ONTO INNOVATION INC. (ONTO) FY 2024 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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 ICs, 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 ICs for a multitude of applications, each having unique manufacturing challenges. This includes ICs to enable information processing and management (logic ICs), memory storage (NAND, 3D-NAND, NOR, and DRAM), analog devices (e.g., Wi-Fi and 5G radio ICs, power devices), MEMS sensor devices (accelerometers, pressure sensors, microphones), image sensors, and other end markets including components for artificial intelligence, 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:

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In fiscal 2024, revenue increased 21% compared to fiscal 2023, primarily due to an increase in sales in our inspection business of Dragonfly systems and other products in support of advanced packaging needs for chips used in Artificial Intelligence (AI) applications.

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Gross profit as a percentage of revenue increased to 52.2% for fiscal 2024 compared to 51.5% for fiscal 2023. This was primarily driven by an increase in volume and change in product mix, partially offset by write-downs related to the impairment and exit of certain lithography inventory in fiscal 2024.

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The increase in operating expenses in fiscal 2024 compared to fiscal 2023 was primarily due to increases in research and development, and sales and marketing expenses related to increased headcount and compensation costs, project costs, travel expenses and write-off of purchased in process research and development assets.

Our cash, cash equivalents and marketable securities balance increased to $852.3 million at the end of fiscal 2024 from $697.8 million at the end of fiscal 2023. This increase was primarily the result of $245.7 million of cash generated from operating activities, partially offset by cash used for capital expenditures of $31.9 million, acquisitions of $26.8 million, purchases of common stock of $25.1 million and $19.0 million of cash used for tax payments related to net share settlement of employee stock-based compensation plans.

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In recent years, the U.S. government implemented additional export regulations for U.S. semiconductor technology sold in China. We have applied for export licenses to continue doing business with our customers that are affected by the new export rules. However, the new export controls have resulted in lower net sales in China for fiscal 2024 compared to the prior fiscal years.

For a discussion of the risks related to our business and operations, see Part I, Item 1A – Risk Factors of this Annual Report on Form 10-K.

Results of Operations

The following table sets forth, for the periods indicated, our results of operations as percentages of our revenue. Our results of operations are reported as one business segment.

Results of Operations for 2024, 2023 and 2022

Revenue. Our revenue is derived from the sale of our systems and software, spare parts, and services. Our revenue was $987.3 million, $815.9 million and $1,005.2 million for the years ended December 28, 2024, December 30, 2023 and December 31, 2022, respectively. This represents an increase of 21.0% from 2023 to 2024 and a decrease of 18.8% from 2022 to 2023.

The following table lists, for the periods indicated, the different sources of our revenue in dollars (thousands) and as percentages of our total revenue:

Total systems and software revenue increased $167.1 million for the year ended December 28, 2024, as compared to the year ended December 30, 2023, primarily due to an increase in units shipped of our inspection product line to customers in support of advanced packaging needs for chips used in AI applications. Parts and services revenue is generated from part sales, maintenance service contracts, and system upgrades, as well as time and material billable service calls. During fiscal 2024, the increase in total parts and services revenue was primarily due to increased spending by our customers on system upgrades and repairs of existing systems.

Total systems and software revenue decreased $182.4 million for the year ended December 30, 2023, as compared to the year ended December 31, 2022, primarily due to a decrease in units shipped of our metrology product lines to customers in advanced nodes applications. This decline was partially offset by an increase in units shipped of our inspection and lithography product lines to customers in specialty devices and advanced packaging applications. Parts and services revenue is generated

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from part sales, maintenance service contracts, and system upgrades, as well as time and material billable service calls. During fiscal 2023, the decrease in total parts and services revenue was primarily due to lower factory utilization by several of our customers resulting in a decline in their spare parts requirements.

The following table sets forth, for the periods indicated, our revenue by geographic region as percentages of our revenue.

The overall Asia region continues to account for a majority of our revenues as a substantial amount of the worldwide capacity investments for semiconductor manufacturing continue to occur in this region and we expect that trend to continue.

Gross Profit. Our gross profit has been and will likely continue to be affected by a variety of factors, including manufacturing efficiencies, provision for excess and obsolete inventory, pricing by competitors or suppliers, new product introductions, production volume, inventory step-up from purchase accounting, customization and reconfiguration of systems, international and domestic sales mix, system and software product mix, and parts and services margins. Our gross profit was $515.3 million, $420.3 million and $539.2 million for the years ended December 28, 2024, December 30, 2023, and December 31, 2022, respectively. Our gross profit represented 52.2%, 51.5% and 53.6% of our revenue for the years ended December 28, 2024, December 30, 2023, and December 31, 2022, respectively. The increase in gross profit as a percentage of revenue from 2023 to 2024 was primarily due to an increase in revenue volume and change in product mix, partially offset by write-downs related to the impairment and exit of certain lithography inventory. The decrease in gross profit as a percentage of revenue from 2022 to 2023 was primarily due to decreased revenue volume, unfavorable product mix, and increased manufacturing costs due to inflationary pressures during the 2023 fiscal period.

Operating Expenses.

Our operating expenses consist of:

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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 intellectual property. Our research and development expenses were $116.8 million, $104.4 million and $112.0 million in fiscal years 2024, 2023 and 2022, respectively. The year-over-year dollar increase from 2023 through 2024 was primarily due to write-off of acquired in-process research and development of $4.0 million and increased compensation costs of $1.6 million, outside services costs of $3.3 million, product development costs of $1.9 million, travel costs of $0.6 million, research and development project costs of $0.5 million, freight and duty costs of $0.2 million and depreciation expenses of $0.2 million. The year-over-year dollar decrease from 2022 through 2023 was primarily due to decreases of $4.6 million for the write-off of acquired in-process research and development assets and cost containment initiatives of $3.3 million, partially offset by increases in depreciation expenses of $0.6 million and travel expenses of $0.3 million. We continue to maintain our commitment to investing in new product development and enhancement to existing products.

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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. Our sales and marketing expenses were $76.2 million, $61.8 million and $65.7 million in fiscal years 2024, 2023 and 2022, respectively. The year-over-year dollar increase from 2023 through 2024 was primarily due to increases in total compensation costs of $13.0 million, travel costs of $0.7 million, outside services costs of $0.3 million, sales and marketing costs of $0.3 million and production expenses of $0.1 million. The year-over-year dollar decrease from 2022 through 2023 was primarily due to a decrease in total compensation costs of $1.5 million on lower headcount and variable compensation plan elements, a decrease in outside service expenses of $0.8 million and a decrease in depreciation expense of $0.7 million, partially offset by an increase in travel expenses of $0.3 million.

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General and Administrative. General and administrative expenses are primarily comprised of salaries and related costs for general administrative personnel, as well as other non-personnel related expenses. Our general and administrative expenses were $85.8 million, $83.1 million and $69.6 million in fiscal years 2024, 2023 and 2022, respectively. The year-over-year dollar increase from 2023 through 2024 was primarily due to increases in depreciation expense of $1.8 million and facilities expense of $1.4 million, partially offset by a decrease in freight and duty costs of $0.5 million. The year-over-year dollar increase from 2022 through 2023 was primarily due increased litigation expenses of $7.4 million, restructuring charges of $3.6 million for employee severance costs during the 2023 period, an increase in depreciation expense of $1.9 million and an increase in facilities expenses of $0.4 million.

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Amortization of Identifiable Intangible Assets. Amortization of identifiable intangible assets, primarily purchased technology, was $49.4 million, $54.8 million and $55.3 million in fiscal years 2024, 2023 and 2022, respectively. The consecutive year-over-year dollar decreases from 2022 through 2024 were primarily due to certain assets becoming fully amortized.

Interest income, net. In fiscal years 2024, 2023 and 2022, net interest income was $33.5 million, $20.4 million and $5.0 million, respectively. The increases in net interest income from 2023 to 2024 and from 2022 to 2023 were due to higher average balances and higher interest rates during both the 2024 and 2023 periods, respectively.

Income taxes. The following table provides details of income tax:

The income tax provision differs from the federal statutory income tax rate of 21% for 2024 primarily due to a benefit related to the Foreign Derived Intangible Income Deduction (“FDII”) of $17.0 million, tax effect of share-based compensation of $6.9 million, tax benefits for research and development credits of $6.6 million, a decrease to the Company’s valuation allowance of $1.8 million, and a one-time benefit of $3.2 million related to the recognition of a tax benefit associated with the lapse of a statute of limitations. These benefits were partially offset by non-deductible officer’s compensation of $3.4 million.

The income tax provision differs from the federal statutory income tax rate of 21% for 2023 primarily due to a benefit related to the FDII of $13.0 million, excess benefits related to stock compensation of $3.4 million, tax benefits for research and development credits of $6.4 million, and a one-time benefit of $1.6 million related to the recognition of a tax benefit associated with the lapse of a statute of limitations. These benefits were partially offset by the inclusion of U.S. tax on foreign source income of $0.5 million and non-deductible officer’s compensation of $2.3 million, and an increase to the Company’s valuation allowance of $2.9 million.

The income tax provision differs from the federal statutory income tax rate of 21% for 2022 primarily due to a benefit related to the FDII of $25.4 million, excess benefits related to stock compensation of $3.5 million, tax benefits for research and development credits of $7.1 million, and a one-time benefit of $1.5 million related to the recognition of a tax benefit associated with the lapse of a statute of limitations. These benefits were partially offset by the inclusion of U.S. tax on foreign source income of $1.4 million and non-deductible officer’s compensation of $1.9 million.

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Our future effective income tax rate depends on various factors, such as 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 acquisitions and research and development credits as a percentage of aggregate pre-tax income.

Liquidity and Capital Resources

Our cash, cash equivalents and marketable securities consist of the following:

Sources and Uses of Cash

A summary of cash provided by (used in) operating, investing, and financing activities is as follows:

Operating Activities

Cash provided by operating activities during fiscal 2024 was $245.7 million, which reflects net income, adjusted to exclude the effect of non-cash operating charges, of $290.2 million. Significant non-cash operating charges included depreciation, amortization, share-based compensation, provision for inventory valuation, deferred income taxes and write off of acquired in-process research and development. Cash provided by operating activities in fiscal 2024 increased compared to fiscal 2023 primarily due to higher net income and continued improvements in inventory management.

Cash provided by operating activities during fiscal 2023 was $172.0 million, which reflects net income, adjusted to exclude the effect of non-cash operating charges, of $204.5 million. Significant non-cash operating charges included depreciation, amortization, share-based compensation, provision for inventory valuation and deferred income taxes. Cash provided by operating activities in fiscal 2023 increased compared to fiscal 2022 primarily due to improved inventory management and lower income tax payments.

Our working capital was $1,307.4 million at December 28, 2024 and $1,135.5 million at December 30, 2023.

Investing Activities

We used $226.5 million, $103.4 million and $55.7 million of cash in investing activities in fiscal 2024, 2023 and 2022, respectively. Capital expenditures, net of proceeds in fiscal 2024, 2023 and 2022 were $31.9 million, $19.8 million and $18.4 million. Capital expenditures were primarily for enterprise resource planning systems implementation, investments in facility improvements, demonstration and testing equipment, manufacturing and network equipment. Purchases of marketable securities, net of proceeds from sales and maturities of marketable securities, for fiscal 2024, 2023 and 2022 was $167.9 million, $83.6 million and $4.6 million, respectively. Net cash paid for acquisitions in fiscal 2024 and 2022 was $26.8 million and $4.6 million, respectively. There were no acquisitions in fiscal 2023.

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.

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Financing Activities

We used $35.7 million, $9.5 million and $68.4 million of cash in financing activities for fiscal 2024, 2023 and 2022, respectively. Purchases of our common stock were $25.1 million, $3.2 million and $65.3 million in fiscal 2024, 2023 and 2022, respectively. Tax withholding payments for vested equity awards, partially offset by proceeds from sales of shares through share-based compensation plans were $9.9 million, $5.5 million and $0.8 million for fiscal 2024, 2023 and 2022, respectively. Payments for contingent consideration for acquired business were $0.7 million, $0.8 million and $2.3 million in fiscal 2024, 2023 and 2022.

We have a credit agreement with a bank that provides for a variable-rate 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, up to a maximum of $100 million. As of December 28, 2024, the available line of credit was approximately $100.0 million with an available interest rate of 6.2%. The credit agreement is available to us until such time that either party terminates the arrangement at its discretion. As of the date of this filing, 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. 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. 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.

Contractual Obligations

The following table summarizes our significant contractual obligations at December 28, 2024, and the effect such obligations are expected to have on our liquidity and cash flows in future periods. We are currently unable to provide a reasonably reliable estimate of the amount or periods when cash settlement of this liability may occur.

(1)
Represents our agreements to purchase goods and services consisting of outstanding purchase orders for goods and services.

Critical Accounting Estimates

Management’s discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements included in this Form 10-K, which have been prepared in accordance with accounting principles generally accepted in the United States. Note 2 of Notes to Consolidated Financial Statements describes the significant accounting policies used in the preparation of the consolidated financial statements. Certain of these significant accounting policies are considered to be critical accounting policies and involve critical accounting estimates. We review the accounting policies we use in reporting our financial results on a regular basis. The preparation of the financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, accounts receivable, inventories, business acquisitions, intangible assets, share-based payments, income taxes and warranty obligations. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. These estimates and judgments are regularly reviewed by management on an ongoing basis at the end of each quarter prior to the public release of our financial results.

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Management believes that the following are critical accounting estimates:

Revenue Recognition. Revenue is recognized when control of the promised goods or services are transferred to our customers in an amount that reflects the consideration we expect to be entitled to receive in exchange for those goods or services. We account for a contract when it has approval and commitment from both parties, the rights of the parties and payment terms are identified, the contract has commercial substance and collectability of consideration is probable.

Contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenue to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or the expected cost-plus margin.

Revenue from systems is recognized when we transfer control of the product to our customer. To indicate transfer of control, we must have a present right to payment, legal title must have passed to the customer and the customer must have the significant risks and rewards of ownership. We generally transfer control for system sales when the customer or the customer’s agent picks up the system at our facility. We provide an assurance warranty on our systems for a period of twelve to fourteen months against defects in material and workmanship. We provide for the estimated cost of product warranties at the time revenue is recognized.

Depending on the terms of the systems arrangement, we may also defer the recognition of a portion of the consideration expected to be received because we have to satisfy a future obligation (e.g., installation and extended warranties). We use an observable price to determine the standalone selling price for separate performance obligations or a cost-plus margin approach when one is not available.

Revenue from software licenses, which is primarily sold without systems, is recognized upfront at the point in time when the software is made available to the customer. Software licenses provide the customer with limited rights to use the software. Revenue from licensing support and maintenance is recognized as the support and maintenance are provided, which is over the contract period.

Revenue from parts is recognized when we transfer control of the product, which typically occurs when we ship the product from our facilities to the customer.

Revenue from services primarily consists of service contracts, which provide additional maintenance coverage beyond our assurance warranty on our products, service labor, consulting and training. Revenue from service contracts is recognized ratably over the term of the service contract. Revenue from service labor and consulting is recognized as services are performed.

We record contract liabilities when the customer has been billed in advance of completing our performance obligations. These amounts are recorded as deferred revenue in the Consolidated Balance Sheets.

Business combinations. We account for business combinations under the acquisition method of accounting, which requires us to recognize separately from goodwill the assets acquired, and the liabilities assumed at their acquisition date fair values. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recognized in our consolidated statements of operations. Accounting for business combinations requires our management to make significant estimates and assumptions, especially at the acquisition date including our estimates for intangible assets, contractual obligations assumed, restructuring liabilities, pre-acquisition contingencies, and contingent consideration, where applicable. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are based, in part, on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Estimates in valuing certain acquired intangible assets under the income approach include growth in future expected cash flows from product sales, acquired technologies, technology obsolescence rates, estimated cash flows from the projects when completed and discount rates. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results.

Inventory Valuation. Inventories are stated at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less predictable costs of completion, disposal and transportation. Cost is generally determined on a first-in, first-out basis, and includes material, labor and manufacturing overhead costs. We review and set standard costs as needed, but at a minimum, on an annual basis, at current manufacturing costs in order to approximate actual costs. We maintain reserves for our excess and obsolete inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future product lifecycles, product demand and market conditions.

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If actual product lifecycles, product demand and market conditions are less favorable than those originally projected by management, additional inventory write-downs may be required.

Indefinite-Lived and Long-Lived Assets. Goodwill is tested for impairment during the fourth quarter, or whenever events or circumstances indicate that its carrying value may not be recoverable. Goodwill impairment is tested at the reporting unit level, which is defined as an operating segment or one level below the operating segment. Goodwill is reviewed for impairment using either a qualitative assessment or a quantitative goodwill impairment test. If the Company chooses to perform a qualitative assessment and determine the fair value more likely than not exceeds the carrying value, no further evaluation is necessary. When the Company performs the quantitative goodwill impairment test, it compares fair value to carrying value, which includes goodwill. If fair value exceeds carrying value, the goodwill is not considered impaired. If the carrying value is higher than the fair value, the difference would be recognized as an impairment loss.

For other long-lived assets, we periodically review long-lived assets, other than goodwill, for impairment whenever changes in events or circumstances indicate that the carrying amount of an asset may not be recoverable. Assumptions and estimates used in the determination of impairment losses, such as future cash flows and disposition costs, may affect the carrying value of long-lived assets and the impairment of such long-lived assets, if any, could have a material effect on our consolidated financial statements.

Income Taxes. As part of the process of preparing our consolidated financial statements, we are required to estimate our current tax exposure together with our temporary differences resulting from differing treatment of items for tax and accounting purposes. These temporary differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. Management judgment is required in determining our provision for income taxes and any valuation allowance recorded against our deferred tax assets. The need for a valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred taxes will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to adjust the valuation allowance, which could materially impact our financial position and results of operations.

We recognize liabilities for uncertain tax positions based on a two-step process. The first step requires us to determine if the weight of available evidence indicates that the tax position has met the threshold for recognition; therefore, we must evaluate whether it is more likely than not that the position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step requires us to measure the tax benefit of the tax position taken, or expected to be taken, in an income tax return as the largest amount that is more than 50% likely of being realized when effectively settled. This measurement step is inherently difficult and requires subjective estimations of such amounts to determine the probability of various possible outcomes. We reevaluate the uncertain tax positions each quarter based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues, and new audit activity. Such a change in recognition or measurement could result in the recognition of a tax benefit or an additional charge to the tax provision in the period.

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