NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

(Unaudited)

NOTE 1. Basis of Presentation

The accompanying interim unaudited Condensed Consolidated Financial Statements have been prepared by Rudolph Technologies, Inc. (the “Company” or “Rudolph”) and in the opinion of management reflect all adjustments, consisting of normal recurring accruals, necessary for their fair presentation in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).  Preparing financial statements requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes.  Actual amounts could differ materially from reported amounts.  The interim results for the three and six month periods ended June 30, 2019 are not necessarily indicative of results to be expected for the entire year or any future periods.  This interim financial information should be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 10-K”) filed with the Securities and Exchange Commission (“SEC”) on February 15, 2019.  The accompanying Condensed Consolidated Balance Sheets at December 31, 2018 has been derived from the audited consolidated financial statements included in the 2018 10-K.

Recent Accounting Pronouncements

Recently Adopted

Effective January 1, 2019, the Company adopted Accounting Standards Update (“ASU”) No. 2018-07, “Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.”  This ASU expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees.  An entity should apply the requirements of Topic 718 to nonemployee awards except for specific guidance on inputs to an option pricing model and the attribution of cost.  The ASU is effective for the fiscal years beginning after December 15, 2018, including interim periods within that fiscal year.  The adoption of ASU No. 2018-07 did not have a material impact on the Company’s consolidated financial position, results of operations, and cash flows.  

Effective January 1, 2019, the Company adopted ASU No. 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.”  The new guidance allows companies to reclassify stranded tax effects resulting from the Tax Cuts and Jobs Act (the “Tax Act”) from accumulated other comprehensive income to retained earnings.  The guidance also requires certain new disclosures regardless of a company’s election.  The standard is effective for annual periods beginning after December 15, 2018 and for interim periods within those annual periods, with earlier adoption permitted.  The adoption of ASU No. 2018-02 did not have a material impact on the Company’s consolidated financial position, results of operations, and cash flows.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” ASU No. 2016-02 requires that lessees recognize virtually all of their leases on the balance sheet, by recording a right-of-use asset and lease liability. On January 1, 2019, the Company adopted ASU No. 2016-02 using the modified retrospective method which applies the provisions of the standard at the effective date without adjusting the comparative periods presented.  The Company also elected the package of practical expedients.

There was not a cumulative-effect adjustment to the Company’s beginning retained earnings as a result of adopting ASU No. 2016-02. The Company has recognized additional operating lease assets and obligations of $14.4 million as of January 1, 2019. The Company elected to not reassess prior conclusions related to the identification, classification and accounting for initial direct costs for leases that commenced prior to January 1, 2019. For additional disclosure and detail, see Note 6 of the Notes to the Condensed Consolidated Financial Statements, “Leasing Arrangements.”

Recently Issued

In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.”  This ASU is part of the FASB’s larger disclosure framework project intended to improve the effectiveness of financial statement footnote disclosure.  ASU No. 2018-13 modifies required fair value disclosures related primarily to level 3 investments.  This ASU is effective for annual periods beginning after December 15, 2019 and interim periods within those annual periods.  The adoption of ASU No. 2018-13 is not expected to have a material effect on the Company’s consolidated financial position, results of operations, and cash flows.

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In May 2017, the FASB issued ASU No. 2017-09, “Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting.”  This ASU amends the scope of modification accounting for share-based payment arrangements and provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under Accounting Standards Codification (“ASC”) 718.  The ASU is effective for the fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years.  The adoption of ASU No. 2017-09 is not expected to have a material effect on the Company’s consolidated financial position, results of operations, and cash flows, if any.

In January 2017, the FASB issued ASU No. 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.”  This ASU eliminates Step 2 from the goodwill impairment test.   Accordingly, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss will be recognized in an amount equal to the excess, limited to the total amount of goodwill allocated to the reporting unit.  The ASU is effective for the fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years.  The Company is currently evaluating the effect the adoption of ASU No. 2017-04 will have on its consolidated financial position, results of operations, and cash flows, if any.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which represents a new credit loss standard that will change the impairment model for most financial assets and certain other financial instruments. Specifically, this guidance will require entities to utilize a new “expected loss” model as it relates to trade receivables, notes receivable and other commitments to extend credit held by a reporting entity. In addition, entities will be required to recognize an allowance for estimated credit losses on available-for-sale debt securities, regardless of the length of time that a security has been in an unrealized loss position. This guidance will be effective for annual reporting periods beginning after December 15, 2019, including interim periods within those annual reporting periods, and early adoption is permitted. The Company is currently evaluating the potential impact that the adoption of this guidance may have on its consolidated financial position, results of operations, and cash flows.

Recently issued accounting guidance not discussed above is not applicable.

NOTE 2. Business Combinations

On June 23, 2019, the Company entered into an agreement and plan of merger to combine in an all-stock merger of equals transaction with Nanometrics Incorporated (“Nanometrics”), a provider of advanced process control metrology and software analytics.  The transaction was unanimously approved by the board of directors of both companies and is subject to the satisfaction of customary closing conditions, including receipt of customary regulatory approvals and approval by the shareholders of each company.  The Company anticipates the merger to close in the second half of 2019.  Under the terms of the agreement, Rudolph stockholders will receive 0.8042 shares of Nanometrics common stock for each share of Rudolph common stock.  Upon completion of the merger, current Nanometrics stockholders will own approximately 50% of the combined company and current Rudolph stockholders will own approximately 50% of the combined company.    In addition, if the merger agreement is terminated prior to completion of the merger, a termination fee of $26.0 million if the merger agreement is terminated under circumstances specified in the merger agreement.  During the three months ended June 30, 2019, the Company accrued $2.5 million of direct costs associated with the merger.

NOTE 3. Fair Value Measurements

The Company applies a three-level valuation hierarchy for fair value measurements.  This hierarchy prioritizes the inputs into three broad levels.  Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.  Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the asset or liability.  Level 3 inputs are unobservable inputs based on management’s assumptions used to measure assets and liabilities at fair value.  A financial asset’s or liability’s fair value measurement classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

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The following tables provide the assets and liabilities carried at fair value measured on a recurring basis at June 30, 2019 and December 31, 2018:

Level 1 inputs are based on quoted market prices that are available in active markets.  The Company does not have any recurring financial assets and liabilities that are recorded in its Condensed Consolidated Balance Sheets as of March 31, 2019 and December 31, 2018 that are classified as Level 1 inputs.

The Company’s available-for-sale debt securities classified as Level 2 are valued using observable inputs to quoted market prices, benchmark yields, reported trades, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency.  The foreign currency forward contracts are primarily measured based on the foreign currency spot and forward rates quoted by the banks or foreign currency dealers.  Investment prices are obtained from third party pricing providers, which model prices utilizing the above observable inputs, for each asset class.

Level 3 liabilities consisted of contingent consideration related to an acquisition for which the Company uses a discounted cash flow model to value these liabilities.  The Level 3 assumptions used in the discounted cash flow model for the contingent consideration included projected revenue, timing of cash flows and estimates of discount rates of 9.2% and 9.4% for the six months ended June 30, 2019 and 2018, respectively.  A significant decrease in the projected revenue or increase in discount rates could result in a significantly lower fair value measurement for the contingent consideration.  

This table presents a reconciliation of all liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2019:

See Note 4 for additional discussion regarding the fair value of the Company’s marketable securities.

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Fair Value of Other Financial Instruments

The carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximates fair value because of the short-term maturity of these instruments.  The estimated fair value of these obligations is based primarily on a market approach, comparing the Company’s interest rates to those rates the Company believes it would reasonably receive upon re-entry into the market.  Judgment is required to estimate the fair value, using available market information and appropriate valuation methods.

The carrying amount of the convertible notes receivable approximates fair value based on current interest rates for instruments with similar characteristics.  Convertible notes receivable are initially recognized at fair value. The Company does not subsequently adjust the fair value of these convertible notes receivable unless it is determined that the convertible notes receivable are impaired. The Company considers the issuer’s financial condition, payment history, and other relevant factors when assessing the collectability of a convertible note and to reserve the portion of such convertible note for which collection does not appear likely. Interest income is recognized as earned.

NOTE 4. Marketable Securities

The Company has evaluated its investment policies and determined that all of its marketable securities, which are comprised of debt securities, are to be classified as available-for-sale.  The Company’s available-for-sale debt securities are carried at fair value, with the unrealized gains and losses reported in Stockholders’ equity under the caption “Accumulated other comprehensive loss.”  Realized gains and losses on available-for-sale securities are included in “Other expense (income)” on the Condensed Consolidated Statements of Operations.  The Company records other-than-temporary impairment charges for its available-for-sale debt securities when it intends to sell the securities, it is more-likely-than not that it will be required to sell the securities before a recovery, or when it does not expect to recover the entire amortized cost basis of the securities.  The cost of securities sold is based on the specific identification method.

The Company has determined that the gross unrealized losses on its marketable securities at June 30, 2019 and December 31, 2018 are temporary in nature.  The Company reviews its investment portfolio to identify and evaluate marketable securities that have indications of possible impairment.  Factors considered in determining whether a loss is other-than-temporary include the length of time and extent to which fair value has been less than the cost basis, credit quality and the Company’s ability and intent to hold the securities for a period of time sufficient to allow for any anticipated recovery in market value.

At June 30, 2019 and December 31, 2018, marketable securities are categorized as follows:

The amortized cost and estimated fair value of marketable securities classified by the maturity date listed on the security, regardless of the Condensed Consolidated Balance Sheets classification, is as follows at June 30, 2019 and December 31, 2018:

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The following table summarizes the estimated fair value and gross unrealized holding losses of marketable securities, aggregated by investment instrument and period of time in an unrealized loss position, at June 30, 2019 and December 31, 2018:

See Note 3 for additional discussion regarding the fair value of the Company’s marketable securities.

NOTE 5. Derivative Instruments and Hedging Activities

The Company, when it considers it to be appropriate, enters into forward contracts to hedge the economic exposures arising from foreign currency denominated transactions. At June 30, 2019 and December 31, 2018, these contracts included the future sale of Japanese Yen to purchase U.S. dollars.  Derivative instruments are measured at fair value and recognized as either, “Prepaid expenses and other current assets” or “Other current liabilities” in the Condensed Consolidated Balance Sheets with changes in the net derivatives position reflected in operating cash flows.  The foreign currency forward contracts were entered into by the Company’s Japanese subsidiary to economically hedge a portion of certain intercompany obligations.  The forward contracts are not designated as hedges for accounting purposes and decreases in the fair value of $6 and $55 for the six months ended June 30, 2019 and 2018, respectively, are recorded under the caption “Other expense (income), net” in the Condensed Consolidated Statements of Operations.

The dollar equivalent of the U.S. dollar forward contracts and related fair values as of June 30, 2019 and December 31, 2018 were as follows:

NOTE 6. Leasing Arrangements

The Company leases space for its corporate headquarters, manufacturing, sales and service operations, vehicles and information technology equipment under operating leases. All of the Company’s leases are operating leases.  The Company elected not to apply Accounting Standard Codification Topic 842 (“ASC 842”) to arrangements with lease terms of less than 12 months.  Operating lease right-of-use assets and obligations are reflected within the captions “Operating lease right-of-use assets,” “Current operating lease obligations,” and “Non-current operating lease obligations,” respectively, on the Condensed Consolidated Balance Sheets.

Operating lease costs were $869 and $1,746 during the three and six months ended June 30, 2019.  These costs are primarily related to long-term operating leases, but also include immaterial amounts for short-term leases less than 12 months.  Operating lease costs are recognized on a straight-line basis over the terms of the leases.

Additional operating lease right-of-use assets of $222 were recognized as non-cash asset additions that resulted from new operating lease liabilities as of the six months ended June 30, 2019. Cash paid for amounts included in the measurement of operating lease liabilities was $1,656 during the six months ended June 30, 2019 and is included in operating cash flows.

The Company often has the option to renew lease terms for buildings and other assets. The exercise of lease renewal options are generally at the Company’s sole discretion. In addition, certain lease arrangements may be terminated prior to their original expiration date at the Company’s discretion. The Company evaluates renewal and termination options at the lease commencement date to determine if it is reasonably certain to exercise the option on the basis of economic factors. The weighted average of the remaining lease term for operating leases as of June 30, 2019 was 7.9 years.

The discount rate implicit within the Company’s leases is generally not determinable and therefore the Company determines the discount rate based on its incremental borrowing rate. The incremental borrowing rate for our leases is

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determined based on the lease term in which lease payments are made. The weighted average discount rate used to measure operating lease liabilities as of June 30, 2019 was 4.7%.

The following table presents information about the amount and timing of cash flows arising from the Company’s operating leases as of June 30, 2019:

Intangible asset amortization expenses for the three and six months ended June 30, 2019 were $387 and $774, respectively.  For the three and six month period ended June 30, 2018, intangible assets amortization expenses were $383 and $763, respectively.  Assuming no change in the gross carrying value of identifiable intangible assets and estimated lives, estimated amortization expenses for the remainder of 2019 are $774, and for each of the next five years estimated amortization expenses are $1,346 for 2020, $598 for 2021, $532 for 2022, $515 for 2023, and $431 for 2024.

NOTE 8. Convertible Notes Receivable

The Company entered into a convertible loan agreement with Simax Precision Technologies Limited (“Simax”) on May 31, 2018.  Under the agreement, Simax may borrow from the Company up to $15,000 in multiple promissory notes, subject to limitations.  The Company expects to be a supplier of lithography modules to Simax which is focused on the manufacture, sale and service of lithography systems.  

The convertible notes will bear a rate of interest of 4.25% per annum payable on a semi-annual basis.  The convertible notes provide the Company with the option to convert the outstanding indebtedness into equity.   If the Company does not elect to exercise its option to convert the notes into equity, Simax will repay the principal amount outstanding and any outstanding interest in equal installments beginning on the fifth anniversary of the loan date and continuing on a quarterly basis over the next three years.

As of June 30, 2019, the convertible notes receivable balance was $5,000 with accrued interest of $105.

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The Company has established reserves of $11,347 and $11,678 as of June 30, 2019 and December 31, 2018, respectively, for slow moving and obsolete inventory, which are included in the amounts above.

Other assets

Other assets is comprised of the following:

Other current liabilities

Other current liabilities is comprised of the following:

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Other non-current liabilities

Other non-current liabilities is comprised of the following:

NOTE 10. Commitments and Contingencies

Intellectual Property Indemnification Obligations

The Company has entered into agreements with customers that include limited intellectual property indemnification obligations that are customary in the industry.  These guarantees generally require the Company to compensate the other party for certain damages and costs incurred as a result of third-party intellectual property claims arising from these transactions.  The nature of the intellectual property indemnification obligations prevents the Company from making a reasonable estimate of the maximum potential amount it could be required to pay to its customers.  Historically, the Company has not made any indemnification payments under such agreements and no amount has been accrued in the accompanying Condensed Consolidated Financial Statements with respect to these indemnification guarantees.

Warranty Reserves

The Company generally provides a warranty on its products for a period of 12 to 15 months against defects in material and workmanship.  The Company estimates the costs that may be incurred during the warranty period and records a liability in the amount of such costs at the time revenue is recognized.  The Company’s estimate is based primarily on historical experience.  The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.  Settlements of warranty reserves are generally associated with sales that occurred during the 12 to 15 months prior to the quarter-end and warranty accruals are related to sales during the same year.

Changes in the Company’s warranty reserves are as follows:

Warranty reserves are reported in the Condensed Consolidated Balance Sheets under the caption “Accounts payable and accrued liabilities.”

Legal Matters

From time to time, the Company is subject to legal proceedings and claims in the ordinary course of business.  As of June 30, 2019, there are no legal proceedings pending or threatened against the Company that management believes are likely to have a material adverse effect on the Company’s consolidated financial position or otherwise.

Line of Credit

The Company has a credit agreement with a bank that provides for a line of credit which is secured by the marketable securities the Company has with the bank.  The Company is permitted to borrow up to 70% of the value of eligible securities held at the time the line of credit is accessed.  The available line of credit as of June 30, 2019 was approximately $93.0 million with an available interest rate of 4.0%.  The credit agreement is available to the Company until such time that either party terminates the arrangement at their discretion.  The Company has not utilized the line of credit to date.

NOTE 11. Revenue

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Revenue is recognized when control of the promised goods or services are transferred to the Company’s customers in an amount that reflects the consideration the Company expects to be entitled to receive in exchange for those goods or services.  The Company accounts 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, the Company allocates revenue to each performance obligation based on its relative standalone selling price. The Company generally determines standalone selling prices based on the prices charged to customers or the expected cost-plus margin.

The following table represents a disaggregation of revenue by timing of revenue:

See Note 17 of the Notes to the Condensed Consolidated Financial Statements for additional discussion of the Company’s disaggregated revenue in detail.

Systems Revenue

Revenue from systems is recognized when the Company transfers control of the product to the customer.  To indicate transfer of control, the Company 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.  The Company generally transfers control for system sales when the customer or the customer’s agent picks up the system at the Company’s facility.  Payment for the majority of the Company’s systems have 80-90% of the invoice amount due within 30 days and the remaining amount due upon completion of installation, recalibration and qualification by the customer.  The Company provides an assurance warranty on its systems for a period of twelve to fifteen months against defects in material and workmanship.  The Company provides for the estimated cost of product warranties at the time revenue is recognized.

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

Software Licensing, Support and Maintenance Revenue

Revenue from software licenses provides the customer with a right to use the software as it exists when made available to the customer.  Revenue from software licenses are recognized upfront at the point in time when the software is made available to the customer.  Revenue from licensing support and maintenance is recognized as the support and maintenance are provided, which is over the contract period.  Payment for software licensing, support and maintenance is generally due in 30 days.  

Parts Revenue

Revenue from parts is recognized when the Company transfers control of the product, which typically occurs when the Company ships the product from its facilities to the customer.  Payment for parts is generally due in 30 days.  

Services Revenue

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Revenue from services primarily consists of service contracts, which provide additional maintenance coverage beyond the Company’s assurance warranty on its products, service labor, consulting and training.  Revenue from service contracts is recognized ratably over the term of the service contract.  Revenue from service labor, consulting and training is recognized as services are performed.  Payment for services is generally due in 30 days.