Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Executive Summary
We are an innovative manufacturer of semiconductor process equipment. Our proven ion beam, laser annealing, lithography, MOCVD and single wafer wet processing technologies play an integral role in the fabrication and packaging of advanced semiconductor devices. With equipment designed to optimize performance, yield and cost of ownership, Veeco holds leading technology positions in the markets we serve. To learn more about Veeco’s systems and service offerings, visit www.veeco.com.
The Veeco United team executed well in a challenging environment during 2021, accomplishing a number of milestones, including:
● Significant progress on our San Jose capacity expansion project, including shipping the first systems out of this new facility;
● Greatly increased our emphasis on placing evaluation systems with customers. We believe these evaluation systems are a final step in our customer’s selection process;
● Overall 28% revenue growth, led by the Semiconductor and Data Storage markets;
● Achieved $68 million in cash flow from operations;
● Grew backlog by $74 million to $440 million;
● Improved our capital structure by repurchasing $112 million of our 2023 Senior Convertible Notes;
● Improved financial flexibility by entering into revolving credit facility of $150 million; and
● Improved our ESG efforts and disclosures, as reflected in our 2 nd Corporate Sustainability Report released in November 2021.
These accomplishments enabled us to exit 2021 well positioned to execute on our growth plans for 2022.
COVID-19 Update
As a result of the COVID-19 pandemic, governmental authorities have implemented and are continuing to implement numerous and constantly evolving measures to try to contain the virus, such as travel bans and restrictions, limits on gatherings, quarantines, shelter-in-place orders, vaccine mandates, and business shutdowns. We have important internal and third-party manufacturing operations in the U.S. and Singapore, and sales and support operations in China, Germany, Japan, Malaysia, Philippines, Singapore, South Korea, Thailand, Taiwan and the United Kingdom, all of which have been affected by the COVID-19 pandemic.
Measures providing for business shutdowns generally exclude certain essential services, and those essential services include critical infrastructure and the businesses that support that critical infrastructure. Our operations are considered part of the critical and essential infrastructure defined by applicable government authorities and, although governmental measures to contain the pandemic may be modified or extended, our manufacturing facilities remain open. We believe our diverse product offerings and the critical nature of certain of our products for infrastructure insulate us, to some extent, from the adverse effects of the pandemic; however, a prolonged economic downturn will adversely affect our customers, which could have a material adverse effect on our revenues, particularly if customers from whom we derive a significant amount of revenue reduce or delay purchases to mitigate the impacts of the pandemic or fail to make payments to us on time or at all.
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We serve a global and highly interconnected customer base across the Asia-Pacific region, Europe, and North America. Our net sales to customers located outside of the United States represented approximately 62% of our total net sales for the year ended December 31, 2021, and 68% and 70% for the years ended December 31, 2020 and 2019, respectively, and we expect that net sales to customers outside the United States will continue to represent a significant percentage of our total net sales. As a result, our business will be adversely impacted by further deterioration in global economic conditions, particularly in markets in Asia and Europe.
We are starting to see the effects of the macroeconomic inflationary cost environment and supply chain disruptions due to strained transportation capacity, labor shortages and absenteeism associated with COVID-19, and high global demand as markets reopen and economic stimulus drives growth. These effects include longer lead times and increased costs. We are taking proactive steps in an effort to manage the impact to our business, including buying in advance and re-sourcing components on a more frequent basis. We continue to monitor our global supply chain and may experience additional disruptions in future periods, which could cause a disruption in our ability to obtain raw materials or components required to manufacture our products.
Like many in our industry, we are managing through the effects of the COVID-19 pandemic. Although the full extent of the COVID-19 pandemic’s impact on our business, results of operations, supply chain, and growth can not be predicted or quantified, we proactively endeavor to identify potential challenges to our business and have been executing business continuity activities to manage disruptions in our business and continue to provide critical infrastructure to our customers. In response to the pandemic, we have taken, or intend to take, the following steps, among others, to keep our employees safe and minimize the spread of the virus, while continuing to serve our customers:
● implemented rigorous health and safety protocols at our manufacturing facilities, including extensively and frequently disinfecting our facilities, limiting access to our facilities, checking temperatures of individuals entering our facilities, staggering shifts to minimize employee overlap in gowning areas, and providing protective equipment;
● mandated remote working arrangements for employees who do not need to be physically present on the manufacturing floor or at customer facilities;
● implemented virtual meetings, customer demos, and factory acceptances to enable customers to review data and performance of their system in our factory remotely via live video;
● performing service and support activities remotely, when possible, to resolve customer issues and enable our customers to maintain their operations;
● proactively identified gaps in our supply chain and re-sourced a number of components in order to maintain our customer shipment commitments and mitigate single points of failure;
● monitoring our IT systems and implementing contingency and disaster recovery plans to support our IT infrastructure to ensure that our systems remain continuously operative; and
● continuing to monitor and, if necessary, reduce our operating expenses and capital expenditures to maintain financial flexibility and profit margins.
While these steps have been effective so far, there could be additional challenges ahead that may impact either our operations or those of our customers, which could have a negative effect on our financial performance, including productivity and capacity impacts as a result of the ongoing pandemic. We expect to continue to implement these measures until we determine that the COVID-19 pandemic is adequately contained for purposes of our business, and we may take further actions as government authorities require or recommend or as we determine to be in the best interests of our employees, customers and suppliers. As a result, we may incur additional expenses in future periods in response to the pandemic, which could adversely affect our financial position, results of operations, or cash flows. In addition, we may revise our approach to these initiatives or take additional actions to meet the needs of our employees and customers, and mitigate the impact of the pandemic on our business.
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Business Update
We categorize our revenue by the end-markets into which we sell. Our four end-markets are: Semiconductor; Compound Semiconductor; Data Storage; and Scientific & Other.
Sales in the Semiconductor market grew 49% in 2021 and were driven by our laser annealing systems for logic devices and lithography systems for Advanced Packaging. We continue to build momentum for our laser annealing solutions with advanced node logic customers. We have been winning additional application steps with leading manufacturers. We have evaluation systems at a DRAM manufacturer and are working with new and existing logic customers on their next manufacturing nodes. We also continue to deliver our laser annealing systems to trailing node logic manufacturers. Our lithography systems for Advanced Packaging are aligned with longer-term growth of FOWLP and other Advanced Packaging applications such as heterogeneous integration. Additionally, the ongoing adoption of EUV Lithography for advanced node, semiconductor manufacturing continues to drive demand for our mask blank systems. Overall, our technology and market strategy is well aligned with trends such as artificial intelligence, mobile connectivity and high performance computing that drive the Semiconductor market. We expect continued growth in this market. Finally, we have begun shipping systems from our new San Jose facility, and expect to fully transition to this new location in 2022.
We address the Compound Semiconductor market with a broad portfolio of technologies including primarily Wet Processing and MOCVD, along with MBE and Ion Beam, all of which have been developed to support emerging applications such as 5G driven RF device/filter manufacturing, Gallium Nitride power electronics, and photonics applications including edge-emitting lasers and micro-LEDs. Sales in the Compound Semiconductor market were flat in 2021. However, we did experience strong growth in equipment shipments for RF Devices and we expect future growth to come from MOCVD and other system shipments in the Photonics market.
Sales in the Data Storage market have been growing for several years, primarily driven by shipments of Ion Beam systems. Demand for our Ion Beam products was driven by cloud-based storage growth. In order to be successful, hard disk drive manufacturers are required to improve areal density of magnetic heads for hard disk drives and are manufacturing drives with an increasing number of heads. After multiple years of customers accelerating their capacity additions, contributing to growth in 2021 of 37%, we expect a period of slowing capacity adds by our data storage customers, resulting in an expected revenue decline in our data storage business in 2022 from recent levels. With data proliferation forecasted to continue to grow, however, we feel confident about the long-term prospects of our data storage business.
Sales in the Scientific & Other market are largely driven by sales to governments, universities, and research institutions. Revenue was slightly higher in 2021 compared to 2020, and we expect sales in this market to grow modestly in the long run, in line with GDP.
Overall, we enter 2022 with strong backlog in our semiconductor and compound semiconductor markets which, along with our customer engagements and order activity, lead us to expect revenue growth in the coming year as we make progress toward our long-term financial target model.
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Results of Operations
Years Ended December 31, 2021 and 2020
The following table presents revenue and expense line items reported in our Consolidated Statements of Operations for 2021 and 2020 and the period-over-period dollar and percentage changes for those line items. Our results of operations are reported as one business segment, represented by our single operating segment.
For the year ended December 31,
Change
2021
2020
Period to Period
(dollars in thousands)
Net sales
$
583,277
100
%
$
454,163
100
%
$
129,114
28
%
Cost of sales
341,003
58
%
259,863
57
%
81,140
31
%
Gross profit
242,274
42
%
194,300
43
%
47,974
25
%
Operating expenses, net:
Research and development
88,680
15
%
78,994
17
%
9,686
12
%
Selling, general, and administrative
84,536
14
%
76,251
17
%
8,285
11
%
Amortization of intangible assets
12,280
2
%
15,333
3
%
(3,053)
(20)
%
Restructuring
—
—
%
1,097
—
%
(1,097)
*
Asset impairment
—
—
%
281
—
%
(281)
*
Other operating expense (income), net
68
—
%
(221)
—
%
289
(131)
%
Total operating expenses, net
185,564
32
%
171,735
38
%
13,829
8
%
Operating income (loss)
56,710
10
%
22,565
5
%
34,145
151
%
Interest income (expense), net
(26,020)
(4)
%
(23,188)
(5)
%
(2,832)
12
%
Other income (expense), net
(5,010)
(1)
%
(7,841)
(2)
%
2,831
(36)
%
Income (loss) before income taxes
25,680
4
%
(8,464)
(2)
%
34,144
*
Income tax expense (benefit)
(358)
—
%
(73)
—
%
(285)
*
Net income (loss)
$
26,038
4
%
$
(8,391)
(2)
%
$
34,429
*
* Not meaningful
Net Sales
The following is an analysis of sales by end-market and by region:
Year ended December 31,
Change
2021
2020
Period to Period
(dollars in thousands)
Sales by end-market
Semiconductor
$
247,051
43
%
$
165,909
37
%
$
81,142
49
%
Compound Semiconductor
106,972
18
%
107,922
24
%
(950)
(1)
%
Data Storage
168,760
29
%
123,288
26
%
45,472
37
%
Scientific & Other
60,494
10
%
57,044
13
%
3,450
6
%
Total
$
583,277
100
%
$
454,163
100
%
$
129,114
28
%
Sales by geographic region
United States
$
217,209
38
%
$
145,353
32
%
$
71,856
49
%
EMEA
55,129
9
%
73,124
16
%
(17,995)
(25)
%
China
105,998
18
%
57,589
13
%
48,409
84
%
Rest of APAC
204,633
35
%
177,569
39
%
27,064
15
%
Rest of World
308
—
%
528
—
%
(220)
(42)
%
Total
$
583,277
100
%
$
454,163
100
%
$
129,114
28
%
Total sales increased for the year ended December 31, 2021 against the comparable prior year period primarily in the Semiconductor and Data Storage markets. By geography, sales increased in the United States, China, and Rest of APAC
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regions, partially offset by decreases in the EMEA region. The increase in sales in the United States was primarily driven by shipments to Data Storage and Compound Semiconductor customers, while the increase in sales in the Rest of APAC region was primarily driven by shipments to Semiconductor and Data Storage customers. The increase in sales in the China region was primarily driven by shipments to Semiconductor customers. The decrease in sales in the EMEA region was primarily driven by a decrease in shipments to Data Storage customers. Included within the Rest of APAC region for the year ended December 31, 2021 were sales in Taiwan and South Korea of $65.2 million and $50.4 million, respectively, while sales within Rest of APAC region for the year ended December 31, 2020 included sales in Singapore and Taiwan of $49.4 million and $40.0 million, respectively. We expect there will continue to be year-to-year variations in our future sales distribution across markets and geographies. In light of the global nature of our business, we are impacted by conditions in the various countries in which we and our customers operate.
Gross Profit
In 2021, gross profit increased compared to 2020 primarily due to an increase in sales volume, partially offset by decreased gross margins. Gross margins decreased principally due to an increase in spending as we invested in service infrastructure and capacity expansion to meet the growing demands for our semiconductor product lines and supporting our evaluation systems at customers , as well as product and region mix of sales in the period. We expect our gross margins to fluctuate each period due to product mix and other factors, while we remain committed to increasing our overall gross margins.
Research and Development
The markets we serve are characterized by continuous technological development and product innovation, and we invest in various research and development initiatives to maintain our competitive advantage and achieve our growth objectives. Research and development expenses increased in 2021 compared to 2020 primarily from personnel-related expenses as we invest in new research and development and additional applications for our technology in order to be well positioned to capitalize on emerging global megatrends and support longer term growth in Semiconductor and Compound Semiconductor markets. However, expenses as a percentage of revenue have decreased when compared to the prior period.
Selling, General, and Administrative
Selling, general, and administrative expenses increased in 2021 compared to 2020 primarily due to higher variable expenses associated with the increase in revenue, profitability, and order in-take. However, expenses as a percentage of revenue have decreased when compared to the prior year period. Given the uncertainty regarding the impacts on our business resulting from the COVID-19 pandemic, we are focused on the proactive management of expenses. In future periods, we may incur additional selling, general and administrative expenses to support our responses to the COVID-19 pandemic. In addition, we are currently experiencing some duplicate operating expenses for the transition from our existing facility in San Jose, California to our new leased facility, and we expect to continue to do so until this transition is completed over the next several quarters.
Amortization Expense
Amortization expense decreased in 2021 compared to 2020 primarily due to changes in amortization expense to reflect expected cash flows of certain intangible assets, as well as certain other intangible assets becoming fully amortized in 2021.
Interest Income (Expense)
For the year ended December 31, 2021, we recorded net interest expense of $26.0 million, compared to $23.2 million for the comparable prior period. The increase in interest expense was primarily related to the issuance of the 2027 Notes in May 2020 and the 2025 Notes in November 2020, partially offset by the partial repurchases and exchange of the 2023 Notes in 2020 and 2021, as well as an increase in interest income of approximately $0.8 million as compared to the prior period. Included in interest expense for both of the years ended December 31, 2021 and 2020 were non-cash charges of
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$13.8 million related to the amortization of debt discount and transaction costs of the 2023 Notes, 2025 Notes, and 2027 Notes.
Other Income (Expense)
On November 5, 2021, we entered into a privately negotiated note purchase agreement with a holder of our outstanding 2023 Notes, under which we agreed to repurchase and retire approximately $111.5 million in aggregate original principal amount of the 2023 Notes, with a carrying amount of $105.5 million, for cash consideration of approximately $115.6 million, and approximately $1.0 million of accrued and unpaid interest. We accounted for the partial settlement of the 2023 Notes as an extinguishment, and as such, recorded a loss on extinguishment of approximately $4.0 million for the year ended December 31, 2021. In addition, we recorded a non-cash impairment charge of approximately $1.0 million related to an equity investment without a readily observable market price.
On May 18, 2020, in connection with the completion of a private offering of $125 million aggregate principal amount of 3.75% convertible senior notes, we repurchased and retired approximately $88.3 million in aggregate principal amount of our outstanding 2023 Notes, with a carrying amount of $78.1 million, for approximately $81.2 million of cash. Additionally, on November 11, 2020, we entered into a privately negotiated exchange agreement with a holder of our outstanding 2023 Notes, under which we agreed to retire $125.0 million in aggregate original principal amount of the 2023 Notes, with a carrying amount of $113.1 million, in exchange for the issuance of $132.5 million in aggregate principal amount of new 3.50% convertible senior notes. We accounted for both transactions as an extinguishment of the 2023 Notes, and as such, recorded a loss on extinguishment of approximately $7.8 million for the year ended December 31, 2020.
Income Taxes
The 2021 income tax benefit of $0.4 million is comprised of a $0.7 million income tax benefit related to the reduction of uncertain tax positions based upon settlements with tax authorities, partially offset by a $0.3 million income tax expense attributable to the foreign income taxes and foreign withholding taxes.
The 2020 income tax benefit of $0.1 million is comprised of: (i) a $0.8 million income tax benefit related to the amortization and subsequent sale of certain intangible assets during the year, which was partially offset by (ii) a $0.5 million income tax expense attributed to the profitable non-U.S. operations, as well as withholding tax to repatriate certain foreign earnings as a result of changes in tax laws under the 2017 Tax Act, and (iii) a $0.2 million income tax expense related primarily to U.S. tax amortization of our indefinite-lived intangible assets that is not available to offset existing deferred tax assets, as well as state and local income taxes.
Years Ended December 31, 2020 and 2019
See Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, filed with the SEC on February 22, 2021, for Management’s Discussions and Analysis of Financial Condition and Results of Operations for the fiscal year ended December 31, 2019.
Liquidity and Capital Resources
Our cash and cash equivalents, restricted cash, and short-term investments are as follows:
December 31,
December 31,
2021
2020
(in thousands)
Cash and cash equivalents
$
119,747
$
129,625
Restricted cash
725
658
Short-term investments
104,181
189,771
Total
$
224,653
$
320,054
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A portion of our cash and cash equivalents is held by our subsidiaries throughout the world, frequently in each subsidiary’s respective functional currency, which is typically the U.S. dollar. At December 31, 2021 and 2020, cash and cash equivalents of $38.3 million and $40.2 million, respectively, were held outside the United States. As of December 31, 2021, we had $12.8 million of accumulated undistributed earnings generated by our non-U.S. subsidiaries for which the U.S. repatriation tax has been provided. Approximately $5.3 million of undistributed earnings would be subject to foreign withholding taxes if distributed back to the United States. We believe that our projected cash flow from operations, combined with our cash and short-term investments, will be sufficient to meet our projected working capital requirements, contractual obligations, and other cash flow needs for the next twelve months, including scheduled interest payments on our convertible senior notes.
A summary of the cash flow activity for the year ended December 31, 2021 and 2020 is as follows:
Cash Flows from Operating Activities
For the year ended December 31,
2021
2020
(in thousands)
Net income (loss)
$
26,038
$
(8,391)
Non-cash items:
Depreciation and amortization
26,058
30,697
Non-cash interest expense
13,819
13,792
Deferred income taxes
(651)
(299)
Share-based compensation expense
15,249
12,703
Loss on extinguishment of debt
4,029
7,841
Asset impairment
—
281
Impairment of equity investment
980
—
Provision for bad debts
—
140
Changes in operating assets and liabilities
(17,780)
(13,743)
Net cash provided by (used in) operating activities
$
67,742
$
43,021
Net cash provided by operating activities was $67.7 million for the year ended December 31, 2021 and was due to net income of $26.0 million and adjustments for non-cash items of $59.5 million, partially offset by a decline in cash flow from operating activities due to changes in operating assets and liabilities of $17.8 million. The changes in operating assets and liabilities was largely attributable to increases in accounts receivable and inventories and decreases in deferred revenue, partially offset by increases in accounts payable and cash received for landlord reimbursements for leasehold improvements.
Net cash provided by operating activities was $43.0 million for the year ended December 31, 2020 and was due to the net loss of $8.4 million plus a decline in cash flow from operating activities due to changes in operating assets and liabilities of $13.7 million, being more than offset by adjustments for non-cash items of $65.2 million. The changes in operating assets and liabilities was largely attributable to increases in accounts receivable and inventories and decreases in deferred revenue, partially offset by increases in accounts payable and customer deposits.
Cash Flows from Investing Activities
For the year ended December 31,
2021
2020
(in thousands)
Capital expenditures
$
(40,643)
$
(6,802)
Changes in investments, net
83,446
(74,493)
Proceeds from held for sale assets, net of costs to sell
1,725
9,503
Net cash provided by (used in) investing activities
$
44,528
$
(71,792)
The net cash provided by investing activities during the year ended December 31, 2021 was attributable to the net change in investments, partially offset by capital expenditures. We experienced increased capital expenditures associated
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with the build-out of our newly leased facility in San Jose, California during 2021, and expect to complete this build-out over the next several quarters. In addition, we expect a period of some duplicate operating expenses until the transition from our pre-existing facility to our new facility is completed. The net cash used in investing activities during the year ended December 31, 2020 was attributable to net change in investments as well as capital expenditures, partially offset by the proceeds from the sale of a non-core product line.
Cash Flows from Financing Activities
For the year ended December 31,
2021
2020
(in thousands)
Proceeds from issuance of 2027 Notes, net of issuance costs
$
—
$
120,095
Purchase of capped calls
—
(10,313)
Repurchase of 2023 Notes
(115,604)
(81,240)
Debt issuance costs
(835)
—
Settlement of equity awards, net of withholding taxes
(5,590)
556
Net cash provided by (used in) financing activities
$
(122,029)
$
29,098
The net cash used in financing activities for the year ended December 31, 2021 was primarily related to the cash used to repurchase $111.5 million principal amount of our 2023 Notes as well as the settlement of equity awards. The net cash provided by financing activities for the year ended December 31, 2020 was primarily related to the net cash proceeds received from the issuance of the 2027 Notes, net of issuance costs, partially offset by the cash used to repurchase the 2023 Notes as well as the purchase of capped calls.
Convertible Senior Notes and Revolving Credit Facility
We have $20.2 million outstanding principal balance of 2.70% convertible senior notes that bear interest at a rate of 2.70% per year, payable semiannually in arrears on January 15 and July 15 of each year, and mature on January 15, 2023, unless earlier purchased by the Company, redeemed, or converted. In addition, we have $132.5 million outstanding principal balance of 3.50% convertible senior notes that bear interest at a rate of 3.50% per year, payable semiannually in arrears on January 15 and July 15 of each year, and mature on January 15, 2025, unless earlier purchased by the Company, redeemed, or converted. Finally, we have $125.0 million outstanding principal balance of 3.75% convertible senior notes that bear interest at a rate of 3.75% per year, payable semiannually in arrears on June 1 and December 1 of each year, and mature on June 1, 2027, unless earlier purchased by the Company, redeemed, or converted. The 2027 Notes are currently convertible by shareholders until March 31, 2022.
We believe that we have sufficient capital resources and cash flows from operations to support scheduled interest payments on these debts. In addition, we have access to a $150.0 million revolving credit facility (including an ability to request an additional $75.0 million, for a total commitment of no more than $225.0 million) to provide for our working capital needs and reimburse drawings under letters of credit and for other general corporate purposes. The Company has no immediate plans to draw down on the facility, which expires in December of 2026. Interest under the Facility is variable based on the Company’s secured net leverage ratio and is expected to bear interest based on SOFR plus a range of 150 to 225 basis points, if drawn. There is a yearly commitment fee of 25 to 35 basis points, based on the Company’s secured net leverage ratio, charged on the unused portion of the Facility.
Contractual Obligations and Commitments
We have commitments under certain contractual arrangements to make future payments for goods and services. These contractual arrangements secure the rights to various assets and services to be used in the future in the normal course of business. We expect to fund these contractual arrangements with cash generated from operations in the normal course of business, as well as existing cash and cash equivalents and short-term investments. In addition, we have bank guarantees and letters of credit issued by a financial institution on our behalf as needed. At December 31, 2021, outstanding bank guarantees and letters of credit totaled $2.7 million and unused bank guarantees and letters of credit of $15.2 million were available to be drawn upon.
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The following table summarizes our contractual arrangements at December 31, 2021 and the timing and effect that those commitments are expected to have on our liquidity and cash flow in future periods.
Payments due by period
Less than
1 – 3
3 – 5
More than
Total
1 year
years
years
5 years
(in thousands)
Principal payments on long-term debt
$
277,673
$
—
$
20,173
$
132,500
$
125,000
Cash interest on debt
42,821
9,861
18,922
11,694
2,344
Operating leases
55,414
4,901
7,748
6,805
35,960
Purchase commitments (1)
192,975
192,975
—
—
—
Total
$
568,883
$
207,737
$
46,843
$
150,999
$
163,304
(1) Purchase commitments are generally for inventory used in the manufacturing of our products. We generally do not enter into purchase commitments extending beyond one year. At December 31, 2021, we have $3.9 million of offsetting supplier deposits that will be applied against these purchase commitments.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires a high degree of judgment, either in the application and interpretation of existing accounting literature or in the development of estimates that affect the reported amounts of assets, liabilities, revenues, and expenses. We continuously evaluate our estimates and judgments based on historical experience, as well as other factors that we believe to be reasonable under the circumstances. The results of our evaluation form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These estimates may change in the future if underlying assumptions or factors change, and actual results may differ from these estimates.
We consider the following significant accounting policies to be critical because of their complexity and the high degree of judgment involved in maintaining them.
Revenue Recognition
We recognize revenue upon the transfer of control of the promised product or service to the customer in an amount that reflects the consideration we expect to receive in exchange for such product or service. We perform the following five steps to determine when to recognize revenue: (1) identification of the contract(s) with customers, (2) identification of the performance obligations in the contract, (3) determination of the transaction price, (4) allocation of the transaction price to the performance obligations in the contract, and (5) recognition of revenue when, or as, a performance obligation is satisfied. Judgment is used in the following areas in the determination of when to recognize revenue:
● Identification of performance obligations and allocation of contract price: Our contracts with customers frequently contain multiple deliverables, such as systems, upgrades, components, spare parts, installation, maintenance, and service plans. We allocate revenue to each performance obligation on a relative stand-alone selling price basis. The stand-alone selling prices are determined based on the prices at which we separately sell the systems, upgrades, components, spare parts, installation, maintenance, and service plans. For items that are not sold separately, we estimate stand-alone selling prices generally using an expected cost plus margin approach. Judgment is required to properly identify the performance obligations within a contract and to determine how the revenue should be allocated among the performance obligations.
● Combination of contracts: Judgment is required when evaluating whether multiple transactions with the same customer or related parties should be considered part of a single contract. This evaluation includes an assessment of whether the contracts or agreements are negotiated or executed within a short time frame of each other or if there are indicators that the contracts are negotiated in contemplation of one another.
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● Variable consideration: Our contracts with customers generally do not contain variable consideration. In the rare instances where variable consideration is included, we estimate the amount of variable consideration and determine what portion of that, if any, has a high probability of significant subsequent revenue reversal, and if so, that amount is excluded from the transaction price.
● Transfer of control: Judgment may be required in the determination of when transfer of control occurs. This judgment may include the interpretation of commercial terms and consideration of the customer’s post-delivery acceptance provisions. Our system sales arrangements, including certain upgrades, generally include field acceptance provisions that may include functional or mechanical test procedures. When we objectively demonstrate that the criteria specified in the contractual acceptance provisions are achieved prior to delivery either through customer testing or our historical experience of our tools meeting specifications, transfer of control of the product to the customer is considered to have occurred and revenue is recognized upon system delivery since there is no substantive contingency remaining related to the acceptance provisions at that date. For new products, new applications of existing products, or for products with substantive customer acceptance provisions where we cannot objectively demonstrate that the criteria specified in the contractual acceptance provisions have been achieved prior to delivery, revenue and the associated costs are deferred. We recognize such revenue and costs upon obtaining objective evidence that the acceptance provisions can be achieved, assuming all other revenue recognition criteria have been met.
Any material changes in the identification of performance obligations, determination and allocation of the transaction price to performance obligations, and determination of when transfer of control occurs to the customer, could impact the timing and amount of revenue recognition, which could have a material effect on our financial condition and results of operations.
Inventory Valuation
Inventories are stated at the lower of cost or net realizable value, with cost determined on a first-in, first-out basis. Each quarter we assess the valuation and recoverability of all inventories: materials (raw materials, spare parts, and service inventory); work-in-process; and finished goods. Obsolete inventory or inventory in excess of our estimated usage requirements is written down to its estimated net realizable value if less than cost. We evaluate usage requirements by analyzing historical usage, anticipated demand, alternative uses of materials, and other qualitative factors. Unanticipated changes in demand for our products may require a write down of inventory that could materially affect our operating results.
Goodwill and Intangible Assets
Goodwill is tested for impairment at least annually in the beginning of the fourth quarter of our fiscal year, which may require significant judgment. We may first perform a qualitative assessment of whether it is more likely than not that the reporting unit’s fair value is less than its carrying amount, and, if so, we then quantitatively compare the fair value of our reporting unit to its carrying amount. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not impaired. If the carrying amount of the reporting unit exceeds its fair value, we then record an impairment loss equal to the difference, up to the carrying value of goodwill.
We determine the fair value of our reporting unit based on a reconciliation of the aggregate fair value of our reporting unit to our adjusted market capitalization. The adjusted market capitalization is calculated by multiplying the average share price of our common stock for the last ten trading days prior to the measurement date by the number of outstanding common shares and adding a control premium. The determination of a reasonable control premium may require significant judgment and is estimated using historical transactions in similar industries.
The carrying values of long-lived assets, including identifiable intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset or asset group be tested for possible impairment, a recoverability test is performed utilizing undiscounted cash flows expected to be generated by that asset or asset group compared to its carrying amount. If the carrying amount of the long-lived asset or asset group is not recoverable on an undiscounted cash
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flow basis, impairment is recognized to the extent the carrying amount exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models or, when available, quoted market values and third-party appraisals. It is not possible for us to predict the likelihood of any possible future impairments or, if such an impairment were to occur, the magnitude of any impairment.
Intangible assets with finite useful lives, including purchased technology, customer-related intangible assets, patents, trademarks, backlog, and software licenses, are subject to amortization over the expected period of economic benefit to us. We evaluate whether events or circumstances have occurred that warrant a revision to the remaining useful lives of intangible assets. In cases where a revision is deemed appropriate, the remaining carrying amounts of the intangible assets are amortized over the revised remaining useful life.
Intangible assets related to in-process research and development (“IPR&D”) projects are considered to be indefinite-lived until the completion or abandonment of the associated R&D efforts. If and when development is complete, the associated assets would be deemed long-lived and would then be amortized based on their respective estimated useful lives at that point in time. Indefinite-lived intangible assets are tested for impairment at least annually in the beginning of the fourth quarter of our fiscal year. In testing indefinite-lived intangible assets for impairment, we may first perform a qualitative assessment of whether it is more likely than not that the fair value of the indefinite-lived intangible asset is less than its carrying amount, and, if so, we then quantitatively compare the fair value of the indefinite-lived intangible asset to its carrying amount. We determine the fair value of our indefinite-lived intangible assets using a discounted cash flow method.
Income Taxes
We estimate our income taxes in each of the jurisdictions in which we operate. Deferred income taxes reflect the net tax effect of temporary differences between the asset and liability balances recognized for financial reporting purposes and the balances used for income tax purposes, as well as the tax effect of carry forwards. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Realization of our net deferred tax assets is dependent on future taxable income.
We recognize the effect of income tax positions for only those positions which are estimated to more likely than not be sustained if challenged. We reflect changes in recognition or measurement in the period in which our change in judgment occurs. We record interest and penalties related to uncertain tax positions in income tax expense. Income taxes related to the global intangible low-taxed income (“GILTI”) rules are expensed as incurred.
Recent Accounting Pronouncements
We adopted ASU 2019-12 in the second quarter of 2020. Additionally, we will adopt ASU 2020-06 effective January 1, 2022. Refer to Note 1, “Significant Accounting Policies,” for additional information.
We are also evaluating other pronouncements recently issued but not yet adopted. The adoption of these pronouncements is not expected to have a material impact on our consolidated financial statements.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.