Claire McAdams - IR Timothy Stultz - President and CEO Jeffrey Andreson - CFO.

Weston Twigg - Pacific Crest Patrick Ho - Stifel Nicolaus Andrew Masuda - D.A. Davidson Shawn Yuan - RBC Capital Markets.

Good day, ladies and gentlemen and welcome to the Nanometrics’ Fourth Quarter and Full Year 2014 Financial Results Conference Call. A Q&A session will be held at the end of the conference. Until that time, all participants will be in a listen-only mode. Please note that this conference call is being recorded today, February 02, 2015.

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

Thank you and good afternoon everyone. Welcome to the Nanometrics’ fourth quarter and full year 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 fourth quarter and full year 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 1:00 PM Pacific this afternoon.

The press release and supplemental financial information are also available on our website at 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 technologies, 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 the call over to Tim Stultz.

Tim?.

revenues up 18% to 28% in the range of $47 million to $51 million and on a non-GAAP basis, gross margin increasing to 46% to 47.5%; operating expenses up $21 million to $21.7 million and breakeven to $0.09 in earnings per share. With that, I'll turn it over to Jeff..

Thanks Tim. 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 end market and geographic region is available in the Investor section of our website.

Fourth quarter revenues were $39.7million, up 46% from Q3 and down 14% from Q4 2013. Product revenues increased 14% from Q4 2013. Product revenues increased 62% to $31.6 million compared to $19.5 million in the prior quarter while service revenues of $8.1 million increased 6% from the prior quarter on slightly higher upgrades.

The sharp increase in product revenue was driven primarily by increased sales in DRAM and foundry segments. In aggregate, fourth quarter revenues were comprised of 64% automated systems, 10% integrated metrology systems, 6% materials characterization systems, and 20% service and upgrades.

By end market, DRAM revenues increased 62% from Q3 to comprise 35% of product revenues in the fourth quarter. NAND revenues increased 15% to comprise 27% of product revenues and foundry revenues increased from 7% in Q3 to 27% of product revenues in Q4.

Logic comprised 4% of product revenues and the LED bare wafer silicon and discrete end market comprised 7% of product revenues. Our 10% customers in the fourth quarter included Samsung at 24%, Micron at 18%, TSMC at 16% and Toshiba at 10% 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 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 noncash tax adjustments for tax assets.

Our Q4 gross margin was 45.4% as compared to the prior quarter of 44.6%. Gross margin was within our guidance but lower than our model this quarter due to product mix, unfavorable absorption carried over from the third quarter and seasonally weaker service gross margin.

Product gross margin increased to 47.3% from 44.9% in the third quarter primarily as a result of improved factory utilization while service gross margin was 38% down from 43.9% in Q3. Operating expenses of $20.5 million were at the midpoint of our guidance and included the cost savings of several shutdown days during the quarter.

For Q1 the expected increase in operating expenses from the fourth quarter is primarily related to the typical seasonal increases in payroll and other taxes, no shutdowns and variable compensation programs.

Beyond Q1 and depending on the level of profitability and variable compensation, we expect quarterly operating expenses to normalize in the $20 million to $22 million range with the back half of the year being at the lower end of the range. The net loss in the fourth quarter was $3 million or $0.12 per share that is in the midpoint of our guidance.

Turning to the balance sheet, our cash and investments at year end were $84 million or about $3.50 per share. During the fourth quarter the company purchased 363,000 shares of stock, $5.3 million under its existing stock repurchase plan. There is approximately $6 million remaining on the total plan of up to $20 million.

Free cash flow from operations was $5.9 million in the fourth quarter. Our DSOs this quarter decreased to 59 days. Inventory in the fourth quarter increased slightly to $37 million to support the higher revenue volume expected in the first quarter. And with that, I'll turn the call over for questions.

Operator?.

Thank you. [Operator Instructions] The first question is from Weston Twigg of Pacific Crest. Your line is open..

Hi yeah, thanks for taking my question.

Number one, just logic still seems to be a bit low and I was wondering if may be you could give us some idea of when you think that customer base might pick back up this year?.

Hi Wes, this is Tim.

You know the advanced logic?.

Yeah..

Yeah, so you know, as you know the most recent rollout of Tools is kind of winding down. The next ramp of that is not expected to occur until towards the end of the year in terms of general timing and then this still is an open issue. How much of a ramp we're going to see at that timeframe. But it is certainly not any sooner than the end of the year..

Okay, and then I guess with that in mind, can you give us an idea in terms of how big you think the OCD market is now or may be was in 2014 and then how big it might be by the end of 2015?.

We believe that the OCD market grew about 20% year-on-year between 2013 and 2014 and that's right around $200 million in total. We think that it is going to at least keep pace with the overall spending trends perhaps a little upside to that..

Okay and then, just finally and then I'll get back in the queue after this, but just on gross margin, it looked a little low, I thought it might be a bit higher on the Q1 guide, just wondering if you can give us any idea at what revenue level you think you might get back above 50% gross margin?.

Hey Wes, it's Jeff. Yeah this quarter the guidance is a little lower than our model because we're still carrying some of that unabsorbed for lower absorption in the factory and into our Tool margins and so I think once we can sustain $50,000 or near $50,000 run rate we should be able to see 50% gross margins.

It could happen earlier if the mix is favorable, but certainly we're looking at that. There's lot of programs focused around improving costs as we get into the second half of the year..

Okay, very helpful, thank you..

Thank you and the next question is from Patrick Ho of Stifel Nicolaus. Your line is open..

Thank you very much.

Tim maybe first off in terms of the industry outlook with a lot of the moving pieces with certain customer segments, how do you see the first half shaping up in terms of overall spending trends particularly on the foundry side where you've made these penetrations? Are you concerned about any moving pieces from quarter-to-quarter or do you see that somewhat firming up based on your visibility?.

Yeah Patrick thanks, good question. I think there's always a risk of things moving around quarter-to-quarter whenever held up certainty. But if I characterize the first half and what drives I think the industry drivers will be we're seeing continued strength in the foundry logic area and we're seeing a continued spending in DRAM.

What we're not seeing is a lot of strength in the next generation 3D NAND or the advanced logic which we think is more of a second half back end of second half event..

Great, that's really helpful. May be Jeff a question for you, may be just following off of Wes' question, you mentioned second half you should start seeing the gross margin level begin to track towards your normalized model.

As the year progresses what is I guess the biggest variables, is it customer mix, absorption, product mix, what's going to be the biggest influence for you to get back to your normalized operating model?.

Yeah, well I think some of it is going to be customer product mix, of course in Q1, it is really, I think the other big leverage are going to be some initiatives we have around driving material costs down and efficiency through the factory and the service organization, may be kind of being evaluated..

Great, thank you very much..

Thank you, and the next question is from Tom Diffele of D.A. Davidson. Your line is open..

Hi, this is Andrew Masuda calling in for Tom.

Tim, I was just wondering if you could give us I guess your view of NAND spending throughout the year and may be kind of differentiate between planar and expectations for 3D?.

Yeah, well that's a good question Andrew.

So we see continued investments in next generation planar NAND, so it is a backup to what's going on in 3D NAND and 3D NAND yields have not been, it didn’t come on line as rapidly as we were hoping and also the number of peers that were going to be needed for 3D NAND to reach kind of a price performance parity has gone up.

So it started out at 24 pairs, going to 32, many folks are going to the 48 to 50 side of it.

So, what we're seeing is payroll investment in all the memory customers both in the planar and that's ongoing now and then the, with what we got, one leader in the 3D NAND side who has got, had a pause between Phase 1 and Phase 2, while the other ones are trying to do a little catch it by technology investments and getting the first generations launched..

Okay.

And what's your timing on the expectation of that, the customer who is in the lead on the 3D NAND spend, when would you expect to see them pick up spending for the second phase of investment?.

Yes, that's a good question which I wish I had a precise answer, but based on everything we're seeing by now it is a late second half subject to the fact that if they can get the yield and or the pricing within the NAND market shifts.

But under the current economic environment, the current pricing and the current yields, I think it's a back end of second half..

Okay. Great. And then just one question for Jeff.

Is there any meaningful foreign currency exchange exposure to the yen or the euro for you guys?.

We -- obviously this last quarter it moved a lot, and it was a couple of hundred thousand. So we try and manage it fairly closely. We don't do a very aggressive hedging strategy. We were looking at doing one on the balance sheet side eventually, which would help improve that, at least quarter-to-quarter..

Okay. Thank you..

Thank you. [Operator Instructions] And the next question is from Weston Twigg of Pacific Crest. Your line is open..

Hey, thanks for realigning me back again. I just had a couple more questions. One just wanted to spend a second on your long-term model that you presented last month at a conference. It occurred to me that that's significantly lower than the previous model that I had been looking at from a couple of years ago.

The old model showed revenue over $80 million a quarter, gross margin over 55%. And the new model is showing revenue over $65 million a quarter and gross margin over 52%.

So I'm just wondering if maybe you could help us understand what has changed from your perspective over the last couple of years to drive a lower target model?.

Well, I think one of the biggest changes from the last model was that we had a fairly large MC business factored into that, I think. And that -- those are a little bit higher margins. But other than that, I think if you look at the flow-through, it's not woefully off that model..

So Wes, another thing too, is that we are trying to identify -- with the new model, its like, how soon do we get back onto the model. So if you look at the earlier one, that we felt we had to reach to a higher revenue levels to get onto the model in a meaningful way.

And actually I would look at the new model as more optimistic, showing that we're going to get onto our contribution margin model at a lower revenue run rate than the previous one you're referring to..

Okay.

So trying to give us an idea, in terms of just a more realistic midterm revenue target, rather than kind of a longer term?.

No, absolutely. I mean, so, if you go back, there was enough uncertainty at that time as to when we would be able to get back on the model. And so we wanted to identify at what the revenue levels would we comfortably and confidently get back on the model.

And you can see that drop in the model down to the $60 million, $65 million from the $80 million means that we have a lot more confidence of getting onto a robust financial model at a lower revenue level. And that you should see the leverage go forward after that, starting with a lower point..

Great. Okay. And if I could, I have a couple more questions. One, just wondering if you could comment on the new competitive win for Atlas you had in the fourth quarter. It looked like that was for 3D NAND. Is that right? And if you can give us any idea, in terms of like color or timing of when that might contribute that would be helpful..

Yes, so, it was. It's a new win. It was another one of the head to heads. They've added nicely to our -- both our tool rec position, as well as our customer position. As far as timing, we're already recognizing revenue benefit from that. And as that particular customer starts to fill out their fab and drive up the ramp, we should benefit accordingly..

Okay. One more question. There was a large order filed on the Taiwan Stock Exchange with TSMC. I think that was the first time I've seen you show up in their filings. I was just wondering if you could comment, I think it was roughly a $21 million order. If you can comment on sort of how you see that customer tracking through the year.

Do you think that -- something that would represent the full year, or would there be upside maybe to that business throughout the year?.

Yes, that's good. I'm glad to try to clarify that one, as well. So, it was nice to see us reported by TSMC. That's a nice one. You're right, as far as I know, that's a first for us. But I think the important point is that that number represents an accumulation of business over the year, it wasn't a single order. So it's good business.

They continue to be a strong customer; obviously hit the 10% mark again this quarter. And we see good, solid position and a growing opportunity with them. But it wasn't a single order, Wes..

Okay. Got it. And then, maybe just finally on the foundry side. I haven't done the math yet to see what the foundry revenue was in 2014.

But can you give us an idea of what you think that will be in 2015, as the FinFET ramp gets underway and you benefit from some of these recent wins? Maybe as a -- I don't know as a percentage of the total or percentage growth year-over-year?.

Do you want to speak to that, or do you….

I'm just saying that the foundry ended up being $27 million, almost $28 million, right?.

21%..

21%, yes. And year-over-year growth, I don't know if we're ready to give you year-over-year growth color at this point. But foundry is still, I think, relatively strong in the first half..

All right. Thank you very much..

[Operator Instructions] And the next question is from Mahesh of RBC Capital Markets. Your line is open..

Hi, this is Shawn Yuan for Mahesh. Thanks for taking my questions. Tim, I looked at your DRAM revenue. It's been at a very high level for through 2014. And that, we're thinking is mostly driven by capacity addition, as well as conversion to 25-nanometer.

And then in your prepared remarks, you mentioned that in 2015, it looks like DRAM is going to continue at a high level, driven by 20-nanometer conversion.

Can you quantify your opportunities from 25 to 20-nanometer? Could the revenue stay at the same level or higher or lower?.

It's a good question. I won't quantify it, but there's two things I'll refer to. One is, if you referred to our IR presentation, we show the incremental opportunity per 10,000 wafer starts going from the 25 to 20-nanometer.

But on a qualitative basis, I believe that 20-nanometer represents anywhere from about a 12% to a 15% increase, incremental benefit to us over the 25. And as long as we sustain our competitive position on those key accounts, which we're doing our best to do, that should be the upside to our DRAM revenue expectations..

Great, thanks. And then one more question on the overall revenue. When we look at 2014, your revenue grew up almost -- around 15%. So it's roughly in line with the WFE market growth, 10% to 15% range, for 2014. And then for 2015, you are looking at 5% to 10%.

So do you think your revenue is going to grow along in line with the market, above or below? And then you also in your Q&A session, you said that OCD market is going to be up about 20%.

Do you think you're going to be able to outgrow the market in 2015?.

So, good question. Let me step back to the first observation. So, our total revenues grew about 15%, which is a few percentage points higher than at least most folks are calculating the growth in the WFE spending. Importantly for us is that our product revenues grew 24%.

And if I take our product revenues that are -- face the semiconductor industry and excluding materials characterization, those revenues grew 32%. So our semiconductor when we compare against WFE, which is a semiconductor market, we have materially outpaced the industry spending year-on-year going into 2014.

With the share gains that we've got, the new tool positions we have and the outlook, I think we're going to continue to outpace and outperform the industry against WFE spend going into next year..

Okay. Thanks, Tim..

Thank you. [Operator Instructions] And at this time, there are no further questions. I would now like to turn the conference back over to Tim Stultz for closing remarks..

Thank you once again for participating in our call. In closing, I bring your attention to the terrific contributions of the NANO workforce who are committed to driving increased stakeholder value and are united around the vision and mission of our company.

We look forward to reporting on the results of our operational and financial performance for the first quarter results in April. And in the meantime, please be on the lookout for an invitation to our Investor and Analyst Day in New York, scheduled for June 3rd. With that, we conclude our conference call today. Thank you again..

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day..