Claire McAdams - Investor Relations Timothy Stultz - President and Chief Executive Officer Jeffrey Andreson - Chief Financial Officer.

Weston Twigg - Pacific Crest Patrick Ho - Stifel Nicolaus Josh Baribeau - Canaccord Mahesh Sanganeria - RBC Capital Markets.

Good day, ladies and gentlemen and welcome to the Nanometrics’ Third Quarter 2014 Financial Results Conference Call. A question-and-answer session will be held at the end of the call. Until that time, all participants will be in a listen-only mode. Please note that this conference is being recorded today, October 28, 2014.

At this time, I would like to turn the call over to your host, Claire McAdams. Please go ahead..

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

Then, Jeff 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 also 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 general economic conditions, changes in timing and levels of industry spending, the adoption and competitiveness of our products, industry adoption of new technology and manufacturing processes, customer demand, shifts in timing of orders or product shipments, timing of product acceptance, 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 over the call to Tim Stultz.

Tim?.

Thank you, Claire. Good afternoon, everyone and thank you for taking the time to join us on our call today. Before going into my prepared remarks on the business, I have a couple of organizational announcements to make. First, I am pleased to welcome Jeff Andreson to our executive team as Chief Financial Officer.

Jeff brings to Nanometrics an incredible pedigree of functional and management expertise, industry experience and a track record of operational excellence. He is a welcome addition to my staff and is already making meaningful contributions to our company.

Second, it is with mixed emotions that I announce the retirement plans of Bruce Crawford, our Chief Operating Officer. Bruce is a long time industry veteran who played a key role in helping us turn Nanometrics around during some very trying times.

Bruce has decided to make the December quarter his final quarter in the business world and will be retiring at the end of the calendar year. While I hate to see him go, I am happy to see him have more time to pursue his love of the outdoors and time with his family.

We thank him for all his contributions over the last 8 years at Nano and wish him the very best in his next phase of his life. Now, turning to my prepared remarks, I will comment on the highlights of the quarter, make some brief observations on the industry environment and business outlook and provide guidance for the December quarter.

Our third quarter financial performance came in largely as forecasted. We experienced the expected decline of greater than 80% in process control spending by our two largest customers, which was offset in part by business recently won at the world’s second largest memory company.

Micron for the first time became a 10% customer and is expected to continue to be a strong contributor to our revenues in the quarters to come. Our share gains at this customer were across multiple product platforms for tools to be used on its leading edge devices following successful head-to-head competitions against incumbent companies.

Up until the second quarter of this year, three customers principally drove Nano’s business. In the second quarter, for the first time ever, we have five 10% customers, adding two important pure-play foundry customers to the mix.

This quarter, we added Micron to our key customer list and can now point to having tool-of-record positions at each of the top seven wafer fab equipment spenders.

Additionally, in the third quarter, we added another pure play foundry customer to our tool-of-record list following a successful head to head competition that resulted in the purchase of our complete NanoCD suite including our flagship Atlas tool and NanoDiffract software for the development of their next generation FinFET devices.

These wins are further evidence of the progress we are making in penetrating new customer accounts, diversifying our customer base and expanding our footprint as well as the specific focus on growing our pure play foundry business.

As we have repeatedly said, major technology inflection points and architectural changes such as FinFET, 3D NAND, advanced packaging and advanced process control methodologies are key opportunities for Nano to gain share and increase our footprint and outpace industry growth.

In addition to our competitive success in these areas, there are three industry trends which are further driving an upside to our business. First, critical dimension feature size reductions or shrinks are becoming increasingly more difficult particularly in the phase of continued delays in UV lithography.

This has led to widespread adoption of complex lithography methodologies such as double and triple patterning which in turn drives an increase in demand for process control metrology tools.

Second, new device architectures and process flows are more complex than ever requiring tighter monitoring and control to extract process results with reduced tolerances.

This is leading to a broader adoption of advanced process control methodologies, where data from our tools is being used in feed forward and feed backward strategies to control and extract better performance from process tools.

And thirdly, our customers’ highly competitive environment combined with the economics of new device development puts a very high premium on time to yield in concert with aggressive high volume ramps.

Our tools and modeling algorithms are playing a key role in helping these customers rapidly develop new devices, get their processes under control, improve their yields and support their rapid manufacturing ramps. All in all, this creates a very exciting business environment for Nanometrics.

We believe we are well positioned to continue to take advantage of these opportunities with our technologies, product platforms, demonstratability to compete and win tool-of-record positions and ongoing close collaborations with our key customers.

As we look towards 2015 and beyond, analysts predict another year of growth and continued robust spending on wafer fab equipment. The industry is also experiencing continued customer consolidation where major shifts in spending by a single large customer can result in short-term volatility.

We have successfully mitigated this to some extent by diversifying our customer base. However, no one is completely immune to these swings as evidenced by the quarterly fluctuations experienced by even the largest equipment suppliers in our industry.

The other side of consolidation in our customer base however, is a more disciplined approach to investment strategies. Because of this we do expect a continuation in reduced long-term cyclicality in spending on fab equipment and this is basically good news.

Another relevant industry trend is the shift in the end user demand for our customers’ products to the consumer market driving increased competition for higher performance devices with reduced product lead times and shorter lifecycles.

This translates to pressure on us, the equipment suppliers to also reduce our lead times and have the ability to respond to rapid changes in tool demand and deployments with short notice. While this is very challenging, particularly in the areas of supply chain and inventory management, we believe it is also an opportunity to differentiate ourselves.

Having a flexible business model that can respond to rapid changes and offer burst capacity, can lead to an additional competitive edge in an already highly competitive environment. This is – this impact will be a key area of focus for our operations team in 2015.

Turning to our financial model and outlook, we have recently taken steps to consolidate some of our international engineering and development activities into our domestic operations. We expect this will result in greater efficiencies and product development, improved time-to-market and reduced operating expenses.

We have also been driving to improve our gross margins through cost reductions, as well as improved value selling, which translates to higher selling prices. We are seeing progress on both of these fronts and continue to expect to return to 50% or better gross margins as our revenues grow and we are able to leverage these improvements.

Summing it up, we have a very optimistic business outlook going forward. We are serving the right markets with the right products at the right time. We continue to make share gain on leading-edge device applications with the leaders in the semiconductor industry who are expected to simultaneously wrap new technologies next year and into 2016.

We are improving our gross margins across multiple product platforms and trimming our operating expenses. Coming of a low quarter we see a market uptick in revenues as we end the year and continue growth going into 2015.

And we have a global infrastructure in place to support significant quarterly revenue increases with minimal incremental spending leading to a strong and leverageable financial model.

Combining our established competitive positions and focus on operational execution and the current forecast wrinkly spending by our key customers, we believe we are well positioned for growth, outperformance and profitability in 2015.

Turning to our near-term outlook, we see continued strength in the memory market primarily for DRAM and 3D NAND devices. Spending in the foundry market for 16-nanometer, 14-nanometer foundry production is also expected to increase. And we are seeing increased demand for our UniFire for advanced packaging applications.

Revenues up 33% to 47% in the range of $36 million to $40 million and on a non-GAAP basis gross margin of 43% to 47%, operating expenses of $20 million to $21 million and a loss of $0.08 to $0.24 per share.

Our expectations for the fourth quarter should result in year-on-year revenue growth outpacing the industry with several large customers each contributing to our company’s revenues and meaningful contributions by each semiconductor end-markets, including both Planar and 3D NAND, DRAM logic and importantly pure-play foundry.

Well we are not providing guidance beyond Q4 at this time we do expect another uptick in sales for the first quarter of 2015.

Jeff?.

Thanks, Tim and I am very happy to be here on my first earnings call with everyone.

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, customer and market and geographic region is available in Investor section of our website.

Third quarter revenues were $27million, down 44% from the prior quarter and down 31% from Q3 2013. Product revenues decreased 50% to $19.5 million compared to $39.2 million in the prior quarter, while service revenues were down 13% to $7.6 million from $8.8 million in the prior quarter.

As expected, the decline in product sales reflected a significant decline in process control spending by our two largest customers partially offset by increased sales to Micron. The decline in service revenues was a result of lower upgrade business during the quarter.

In aggregate, third quarter revenues were comprised of 59% automated systems, 6% integrated meteorology systems, 7% materials characterization systems and 28% service and upgrades. By end market, DRAM revenues increased 6% from Q2 to comprise 34% of product revenues in the third quarter.

NAND comprise 39% of product revenues, while logic and foundry end markets comprise 1% and 7% of product revenues respectively. The LED bare wafer silicon and discrete end market comprise 19% of product revenues. Our 10% customers included SK Hynix at 27% and Micron at 25% of total revenues for the quarter.

As a reminder, our revenue segmentation information is available on our website. I’ll now discuss the remainder of the P&L metrics which were non-GAAP measures unless I identify the measure as GAAP based.

These measures exclude the impact of amortization of acquired intangible assets, restructuring charges and the valuation allowance for our US deferred tax assets.

Our Q3 gross margin was 44.6% lower than the prior quarter due to the decreased sales volume but 3 percentage points above the midpoint of our guidance primarily due to favorable product mix and higher utilization of our field service operations.

Product gross margin reflected the decline in tool sales volume and factory absorption and was 44.9% while service gross margin was 43.9%, down from Q2 on lower upgrade sales, but still reflecting solid gross margins on our core service business.

Operating expenses, up $20.2 million were near the low end of our guidance, as we continue to defer discretionary spending more possible, pending the expected rebound in revenue levels. As announced last quarter, we’re in the process of consolidating our UK engineering operations into the United States.

In order to improve operational efficiency, reduce redundancies and eliminate certain overhead costs. These efforts resulted in a GAAP restructuring charge of $1.7 million in the third quarter. We expect to incur an additional $300,000 to $500,000 in restructuring costs in the fourth quarter relating to this activity.

Going forward, we expect the full impact of these efforts to result in an ongoing OpEx reduction of at least $500,000 per quarter by Q2 2015. And that loss for the third quarter was $5.9 million or $0.24 per share, around the midpoint of our guidance. Our GAAP net loss includes a non-cash $21 million valuation allowance on our U.S.

deferred tax assets, recorded as a result of our U.S. profits falling into accumulative three year loss. On an ongoing basis, we expect to incur a nominal tax expense each quarter related to our foreign profits. For Q4, this will be approximately $300,000 and I intend to provide the expected tax expense reflected in each quarter’s guidance.

Turning to the balance sheet, at September 27, our cash and investments were $84 million or about $3.50 per share. Our DSOs increased to 86 days, above our historical experience due to the majority of Q3 shipments taking place in the last month of the quarter. Inventory decreased about $1.8 million to $36.3 million at the end of the third quarter.

And with that, I will turn the call over for questions..

Thank you. (Operator Instructions) Our first question comes from the line of Weston Twigg from Pacific Crest..

Hi, yes. Thanks for taking my question. I just wanted to ask a little bit more about foundry traction since that seems like it should be a good growth driver next year. So, I am wondering if you are seeing any evidence of the 14 nanometer or 16 nanometer FinFET ramps today and what that looks like in Q4.

And then the outlook of that ramp maybe through the first half of 2015?.

Yes. Weston thanks for calling in. We are seeing that we expect to see some support of our business and growth drivers come out of the 16 nanometer, 14 nanometer, a little bit now, but most of it is the front end of 2015..

Is that across several foundries right now, are you seeing primarily one or two or could you give maybe some color on just the level of activity?.

Yes, I would say that we have got one strong leader. The other people are still lagging in terms of ramping on production, but you have someone ready to turn on the factory..

Okay, good.

And then just finally, could you maybe give us an idea of your thoughts on the IBM global foundry agreement, given that you have historically relatively low exposure to IBM?.

Yes, I don’t think it’s really that material to us. Our primary – we don’t have a great position at global as we all know, but we have had gotten some additional traction and a little bit of movement as a result of our relationship with Samsung and their relationship with the global.

I think that the IBM global transaction is more about people and IP and some advance development than it is about near-term 16 nanometer, 14 nanometer FinFET..

Perfect, very helpful. Thank you..

You bet..

Thank you. And our next question comes from the line of Patrick Ho from Stifel Nicolaus..

Thank you very much. Tim, on your prepared remarks, you talked about shorter lead times that you are seeing as well as those across the industry. And you also talked about the no transitions are moving faster and faster.

Does that help you in terms of qualifications, in terms of you are not only qualifying for one node, but you may be working with the customer to get them across let’s say two or even three nodes.

How do you see the qualification process and particularly some of the share gains you have generated over the past few years?.

Hi, Patrick. Yes, that’s a good question. I don’t think there is a single engagement that we have that doesn’t encompass multiple node activities, so we need to have product roadmaps.

We have to show that we certainly are competing for a particular node, but the discussions include our product roadmap and what our product solutions would be as applied to the next node. Because of the short lead times, there is short time for qualification.

Also in a number of accounts they are trying to take the process flow from one node to the next with as little change as possible. So we would like to use similar tool sets if not the exact tool sets..

Right, that’s helpful.

And then maybe either for you or Jeff in terms of how you are changing your supply chain as well as your inventory management given the shorter lead times, are there changes that you are doing right now or is that something we should keep an eye on over the next 12 to 18 months as the dynamics of the industry change?.

It’s a little bit of both, but it’s really a big deal for us next year. We have been a little more reactive to it and it kind of shakes up the factory when we get rapid changes in demand. But we are certainly looking through our – we have been working with our supply chain. We are looking at what we can do with our key suppliers.

What we can do for a burst capacity there. We are looking at what do we need to do on inventory management. We are looking platform commonality. We are looking at our long lead time items and deciding whether or not we have to consider small increases in inventory to make sure we can be responsive on particularly long lead time items.

We are also looking at factory floor efficiency, build cycles and we are just – we are looking across the entire board. And I think it will be an area that we will improve on materially in 2015 and going into ’16..

Great.

And a final question for me, you noted on your prepared remarks about DRAM and planar NAND being strong for you this quarter, what’s your big picture take of 3D NAND and the adoption there, do you see continued yield issues or is it more of a demand/kind of cost issue in the near-term?.

Yes. I think it’s both, I mean because yield translates to cost parity. Where we are seeing is a pretty aggressive step. They went 24 to 32 layers.

Most of them are starting to think about the 6X layers, I think that the 3D NAND problems in terms of the challenges on performance and price are pretty substantial which pushes – push some of the investment that we expected towards the end of this year into the latter part of next year. Planar continues for next at least two technology nodes.

And I think that there is – then it splits the market on performance and prices they can charge..

Right. Thank you very much..

Thank you. And our next question comes from the line of Josh Baribeau form Canaccord..

Hi, thanks.

Looking at yield issues in foundry or FinFET, a little bit differently, rather than leading to push outs of capacity expansion, are you seeing so maybe increase in early order activity as a result of maybe part of the debugging process, as a result of the yields?.

But we will certainly get some benefit on the technology side as we try to help them in the R&D or the pilot development areas. But there is really only one customer out there that’s got meaningful capability. And they are getting poised for a ramp and we hope that should contribute nicely to our business going into the first part of next year..

Okay.

And then have you had obviously Micron is I think this is the first time you have talked about them publicly, have you talked about some of the applications that you are – that you have won there?.

Well, it’s primarily in the memory space and there is multiple tools, multiple platforms in different areas of the fab. But we are working with them on their 3D memory devices..

Okay.

Any – so that’s what you are currently recognizing the revenue for 3D?.

Well, that’s a business that we have won is primarily on the device. We haven’t made – there has been no material changes in the DRAM, there wasn’t any open competition in that area. So it’s both the memory cube area and the 3D NAND..

Very good, alright. Thanks. That’s it for me. I will pass it on..

(Operator Instructions) Our next question comes from the line of Mahesh Sanganeria from RBC Capital Markets..

Thank you. Tim, first apologies for sending an email out say – saying that you guided ES positive, I guess though my wish reflected what I read on the press release rather than actually reading it.

But coming back to my question in terms of OpEx, I think last quarter, you guided that the OpEx is going to decline from the December quarter, is the OpEx increase a reflection of your optimism on 2015 first half?.

No, I am not sure which comments you are speaking to, but I think what we have consistently said is that OpEx in the Q3 and Q4 would be down from OpEx in Q1 and Q2 of the year based both on the timing of certain things like your payroll taxes as well as the timing of some of our investments and materials and the NRE in the engineering as those programs wound down.

So, that was – that’s without any restructuring. That was just kind of the trend at OpEx. We also spoke to the fact that changes we are doing on the international structure that we mentioned on our remarks earlier in the UK facility.

Once all is folded in and it plays out would represent about $500,000 per quarter or $500,000 on a quarterly basis lower spend than we had previously, but that wouldn’t play out to the end of the second quarter going into the third quarter..

So, for now we should be modeling close to $20 million and going to $19.5 million in the second half of next year?.

Well, what you have to include in your modeling is that there is always the beginning of the year we are going to have some adjustments to salaries. You also start paying more on your payroll taxes. So, there is a typical seasonal bump going in the first half of the year and then coming off of that bump would be the benefits of the restructuring.

Jeff, would you like to add anything to that?.

I would just say in Q4 too, we also have some variable cost reductions. We have implemented to manage the business as well. And so I don’t think we are going to be coming much out of the range that we have talked about for Q4, but the restructuring will help us make some of those permanent..

Okay.

And then in terms of business overall, I know it’s the lead times have come down, but as Tim as you have talked with the customers, different customers, how far is or how good is your visibility? Do you see the whole year the customers are talking positively or it’s more very strong first half? If you can give us some color on how those conversations are going?.

Yes, we usually talk about whether or not near-term visibility is improving. If I give you just my gut feel to what’s going on, near-term visibility outside of one quarter, I mean certainly within one quarter, we have very good visibility, but outside one quarter has uncertainty because of the rapid swings.

Longer term visibility I feel better about, I feel better about the fact that I know that there are fabs going on. I know there are new devices being built. I know there are ramps being scheduled and I know that we have tool-of-record positions.

So, I think when I kind of squint into the long range, I feel much more comfortable that 2015 should be a good year based on where we are, what our customers are doing, the 16-nanometer 14-nanometer FinFETs, the 3D NANDs, the continued DRAM, our foundry position, our advanced packaging.

But what happens is outside of one quarter, that’s where my uncertainty is actually the largest, 60 days out rather than 90 days to 180 days out..

Okay.

But so on Nanometrics specifically, because you talked about having a diversified customer base, can you give us a sense of how should we model that for next year? I mean, if you think the market is up 5%, the new customers, what do you think that, that can add to your top line numbers?.

Well, I am not going to give you the – I am not going to get into quite that level of guidance as much as I would love to, Mahesh, but I will tell you that if the market is up 5%, we expect to beat that.

We believe that with the new positions, the market share gains and the areas where our tools are going that our revenue growth will outpace spending increases in WFE..

Okay, that’s very helpful, Tim. Thank you..

You bet..

Thank you. (Operator Instructions) And that concludes our question-and-answer session for today. I would like to turn the conference back to Dr. Timothy Stultz for closing comments..

Thank you once again for participating in our call. I am blessed to be surrounded and supported by an outstanding team of employees who make it all happen. By bringing commitment and performance to our company, they never fail to make me proud, always doing their best to create incremental value for all our stakeholders.

Finally, we look forward to reporting on the results of our operational and financial performance for the fourth quarter and year end results next February. With that, we conclude our conference call today. Thank you..

Thank you. Ladies and gentlemen, thank for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone have a good day..