Claire McAdams - Investor Relations Tim Stultz - President and Chief Executive Officer Ronald Kisling - Chief Financial Officer.

Mahesh Sanganeria - RBC Capital Markets Patrick Ho - Stifel Josh Baribeau - Canaccord David Wu - Indaba Global Research.

Good day, ladies and gentlemen and welcome to the Nanometrics' Q2 2014 Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the call over to your host, Ms. Claire McAdams. Ms. McAdams, you may begin..

Thank you, and good afternoon everyone. Welcome to the Nanometrics second quarter 2014 financial results conference call. On today’s call are Dr. Timothy Stultz, President and Chief Executive Officer; and Ronald Kisling, Chief Financial Officer. Shortly, Tim will provide a recap of the second quarter and our perspective looking forward.

Then, Ron will discuss our financial results in more detail after which we will open up the call for Q&A. The press release detailing our financial results was distributed over the wire services shortly after 1 PM Pacific this afternoon. The press release and supplemental financial information are available on our website at www.nanometrics.com.

Today’s conference call contains certain forward-looking statements including, but not limited to financial performance and results including revenue, operating expenses, margins, profitability and earnings per share.

Although Nanometrics believes that the expectations reflected in the forward-looking statements are reasonable, actual results could differ materially from the expectations due to a variety of factors, including timing of product acceptance, general economic conditions, changes in levels of industry spending, the adoption and competitiveness of our products, industry adoption of new technology and manufacturing processes, customer demands, shifts in timing of orders or product shipments, changes in product mix, our ability to successfully realize operating efficiencies and the additional risk factors and cautionary statements set forth in the Company’s Form 10-K on file for fiscal year 2013 as well as other periodic reports filed with the SEC from time-to-time.

Nanometrics disclaims any obligation to update information contained in any forward-looking statement. I will now turn the call over to Tim Stultz.

Tim?.

Thank you, Claire and good afternoon, everyone. We appreciate you taking the time to join us on our call today. Today, my prepared remarks will address highlights of the quarter, some brief comments on the industry environment and update on our business outlook and guidance for the September quarter. Before going forward with my prepared remarks.

I want to first address a disproportionate decline in our expected third quarter revenues relative to our peers. Along with the widely reported pause in the industry spending, we are seeing a precipitous drop in our third quarter spending on process control metrology, by both of our two largest customers.

Revenues from those two customers alone are expected to decline more than 80% quarter-on-quarter. It is highly unusual for us to see such a meaningful simultaneous drop in sales to both of them within the same fiscal quarter. This decline is absolutely not due to a loss in share, but rather is an anomaly due to the timing of their spend.

Further, our announced new slot wins with multiple industry leaders are almost exclusively for advanced leading edge semiconductor devices. Sales from which will manifest as market share gains and revenue growth later this year and through 2015.

Based on these factors, our order pipeline and current customer commits, we do expect a significant snap back in revenues for the fourth quarter and going into 2015. Now turning to a review of our June results. From a financial perspective, the second quarter came in largely in line with our expectations.

With earnings $0.02 better than our midpoint guidance, aided by a 100 basis point quarter-on-quarter improvement in gross margins and slightly lower than forecast spending. Notably, this quarter we had record foundry revenues and we accounted five of the world’s leading semi-conductor manufacturers as 10% customers, a first for now.

We see this as evidence of our progress in key account penetration, reduction in customer concentration and solid execution against our strategic initiatives.

On the competitive front, we gained additional market share of one of the industry’s largest memory manufacturers by winning new tool record positions for both our Atlas automated and IMPULSE integrated metrology systems for 3D NAND process control applications.

This new slot will contribute materially to our future business as this customer ramps to a 3D memory technology node. During the quarter, we also benefitted from additional deployment of our Atlas optical critical dimension or OCD system into a pure play foundry, high volume manufacturing facility for use of the manufacturer of 1x FinFET devices.

And we received multiple follow on orders for our UniFire for advanced for advanced packaging applications, including installation into new fab locations, further strengthening our position in this emerging market on attraction of this enabling product.

With these new competitive wins and follow on orders, we have now established key process control tool-of-record positions in the leading edge fabs of every major memory, logic and foundry customer.

And by doing so, we continue to strengthen our position as a trusted provider of process control solutions for the most advanced and demanding device fabrication challenges our customers face.

When I use the term process control solutions, I am not simply referring to new tools with enhanced performance capabilities The landscape for process control metrology is in fact changing dramatically as our customers push the envelope in process complexity, while they struggle to extract ever tighter process results and performance matching from their process tools, tool-to-tool and fab-to-fab.

To meet these challenges metrology data from both our automated as well as integrated tools is being used with feed-forward and feed-backward strategies to modify and control process parameters within and between different process steps and tools.

Known as advanced process control or APC, the use of inline and institutional metrology data is becoming ever more critical to delivering consistent performance and accelerated yield ramps in the leading edge devices.

And as a direct result, you can now find our IMPULSE metrology tools integrated onto H, CVD, CMP and track systems at multiple customer sides and being used actively for APC in the most advanced fabs in the world.

The takeaway is that the market for process control metrology solutions is evolving, becoming increasingly critical to meeting the demands of new device fabrication and in-turn driving closer cooperation between process tool suppliers, device manufacturers and APC providers and Nanometrics is playing a similar role in this evolution.

Now turning to industry spending, as we stated last quarter whereas we have seen some strength in DRAM investments, a large amount of 3D NAND and advanced logic spending on process control is being pushed out into the fourth quarter and into 2015.

In addition, a large foundry customer has further delayed the timing of their capacity ramp for FinFET logic devices, as yield and competitive market challenges have driven changes in investment dynamics and strategies within the foundry space.

Collectively, our biggest customers have dramatically cut back their near-term spending on process control metrology for advanced devices and are focusing on process tools for current technology node capacity while they wrestle with yield and performance challenges with the next generation devices.

Since our focus and recent share gains and tool of record positions have been almost exclusively tied to leading-edge devices, these investment push outs have led to a significant drop in demand for our products in the current or third quarter.

Based on our orders, backlog and customer engagements however we are reasonably confident that this is a short-term issue with a revenue turnaround expected in the fourth quarter.

We also hold an optimistic outlook for our strong 2015, as our R&D tool of record selections make the transition to high-volume manufacturing simultaneously our multiple customers in 16/14 nanometer logic and 3D memory devices.

We are further encouraged by forecast by industry analysts for wafer fab equipment starting to increase in 2015 and for an unprecedented six year in a row to be in the range of $30 billion.

And within WFE spend, the reliance upon process control tools and strategies is expanding as the role of traditional shrinks to meet cost performance goals takes a back seat to complex lithography, 3D transistors, 3D memory structures and 3D packaging.

What I can say with certainty is that the level of our engagements with the leading customers in the industry for new applications and tool use cases is continuing to grow at an ever increasing rate. And the number of OCD applications we have developed and deployed into new technology nodes is at an all-time high and growing.

These applications and use cases in-turn will drive incremental tool demand and growth of our business as new nodes roll-out and capacity is put in place. So, while we are faced with a significant drop in forecast revenues in the third quarter.

We are bullish on our long-term outlook and remain committed to our mission of growing market share and increasing our footprint with the largest customers in our industry.

Finally, before turning to our guidance for the third quarter, I will mention that as we discussed in our last call, operating expenses are forecast to come down quarter-on-quarter as we reach completion of certain R&D investments that were accelerated to meet customer demands and needs.

We have also taken some additional steps to reduce spending through restructuring and consolidation of certain foreign operations into our domestic operations. This will improve operational efficiency, reduce organizational redundancies and eliminate some overhead expenditures. Ron will provide more color on this in his prepared remarks.

With that our guidance for the third quarter is as follows. Revenues of $25 million to $30 million and on a non-GAAP basis gross margin of 37% to 46%. Operating expenses of $20.8 million to $21.3 million and a loss of $0.17 to $0.30 per share.

Ron?.

Thank you, Tim and good afternoon. Before I begin my comments, I'd like to remind you that a schedule which summarizes GAAP and non-GAAP financial results discussed on this conference call as well as supplemental revenue segment information by product, mid market and geographic conditions is available in Investor section our Web site.

Second quarter revenues were $48 million, down 7% from Q1 and up 39% from Q2 2013. Product revenues decreased 9% to $39.2 million compared to $43.3 million in the prior quarter, as increased sales of our flagship Atlas automated tools were offset by declines in sales of our UniFire and integrated products from relatively high Q1 levels.

Automated tool revenues in total were essentially flat with the prior quarter and comprise 70% of total revenue. Integrated tool revenue decreased 59% over the prior quarter and comprised 6% of total revenues. Materials characterization tool revenues increased 18% and comprised 6% of total revenues in Q2.

And services revenues increased 6% and comprised 18% of total revenues. By end market the largest increase occurred in foundry, which increased 147% and comprised 33% of tool revenue. Sales into the memory market decreased 42% in Q1 and comprise 41% of total revenue.

Sales into the logic, IDM and data storage end markets increased 38% and comprise 19% of total revenue. And revenues into the LED, silicon wafer and discrete end market decreased 18% and comprise 7% of total revenues.

As Tim mentioned, we hit a new milestone in the quarter with five customers contributing 10% or more to our total revenues for the quarter. Intel contributed 18%; SK hynix 18%; Samsung 16%; GlobalFoundries 15%; and TSMC 11%. As a reminder, our revenue segmentation information is available on our Web site.

Turning to other P&L metrics, my prepared remarks regarding the income statement refer to non-GAAP measures unless I indentify the measure as GAAP based. These measures exclude the impact of amortization of acquired intangible assets. Our Q2 gross margin was 49.1%, just above the midpoint of our guidance and up 100 basis points from the first quarter.

Product gross margin decreased slightly to 49.5% from 50%, and service gross margin increased to 47.1% from 38.4% largely due to the increase in total service revenues which included an uptick in upgrade sales. Operating expenses were essentially flat in Q1, coming in at the low end of our guidance.

As we indicated in our last earnings call, we expect spending to decrease in the second half of 2014 due to typical seasonal declines and completion of certain R&D program resulting in Q3 operating expenses of $20.8 million to $21.3 million, a reduction of between 800,000 and $1.3 million from the second quarter.

In addition, in July we initiated the consolidation of our UK engineering operations into our U.S. operations. This consolidation will improve operational efficiency, reduce organizational redundancies and will eliminate certain overhead costs. This consolidation is expected to reduce ongoing quarterly operating expenses by approximately $500,000.

Due to the timing of these adjustments we will see the full benefit of these changes until the second quarter of 2015.

In connection with this consolidation, we expect to incur between $1.2 million and $1.5 million of expense for severance and other personnel related costs, relocation in facilities, which we will record at a restructuring charge in the third quarter.

Net income in the second quarter was $1.1 million or $0.05 per share compared to $2.1 million or $0.09 per share in the prior quarter. At June 28, our cash and investments were $87 million or $3.64 per share.

Our DSO was 63 days, in line with our historical experience, and inventory decreased $2 million to $38.1 million at the end of the second quarter. We ended the quarter with headcount of 540 employees, a net decrease of 3 employees from the prior quarter. And with that, I’ll turn the call over for questions.

Operator?.

Thank you. (Operator Instructions). Our first question is from Mahesh Sanganeria with RBC Capital Markets. Your line is open..

Tim, just if you can provide some more color on the drop in the third quarter, not a surprise we’ve seen that from other companies reporting. But I haven’t seen this kind of a divergence between lithography process control and dep and etch and in the past where lithography and process control is so far different than the deposition and etch.

So can you give us some, like, can you explain it to us a little bit what’s driving the variation between the segments?.

I think, kind of on a general level, if you look at the investment profiles into process control versus process tools and typically new technology nodes, there is front end loaded investment in process control tools, that then softens as you got to back and when they start adding capacity to it and we see over, outperformance in the process control tool companies in the early phase of the investment cycle and you see relative underperformance versus vis-à-vis process tools.

Now when we look at where we are on the investment cycle with our customers, you will see that the new technology nodes are the ones that are being pushed out. So the logic devices and foundry, the 3D NAND, those things have been pushed out.

There is heavy investment in the 3D NAND early part of this year and towards the end of last year and now there has been a decline in that investment during the second half of the year.

So, a lot of that I think is simply stated, it’s a timing of investment between process tools which are frontend loaded, I mean process control tools which are frontend loaded and process tools which are backend loaded..

And so you are saying that you are going to see a pick-up in the investment in Q4, is that all the customers who are engaged in 16/14 or it’s one or two, how is that working out? The timing of all the customers are kind of -- are they aligned the same way or there is one going to ramp later than others?.

Yes, they are not all exactly aligned together. We would love them to -- but what we are seeing more on the logic side towards the end of the year, in pickups, and at the beginning of next year we start to see more of investment in the second phase of some of the 3D memory devices.

We'll see some pickup towards the end of the year, but there is a little frontend edge to the foundry 16/14 nanometer investments which have been pushed out as I stretched up a 20 nanometer node and then we see a pickup in the second phase investments on 3D NAND around the beginning of the year..

So you are talking about second phase has to be the NAND rather than the new player, so it’s still concentrating on there for the 3D NAND for early next year?.

Yes, I think that when we look at the other folks that are focusing on 3D NAND, there is still a fair gap between where they are in the maturity of development of those products and what we see from some of the leaders in that space.

We see the race tightening and at least one of the competitors is actually starting to accelerate their investment and we may see a pickup of that in the fourth quarter since we are now to a record there..

Thank you. And our next question is from Patrick Ho with Stifel. Your line is open..

Thank you very much. Tim, I apologize if you have already addressed this. I understand with the two of your largest customers coming down significantly in the third quarter.

Are you seeing any other markets like say DRAM, I guess would have help offset some of that sharp decline, or is that something where you see, I guess the capacity buyers in that market segment a little later versus some of your process peers?.

Patrick, I'll make sure I understand.

Are you looking for more clarity on kind of a disparity between our forward guidance and some of our peers or are you talking about in general for the industry?.

No, I think just in general for the industry because I understand there is customer concentration aspect to your decline, but I felt like other market segments like DRAM were picking up during the quarter that you would have seen some of that offset the decline from your two largest customers?.

Right, so within the quarter the results actually come out pretty much in line with what we thought. On the Q2 results in fact we are very pleased that we had for the first time ever 5% to 10% customers showing that we've got some meaningful market penetrations.

If you are talking about the guidance into the third quarter, what we are seeing is that a couple of things are occurring. One is that the 20 nanometer node has been stretched out or probably be larger than a lot of folks thought.

16 nanometer got pushed out, yields on the 3D NAND have been down and as a result they're looking at second generation vertical memory devices as the point of entry. And the fast followers on the 3D memory folks are beginning to make some technology investments that aren’t even close yet, not within the quarter or so, of ramping production.

So we saw some help from DRAM, going back into Q2, DRAM still have some spending going forward but what really turns the corner for us and why we think there will be a material snapback in the fourth quarter is going to be the foundry spending, some of the advanced logic that in particular going into the beginning of 2015, the second phase of the vertical memory devices.

And I think that on top of that we have a newer customer that is pushing pretty hard to become competitive in the 3D memory devices and that is projected to materially contribute to the snapback in Q4 going into Q1..

That’s really helpful. May be then changing the subject a bit, a lot of your customers although not may be publicly are I believe aggressively starting to work on 10 nanometers in addition to getting the ramp of FinFET out there.

From your perspective and I know it’s really early at this point, in the development work, how do you see OCD metrology for yourself in terms of the transition from the first generation of FinFET to 10 nanometers?.

So, there’s two things, what’s going on with OCD metrology and then a little of how does that reflect on Nanometrics, Patrick. First one is, we're seeing increased utilization, increased sampling of the wafers using OCD as a move into these 10 nanometer and smaller devices. We are currently engaged with multiple customers in helping that.

So we are getting -- we get early peaks and go how they're addressing it and some of the challenges going into that process.

So as you see from our investor presentation which you can find on the web, we see multiple anywhere from 15% to 25% increase in the utilization of OCD and the opportunities for OCD going down and as you scale down on the logic devices.

I think the other thing that you were talking about 10 nanometer that may come to play too if that -- there may be because of the extension of 20, you may see either abbreviating or skip of 16 to get down to 14 and 10 in order to remain competitive just because of the timing and the competitive structure and a tremendous push from the end users such as the fabless companies who are pushing very hard on the performance advantages of FinFET..

Thank you. Our next question is from Josh Baribeau with Canaccord. Your line is open..

Certainly one of the nice positives as you pointed out is the top five customers, all accounting for 10% plus, the new one of course being GlobalFoundries.

Do you view this as more of a push from Samsung which was one of your obviously a long term strong customer of yours in that partnership they have there or is there is something else going on that maybe isn’t Samsung’s process?.

Josh a good question and I think we’ve said before that we certainly are benefitted from a very strong position we have at Samsung and in their collaboration with GlobalFoundries that gives us a higher degree of visibility especially when you start looking at process transfer and process monitoring.

So yes, we're benefitted from that relationship and it's increased our position there. We also have some parallel activities within the company that are somewhat independent of that and I think we are making some progress as well. .

I think I heard too much in the prepared remarks about things going on in the back end advanced packaging in TSV, anything new to report on that front?.

As I mentioned, we’ve got follow on orders with the UniFire for advanced packaging as well and data storage where we’re actually putting UniFire into some new locations where they previously had not used the tool. So we feel pretty good about that and a growing traction of that tool going forward.

And if I kind of squint look forward, this is getting close becoming a 10% contributor to our 2014 results if everything stays on track..

Great. And I either may have missed this or just I haven’t had a chance to check the web, you said memory is 41%.

Do you have the breakout Ron of NAND versus DRAM?.

Yes. In Q2, so the breakout DRAM was about 16% and NAND was 13%. Accounts to 20% total..

Thank you. (Operator Instructions) David Wu with Indaba Global Research. Your line is open..

Yes, good afternoon. I was curious about two things.

Number one, is your breakeven on the reduced operating expenses after the restructuring around $45 million a quarter and the other question I have really is the -- at this point when you talk about rebound in the Q4, are we talking about going back to Q1 or Q2 kind of levels or are we talking about somewhat less than that?.

So talking about breakeven first. On a P&L basis, you are correct. Our P&L breakeven is in the mid-40s. On a cash flow basis it’s in the upper 30s. .

As far as the rebound, as we said it’s going to be pretty significant rebound but we are not giving guidance numbers for the fourth quarter yet..

Can you talk a little about if somebody was going to ramp 20 nanometer because there is not much competition out there and decide to push 60 nanometer to a 60 nanometer plus.

When does the orders for 60 nanometer plus show up in your order books [indiscernible]?.

So we actually have orders for the 16 nanometer, 16 nanometer plus, we're actively engaged with that. But I think probably a more direct answer to your question is when do we see a ramp in the volume of that as opposed to some of the pilot line activities. And that’s going to be first half of 2015, before you are going to see that.

Because 20 has had more legs and that a lot of people expect it and with one person having a very strong position in 20, they are not as compelled to push onto the 16 until the other ones start keep putting pressure on them in the market of 20..

Thank you. (Operator Instructions) I'm not showing any further questions at this time..

Well, thank you once again for participating in our call. As always, it is my personal pleasure to point out and recognize the amazing performance of the NANO team of employees as well as our business partners who really make it happen.

We look forward to reporting on the results of our operational and financial performance for the third quarter in October. And with that, we conclude our conference call for today. Thank you..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day..