ONTO Innovation Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

ONTO Innovation Inc. designs, develops, manufactures, and supports process control tools for semiconductor manufacturing, specializing in metrology (measurement) and inspection. They are a key part of the supply chain for advanced semiconductor devices, and are necessary for their high quality production.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: ONTO Innovation, headquartered in Wilmington, Massachusetts, operates within the semiconductor equipment industry, a sector vital to the production of modern electronic devices. The company’s core business revolves around providing metrology and inspection solutions that ensure the high precision and quality control required in the manufacturing process. Their tools are necessary to produce high-end semiconductors, which are primarily purchased by large semiconductor foundries and IDM’s (integrated device manufacturers) to produce their chips.

Revenues Distribution: ONTO’s revenue model is primarily based on the sales of its tools for different parts of the semiconductor manufacturing process. They have a good geographical diversification too and operate across the United States, Europe and Asia with good geographical mix. While most of their revenue comes from the sales of their tools, they also generate revenue from sales of spare parts for these tools and service contracts for their deployed products.

  • Systems and Software: This makes up majority of their revenue, consisting of lithography, metrology, and defect inspection tools
  • Services: Revenue from services, including repairs, applications support, field service and spare parts.
  • Asia: This contributes to majority of ONTO revenue. The company has operations in South Korea, Taiwan, China, and Southeast Asia, among others.

Trends in the Industry:

  • The semiconductor equipment industry is highly cyclical and volatile. It also has high barriers to entry due to substantial investments in R&D and manufacturing facilities needed to stay competitive. A lot of companies are trying to grow in this space due to AI and data centers, but a lot of established companies do not have the moat and will likely have tough time being profitable.
  • The semiconductor manufacturing is becoming increasingly complex, due to high demand for high performance chips with decreased size. This means more complex tools are required with better accuracy to meet the demand.
  • The semiconductor manufacturing equipment sector has also seen a lot of consolidation in the last few years. With most established companies trying to acquire their way to innovation and growth.

Margins & Competitive Landscape: ONTO’s financial metrics show solid profitability with gross margins ranging from 44-52%. They generally have positive operating income and net income. However, in some years their profits were affected due to special charges such as goodwill amortization or unusual expenses. The competitive landscape is highly competitive, and includes companies like Applied Materials, ASML, Lam Research, KLA, and Tokyo Electron, among others. These companies have a larger scale than ONTO and a better brand image. What makes ONTO different: ONTO’s specific expertise lies in process control metrology and inspection tools. A key differentiator is ONTO’s ability to develop and integrate software, metrology, and inspection capabilities. They are also trying to leverage Artificial Intelligence and Machine Learning to make better inspection products, which are very critical in the semiconductor manufacturing process. While ONTO may have a competitive advantage in certain segments of their technology and products, they need to compete with much larger competitors which makes it very difficult to build and maintain a moat.

Financial Analysis: ONTO’s financial statements reflect a growing business in a somewhat cyclical industry. Their revenue and profits had been growing steadily, but took a big hit during 2022 and have been recovering since then. It should be noted that there are also some discrepancies in their 10Q’s regarding when to start fiscal year, with some documents saying Dec 31, 2022, and the others reporting January 1, 2023.

  • Revenue: The company’s revenue growth has been volatile, with the company seeing rapid revenue growth in 2021 with yearly revenue going from $296.5 million to $595.2 million, and declining to $560 million in 2022. Revenue is currently recovering with TTM revenue at 781 million. Revenue growth is largely tied to overall semiconductor sector’s growth.
  • Margins: Gross margins are typically 45%-55%. The operating margins have varied quite a bit depending on their sales, with a large dip in 2022 and gradual recovery since then.
    • Debt: They have low debt on their balance sheet, but this has varied over time. Currently, they have around 500 million of debt outstanding.
  • Cash and equivalents - They have 372 million in cash and equivalents. It’s good for a company with 500-600 million revenue.
  • Earnings: Earnings and EPS have also been volatile based on industry conditions and internal costs, with the lowest year being 2022. They are currently profitable, but their earnings growth depends greatly on the demand for semiconductors.

Recent Concerns, Controversies and Problems:

  • During the Q3 earnings call, there was some concerns regarding the lower full year revenue guidance from the company compared to before, which indicates softer demand for the future.
  • The company is facing challenges in hiring and retaining employees and also is experiencing some delays from suppliers.
  • The company also needs to deal with global trade tensions, and other problems such as natural disasters which can impact the production, operations, and customer deliveries.

Moat Rating: 2/5 ONTO Innovation has a narrow moat. While they have some competitive advantages in their proprietary technology and integration of metrology and inspection tools, it is not strong enough to allow it to establish and maintain a wide-moat. Also, the semiconductor industry is quite competitive, with a few very large established players having significant resources to outcompete ONTO. While they are able to capture a portion of the market share, they will have a very difficult time in increasing the moat, as any innovations can be copied easily. Also, the long term profitability is not guaranteed as the semiconductor industry is cyclical and can face large downturns.

Risks That Could Harm the Moat and Business Resilience

  1. Technological Disruption: Rapid technological advancements in semiconductor manufacturing could make ONTO’s existing tools obsolete, significantly eroding any competitive advantage derived from existing technology. They need to make sure to continually improve and innovate on new products to keep ahead of the competition.
  2. Intense Competition: The semiconductor equipment industry is highly competitive, with established players like ASML and Applied Materials having a much larger scale. They may face increased competition that could pressure their pricing power and profits. The consolidation in this industry also means the companies need to keep up and innovate to avoid falling behind.
  3. Cyclicality of the Industry: The semiconductor industry is cyclical, and ONTO’s revenue and profits are heavily influenced by this cycle. The company’s financial performance could be negatively impacted during a period of low capital expenditure by semiconductor manufacturers, or even potential decline in demand for end use products.
  4. Reliance on Key Customers: If one or few of their large customers decide not to buy their products or to slow down demand for a longer period of time, that can have significant affect on the business.
  5. Supply Chain Challenges: Any disruptions in the semiconductor supply chain can impair ONTO’s ability to meet customer demand, and could lead to decreased revenue and profits. For companies in this field, it’s very important to have stable long-term supply agreements to protect against any kind of disruption.
  6. Macroeconomic Uncertainty: Events like COVID-19 or other global pandemics, trade disputes, political instability, natural disasters, climate change, and economic recessions can all impact ONTO’s manufacturing capabilities, logistics, demand for their products, and future growth. The company can see a decrease in sales revenue and profits during periods of turbulence.

Understandability: 3 / 5 ONTO’s business, while rooted in a complex technological sector (semiconductors) is comprehensible with some diligence. The company’s focus on metrology and inspection makes its business clearer than other complex semiconductor tool manufactures. While understanding the technology might require some specialized knowledge, the business model of selling to semiconductor manufacturers is straightforward. However, some of their financial statements and the details about their debt, equity and other assets can be hard to understand for the retail investor.

Balance Sheet Health: 4 / 5 ONTO’s balance sheet can be considered healthy. They have a good amount of cash, limited debt and positive equity. Their total assets are greater than total liabilities, which also shows that they are stable and financially solvent. Their cash and equivalents are more than their debt, and have the ability to generate cash from its operations. Though there has been a decrease in their cash positions recently because of acquisitions, investments and working capital. The company has a solid balance sheet, but they need to be mindful of increasing liabilities and expenses for the future.