equivalents during the three months ended March 27, 2021 of $0.6 million. • During the three months ended April 2, 2022, financing activities used cash to primarily pay taxes related to shares withheld for share-based compensation plans of $5.3 million and pay contingent consideration for acquired business of $2.3 million, partially offset by proceeds from sales of shares through share-based compensation plans of $0.6 million. • During the three months ended March 27, 2021, financing activities provided cash from proceeds from sales of shares through share-based compensation plans of $3.1 million, partially offset by tax payments related to shares withheld for share-based compensation plans of $2.5 million. From time to time, we evaluate whether to acquire new or complementary businesses, products 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. In the first quarter of 2021, the Company acquired Inspectrology, LLC for $24.0 million in cash and an earnout subject to the achievement of certain revenue targets earned for fiscal 2021 through 2022. The earnout achieved for fiscal 2021 was $2.3 million and was paid in the first half of fiscal 2022. There is potential earnout for up to an additional payment of $5.0 million depending on fiscal 2022 results. As of April 2, 2022, we have accrued $1.9 million for the potential earnout. I n November 2020, the Onto Innovation Board of Directors approved a 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 April 2, 2022, there was $100 million 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 April 2, 2022, the available line of credit was approximately $128.7 million with an available interest rate of 2.0%. 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, although the ultimate impact of the COVID-19 pandemic and its effects on economic conditions and the global supply chain on our future results remains uncertain, we believe our business model and our current cash reserves 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 or other factors 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 or other factors. In addition, a reduction in or volatility with respect to our stock price or a 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. 22 Table of Contents 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 2021 Form 10-K.