Claire McAdams - Investor Relations, Headgate Partners LLC Timothy Stultz - President & CEO Jeffrey Andreson - Chief Financial Officer.

Patrick Ho - Stifel, Nicolaus & Co. Mahesh Sanganeria - RBC Capital Markets Thomas Diffely - D.A. Davidson & Co. Weston Twigg - Pacific Crest Mark Miller - Benchmark Company LLC Jairam Nathan - Sidoti & Company.

Good afternoon and welcome to the Nanometrics’ Second Quarter 2015 Financial Results Conference Call. [Operator Instructions] Please note that this conference call is being recorded today, July 23, 2015. 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’ second quarter 2015 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 second 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 1:00 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, margins, operating expenses, 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 outside of Nanometrics’ control, including levels of industry spending, demand for our products, shifts in timing of customer orders and product shipments, technology adoption rates, changes in customer and product mix, changes in market share, changes in operating expenses, general economic conditions and the additional risk factors and cautionary statements set forth in the company’s Form 10-K on file for fiscal year 2014 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 over to Tim Stultz.

Tim?.

revenues of $43 million to $47 million; and on a non-GAAP basis, gross margin of 47.5% to 49%; operating expenses of $20.4 million to $21 million; and earnings of breakeven to $0.06 per share. I will now turn the call over to Jeff for a detailed review of our financial performance and outlook..

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, end market and geographic region is available in the Investors section of our website.

Second quarter revenues were $48.6 million, down 3% from Q1, above the midpoint of our guidance of $45 million to $50 million, and up slightly from Q2 of 2014.

Product revenues increased 2% to $38.9 million, compared to $38.3 million in the prior quarter, while service revenues of $9.7 million decreased 19% from the prior quarter on lower upgrades as compared to the near record level of upgrades in Q1. By end market, two-thirds of product revenue in Q2 were in the NAND and foundry segment.

In particular, 3D NAND sales more than doubled over Q1 and planar NAND sales increased as well, more than offsetting the anticipated decline in the DRAM segment. NAND sales were 41% of product sales in the quarter, while DRAM comprised 16%. Foundry sales were down quarter on quarter, but remained strong at 26% of product sales.

Logic was fairly flat at 5% of product revenues and all other devices and substrates comprised 13% of product revenues, up from Q1 due to increased sales for wafer substrates and optoelectronic devices.

By product, total second quarter revenues were comprised of 60% automated systems, 13% integrated metrology systems, 7% materials characterization systems and 20% service and upgrades. Our 10% customers in the second quarter included Micron at 32%, TSMC at 17% and SK Hynix at 10% of total revenues for the quarter.

I’ll now discuss the remainder of the P&L which are non-GAAP measures unless I identify the measure as GAAP based. These measures exclude the impact of amortization of acquired intangible assets. Our Q2 gross margin was 48.8%, up 110 basis points from the first quarter and representing our third sequential quarter of gross margin improvement.

Gross margin was at the upper end of our guidance and improved toward the target model, in line with our expectations.

Product gross margin increased to 49% from 47.9% in the first quarter, largely due to improved factory utilization and other cost improvements, while service gross margin was 48%, up from 47.1% in Q1, primarily due to improved service personnel utilization and lower expenses. Operating expenses of $20.7 million were near the low end of our guidance.

We continue to make progress against our target financial model as we were able to maintain an operating profit of $3 million despite a 3% decrease in revenue.

Other income and expense included an unfavorable foreign exchange translation adjustment of approximately $350,000, equivalent to $0.01 per share as compared to a $700,000 favorable adjustment equivalent to $0.03 per share in the previous quarter.

Our tax expense for the quarter was also higher than our guidance due to a year-to-date adjustment driven by a change in the expected geographic mix of profits for the year. [Accordingly] tax expense for the remainder of the year is expected to be in the range of $400,000 to $550,000 a quarter.

Net income for the second quarter was $1.8 million or $0.08 per share. Turning briefly to the balance sheet, our cash and investments at quarter end were $74.8 million or about $3.11 per share. DSOs increased to 82 days, due mainly to – due to the timing of shipments late in the second quarter.

Inventory in the second quarter increased to $43.1 million to support our customer delivery requirements and an increase in finished goods pending customer acceptance. And with that, I will turn the call over to questions.

Operator?.

[Operator Instructions] Our first question comes from the line of Patrick Ho from Stifel, Nicolaus..

Tim, maybe in terms of the September outlook in terms of the market mix, you mentioned that 3D NAND and foundry will continue to be healthy in the September quarter.

Do you see a broadening of customers in both of those segments or are they going to still be concentrated in your largest customers from the June quarter?.

So there are actually four customers out there that are pushing on the 3D NAND area. We’ve obviously identified some of the new ones coming up front on this quarter. We’re seeing deployment in some of the other areas and I would expect to see an expanded mix of customers going forward on the 3D NAND..

And also on the foundry side, would you see a broadening of that or is that still be concentrated primarily in Taiwan?.

The foundry will stay – the mix in customers will stay pretty much the same as it’s been on the foundry side..

Maybe a bigger picture also for you, we’ve seen a lot of [indiscernible] regarding 10 nanometers and the issues that your larger customers had and been pushing that process out actually over a year, how are you seeing your development work with the customers both with them as well as others in terms of the pulls and pushes, some maybe accelerating, obviously one is pushing out, what’s the type of effort that you’re seeing on the 10 nanometer front?.

That’s a good question. We are deeply engaged in all the 10 nanometer development activities, both with our applications team and scientists as well as with our tools. I think that’s pretty well documented, the push outs on our largest customer.

We see continued commitment on the other side, but I haven’t seen anything that I would characterize as a pull in. I think most of it has been playing out the way we saw with a little bit of surprise on the very back end of the year by our larger customer with further push outs..

And final question from me on the advanced packaging market, we’re starting to see a little more activity in terms of some of the applications related to either [indiscernible] what are you seeing on that front and how do you see that marketplace progressing as we head into 2016?.

I think 2016 has the potential to be a good year for our unifier platform, which is primarily serving the advanced packaging market. As you know, we have tools in almost every major account with tool-of-record positions.

We’ve been working on both TSV, microbumps and micropillars and it’s still a low volume activity, but I think it’s a serious commitment to the development of that area and we’re seeing both in the hybrid modules as well as the interposture structures and we’re hoping that 2016 start to see maybe – begin to see an infection in the spending in that space.

That’s yet to be seen..

And our next question comes from the line of Mahesh Sanganeria from RBC Capital Markets..

Tim, the question on 3D NAND, you’re reporting 32% revenues from Micron. That suggest that you’re winning some pretty good business over there, but Samsung is also ramping pretty rapidly in Xeon fab.

I’m surprised I don’t see it there, is that more related towards Q3?.

So for us, as we look at it, as you know, the timing of the metrology investments in an area and in fact that we did win a phase 1 activity, we expect to be tool-of-record and continue to push forward on the phase 2, but it’s more of a timing issue than it is. We see Micron’s spending is ahead of what we’ve seen on the Samsung side.

But we expect that to start to play out for us..

And the second related question, I think Micron [surpasses] 3D NAND is little different in terms of like Samsung being charge strap and Micron and Intel, they’re doing floating gate.

Does that changes the content of OCD between the customers or are they similar?.

So I won’t speak directly to what technologies our customers use. We obviously are tightly bound with NDAs.

But when I look at the applications of OCD on both looking at layers and looking at the underlying active circuits, we see pretty much the same opportunity for the tools regardless of the particular strategy or structural architecture they’re pursuing..

And where do you see the capacity plan from other two customers? I mean, it looks like Samsung and Micron pretty active, do you think that Hynix and Toshiba, they are more of a next year, they will be ramping 3D NAND or do you have any visibility into something there?.

We certainly have some visibility into it as they share their plans with us. If I refer to the publicly announced statement, I think that Toshiba has talked about some fab expansion and development in OTG and thus enjoying tool-of-record positions there. We benefit with that as they populate those.

I don’t think it’s as far out as you might be suspecting right now..

Our next question comes from the line of Tom Diffely with D.A. Davidson..

So Tim, this is the first time in a decade or so that Samsung and Intel have not been one of your top three customers?.

I don’t know if it’s the first time in a decade, but I think it was like Q3 of last year was one of the first times where it’s very notable, they dropped some spending. I think they combined, they dropped like 80%.

So yeah, we’re blessed to have been successful in our account broadening strategy to get into foundries, to get into the 3D NAND and grow our integrated metrology business, which is where the spending is occurring. And I think that’s consistent with what you see in other companies too.

If you look at their revenue mixes, coming out, where they’re seeing the business, DRAM has clearly softened up, logic spending in some of the foundries has been softened and the real push has been in 3D NAND and foundry. We see that going on for at least another quarter..

That’s good news that you can have such a strong quarter without the two big guys, like you mentioned a year ago when that happened, it was bit of a disastrous quarter. So things have changed quite a bit over the last year..

We’ve worked very, very hard on this, as you know, because we were pretty exposed when we were a three-account company and having a meaningful position with the other big spenders and being able to deal with the different cycles in their spending patterns has really helped us produce more consistent revenues and performance..

So when I look at the 3D NAND spending, a year ago in the March quarter you had a nice [slot] business, then again today, for this quarter.

Is it driven by the fact that these are new facilities or is it just when they move to 3D NAND, there is no reuse going on with the older inspection tools?.

That’s kind of a two-part question, it’s a good question. So the first one is that a year ago, most of our business came from one major customer who is making a significant thrust in building a new fab and capacity and we put a lot of tools into that space.

What we’re seeing now are the other 3D NAND manufacturers finally getting, what I would call, their phase 1, they may be doing phase 2 technology nodes, it’s the phase 1 investment effort and we don’t see a lot of reuse, particularly in the integrated and metrology space, where these are being deployed on other platforms.

And so it would require a broad-based reuse of all the other platforms as well and we haven’t seen that on the 3D NAND side..

And then you made some nice penetrations into a couple of 3D NAND players, is there a chance to maybe backfill or get into their DRAM business as well at some point with kind of the split in the door?.

You are reading my strategy crib notes, yes, exactly. One of the things we’ve spoken about quite frequently about our share gains and the new positions, but we have so much greenfield space that we can still go after.

Winning 3D NAND hopefully means that we demonstrate our capability to be a good supplier with good products and have a meaningful conversation to gain incremental footprint in some of these other fabs such as areas where we have the NAND business and we don’t have the DRAM business. We’re working very hard on that..

And then, Tim, in your prepared remarks, you talked about lower level of process control spending by one of your large Asian customers.

I wonder if there is more to that and this was kind of an off quarter, is there a longer term plan to cut the intensity of those tools?.

Well, I think all of them are – all the customers are looking to reuse, but the intent of [indiscernible] was more about the timing of their spend pattern and the timing of their investments schedule..

And last question here, your nice little uptick in the other business, discretes LED, is that sustainable at all or are these kind of one-off tool sets?.

It’s something between one-off and sustainable. I think we’re opportunistic in some of those areas. We have some good spots. If you look at some of the image sensor market, there’s been some nice business for us, the optoelectronics and I think that – and even some of the alternative substrates.

It’s hard to tell at this point, at this early stage as whether or not that’s going to have multi-year traction, but right now it’s improving and it’s nice to get some incremental contribution from our materials characterization group as well..

And our next question comes from the line of Weston Twigg from Pacific Crest..

First, just wondering on the services side, it looks like it’s actually trending down a lot from $12 million to $9.7 million and then maybe roughly $6 million based on guidance in Q3.

So just wondering beyond that, do you see that coming back up and what’s a pretty stable baseline we might think about for 2016?.

The reduction quarter over quarter, as Tim said, was mainly related to some upgrade projects that finished up. The core service business is kind of growing from the low 7s and we hope to grow that to the $7 million to $8 million a quarter range.

So any fluctuation that you’re seeing is really coming on upgrade service, it’s kind of same within that band. And there is a lot of emphasis on trying to get that to grow with the installed base increasing.

So normalized run rate for upgrades is a hard thing to say, because they do fluctuate up and time and as you can see in the first two quarters, they were fairly significant, because they’re actually the biggest delta quarter over quarter..

And Wes, I would also just add to it, we have the offset in the total service revenues which reflects the decrease in upgrade sales, but we saw the margin improvement which means that operation, we are doing some pretty good things to be able to produce a 40% plus margins on just core service activities..

That’s good highlight.

I’m wondering also on operating expenses, I don’t think that you reiterated the plan to keep OpEx at $20 million to $21.5 million per quarter; maybe you did, but is that still the plan for this year?.

Well, I think you’ve seen that – what we said entering the year that was the range we wanted to operate in and that at the end of the year towards the second half, we’re trying to get down to the lower end of that. We are right about in the middle for quarter three. So we are on track with what we wanted to do with OpEx..

And then just finally, I know everybody had been asking about demand commentary, but any thoughts beyond next quarter, what mix might look like in terms of foundry, 3D NAND, DRAM, because DRAM starts to come back, et cetera, any visibility, any color on that visibility would be helpful?.

My commentary would be some wishful thinking, not enlightened thinking at times, because we can’t see that far out. But we see continued strength both in integrated and 3D NAND at this time with some increasing revenues and [pullings] on our tools.

But I think that when we start looking out Q4 and Q1, 2 of the following year, we would expect that at some point the DRAM spending needs to start to recover as demand capacity balance shifts from the way it is right now.

And we certainly would hope that our advanced logic customers start putting some tools in place for their 10 nanometer business, but we don’t see that before 2016..

[Operator Instructions] Our next question comes from the line of Mark Miller from the Benchmark Company..

First of all congratulations on your progress. I would just like to follow-up a couple of things.

In terms of your upgrade revenues, are they at higher margins on your other service revenues?.

Yes, they are above. Core service revenues fluctuate from high 30s to, as Tim said, low 40s and maybe a little bit better now with the utilization and upgrades are, I would say, high 50s, low 60s generally, depending on the content of material..

As we go to the 10 nanometer node, a lot of people especially in the logic side of chip manufacturers saying that that will be a significantly larger mode in terms of equipment than the 1614 which faced challenges with slower ramping, is that your take that the 10 nanometer provides more opportunities than what we’ve seen at 1614 for 3D?.

That falls back into that bucket of wishful thinking for us, which I think that there is some data suggest, we’ve seen a – with all the tools reuse from 22 to 14, and as they pursue the 10 nm on to 7, the technical challenges are more challenging, more difficult. We think process control plays a key role in helping them ramp to yield.

And so we’ve got our fingers crossed if that translates to increased investment in our products..

A competitor has recently – well, actually it was over a year ago, has entered the stress measurement area and it’s a relative measurement tool, I’m just wondering the pros and cons of that tool and they just reported this morning they were signing some further penetration, I’m just wondering what you’re seeing there in terms has the market changed at all?.

It’s a good question. That’s a relatively new product still in terms from being on the commercial front. We don’t really see it, we don’t do toe to toes, or head to heads with it. We have an absolute measurement and we pretty much are in a very solid position providing data that really translates to quantified stress intelligence for the customers.

And I think there is yet to be seen whether or not that relative measurement tool actually gains meaningful traction going forward. But I would just say that we are not – it’s not a market share issue for us, because we actually don’t plan ourselves competing to others..

And my last question, you talked about you didn’t see any or much possibility of reuse for 3D NAND, I’m just wondering in terms of logic, the company also reported that they were seeing some reuse some of their 28 nanometer tools, different technology of course, but they were seeing some reuse sliding over to the 1614.

Do you see much reuse in terms of the logic in terms of your measurement tools?.

Mark, I think that the reuse pressure that we’re seeing is more on the logic side than it’s been on the memory side in terms of the companies trying to shift it and in particular in the 28 drop down to 16, actually 28 and then looking at a little bit of 20 before going to 16.

The intent at that time was to buy tools that would translate straight across those nodes, at least if we’re talking about the same account. And so that doesn’t surprise me.

As we start pushing to the next node of FinFET architecture though, I think that there is a point where you have to adopt the leading edge technology and the process tools as well as metrology tools and that should work in our favor..

And that goes through 10 and seven, is that correct?.

Yes, I mean I think that tool reuse is in fact life for all of us. But I think that it depends on – yes, we are looking at how disruptive or what the discontinuities are in the process flow that affect if gone from one node to the next, if it’s a simple slide sideways, you’re going to see more tool reuse.

If they’ve made a significant change in either the device architecture, the materials they are using or any of the structures, then you see incremental opportunity for metrology and process control tools..

I would assume as that aspect ratio increases, then it gets harder and harder to make this measurements, require better lamps, better [indiscernible] that push that button?.

Yes, I think that that’s ultimately what we need to do. What we have to do is to keep bringing forward new technologies that have compelling improvements and differentiation over what was out there before that then causes the customer to buy the new stuff.

If we don’t bring out, if you don’t continuously innovate and bring new technology to the market, then they will find ways to reuse or they will be obliged to reuse the tools. So part of it is what are we doing to advance our capabilities in parallel what they are trying to advance their device challenges..

Excuse me for asking one more, but if you do integrate new detectors or new sources, how does that affect your build materials, does that change your margin profile at all?.

If we do it right, it improves our margin profile. We are working very hard, we’ve actually strengthened – it’s a good question because we’ve strengthened our supply chain management skill set, working much more closely with our suppliers on the key components.

And while we are driving improvements in the technology, there is a huge amount of pressure from our customers to give them better cost of ownership and that translates in some cases to both higher productivity and lower cost of materials, so we can offer them competitive pricing on their overall tool.

And we engage much more closely than we did in previous years with our key suppliers to try to help them drive their roadmaps while containing their costs..

And our next question comes from the line of Jairam Nathan from Sidoti..

With respect to your comment on integrated, is 3D NAND more integrated intensive, is that the point or is it just – that you are getting more share on it?.

Well, the primary reason our business is growing is share gains. We’ve seen some growth in the integrated metrology market, we see pretty high demand in the memory side of the business as compared to some of the advanced logic and some of the other areas.

But first and foremost, it’s been pretty substantial shifts in share, in market share in our favor that’s helped us grow the business..

And as far as the shift goes, [indiscernible] especially on the operating side or you don’t see that?.

Could you repeat the question? I missed that..

As the mix of integrated goes higher because of the lower ASP, does that impact your margins, on the operating margin – especially operating margin side?.

No, actually we’ve done a really good job of increasing the gross margin of the products and we’re seeing a higher volume. If you look at the number of integrated tools on a given platform, there is multiples of them. So it’s not a one-to-one.

So if you have a particular process tool that may have four chambers, there’s four integrated metrology opportunities. So they have lower ASPs, but they have a higher volume and their gross margins tend to be on par with the other tools..

[Operator Instructions] And I see no further questions. I would like to turn the conference back over to Timothy Stultz for any closing comments..

Thank you. Thank you once again for participating in our call. And thank you to all our employees and business partners whose passion and commitment to our mission in business objectives drive every aspect of any success we ultimately enjoy. With that, we conclude our conference call today..

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