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

Patrick Ho - Stifel Nicolaus Tom Diffely - D.A. Davidson Mahesh Sanganeria - RBC Capital Markets Weston Twigg - Pacific Crest Security Mark Miller - Benchmark.

Good afternoon and welcome to the Nanometrics’ Third Quarter 2015 Financial Results Conference Call. A Q&A 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 call is being recorded today, October 29, 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’ third 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 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 1:00 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, 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 including general economic conditions, changing in timing and levels of industry spending, the adoption in competitiveness of our products, industry adoption of new technology and manufacturing processes, customer demand, shift in timing of orders and 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 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?.

Thank you, Claire. Good afternoon, everyone and thank you for taking the time to join us on our call. Today, I'll speak to the highlights of the September quarter, discuss the drivers behind our business results and revenue outlook and finish with our guidance for the December quarter.

Following my prepared remarks, Jeff will provide additional details on our quarterly financial results, after which we'll open the lines for Q&A. Our third quarter came in largely as expected; however with revenue mix that deferred somewhat from our initial expectations.

We saw a higher mix of high margin upgrades, which helped drive gross margin above the high end of our guidance range. Notably this was our fourth straight quarter of gross margin improvement and the second quarter wherein the gross margin improvement was achieved on lower sales volume quarter-on-quarter.

Margin improvement has been an important area of focus for us and we're pleased to see our efforts in driving operational improvements and maintaining tight cost controls bearing fruit. We're working hard to improve our overall financial performance by driving further operational efficiencies and improvements in our cost structure.

Turning to our business drivers, we saw continued strength in 3D NAND and balanced spending as those two sectors represented greater than 50% of our product sales for the third quarter in a row. We expect this revenue trend to continue into the fourth quarter as well. Our DRAM business continues to be solid in the third quarter.

However, we do see a significant softening in DRAM spending in Q4 as investments in that market are shifting into early 2016. I would characterize we do DRAM spending as being the chief change to our near term outlook, while low spending on advanced logic continues to be a drag on our overall revenue story.

On the product side, our integrated metrology business has been firing on all cylinders with 80% quarter-on-quarter revenue growth following 30% growth the previous quarter. Our first half 2015 revenues from this product group doubled over the second half of 2014 and we expect a similar magnitude increase in the second half of this calendar year.

As a result, we are on track to achieve record level revenues in integrated metrology for the full year 2015, which clearly indicate our strength -- indicate our share gains in this segment. Now I would like to make a few comments about our overall business outlook and in particular our performance relative to industry spending for the year.

Our fourth quarter guidance indicates a quarter-on-quarter revenue decline of between 6% and 15%, primarily resulting from the softening in near term DRAM spending. Generally speaking, this quarter-on-quarter decline is less pronounced than the outlook as already given by many of our peers with a similar exposure to the memory market.

Further given the expansion of our customer base, share gains and success in 3D NAND and foundry businesses we're actually looking forward to another solid year of growth for 2015.

Our revenues are up 14% year-on-year for the first three quarters and we're still on track to achieve double-digit revenue growth for the full year 2015 for the second year in a row and to outperform spending by at least 10 percentage points.

Also worth nothing are the year-to-date margin improvement and P&L flow through associated with our revenue growth. Since the fourth quarter of 2014 we've increased our gross margin by more than 400 basis points.

At the midpoint of our Q4 guidance our full year gross margin flow through of about 60% and our operating margin f flow through of about 70%, both exceed our operating leverage objectives.

As we've mentioned before, the growth in our business is a result of market share gains as well as the increase in use of our flagship OCD technology for advanced technology and leading edge note applications.

Notably in 2015 we're expecting record sales for the foundry segment, in addition to high levels of business from investments and ramps and 3D NAND devices. We also expect to achieve record sales to TSMC, Micron and Toshiba, further demonstrating the success we've had in expanding our customer base.

And as I mentioned earlier, our integrated metrology business is tracking to record levels as well.

In summary, Nanometrics has executed well against our strategic initiatives, targeting key technology inflection points with leading edge solutions, growing our foundry business to record levels and winning tool-of-record positions at multiple new accounts.

All this, while also improving our gross margin, demonstrating strong P&L flow through and improving our bottom line performance. Our work on improving our performance is far from over. However, we believe our focus and trajectory are clearly moving in the right direction as we look beyond Q4.

With that, our guidance for the December quarter is as follows, revenues of $39 million to $43 million and on a non-GAAP basis gross margin of 47% to 49.5%, operating expenses of $20 million to $20.6 million and earnings of breakeven to a loss of $0.10 per share.

I'll now turn the call over to Jeff for a detailed review of our financial performance and outlook.

Jeff?.

Thanks Tim. Before I begin my comments, I would 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 Investor Section of our website.

Third quarter revenues were $45.7 million, down 6% from Q2 above the midpoint of our guidance of $43 million to $47 million and up 68% from Q3 of 2014. Product revenues declined 6% to $36.4 million compared to $38.9 million in the prior quarter and service revenues of $9.3 million decreased 4% from the prior quarter due to a lower level of upgrades.

By end market over 80% of our product revenues in Q3 were in the memory and foundry segments, a similar profile to the second quarter. In particular NAND sales represented 33% of product revenue and consisted primarily of 3D NAND shipments. DRAM sales comprised 22% of product revenue.

Foundry sales remained strong and were similar to Q2 levels comprising 27% of product revenues. Project sales increased slightly to comprise 7% of product revenues and all other devices and substrates comprised 12% of product revenues.

By product, total third quarter revenues were comprised of 46% automated systems, 24% integrated metrology systems, 10% material characterization systems and 20% service and upgrades. Our 10% customers in the third quarter included TSMC at 17%, SK Hynix at 15%, Micron at 14% and Toshiba at 13% of the 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 Q3 gross margin was 49.7% up 90 basis points from the second quarter and represents of poor sequential quarter of gross margin improvement.

Gross margin exceeded the upper end of our guidance primarily due to some upside in high margin software upgrades delivered in the quarter.

Product gross margin decreased to 47.2% from 49% in the second quarter, largely due to product and customer mix, while service gross margin improved significantly to 59.5% from 48% in Q2, due primarily to the incremental software upgrade shipped during the quarter and to a lesser extent better service personnel utilization.

Operating expenses of $20.9 million were near the high end of our guidance due to the timing of R&D materials expenditures.

Our expectation going into this year was to maintain quarterly operating expenses in the range of $20 million and $21.5 million per quarter with back half of the year being in the lower end of this range as reflected in our Q4 guidance.

We're making progress on our operating model by continuing the drive addition operational efficiencies across the company. Our GAAP operating expenses for the fourth quarter will include approximately $1.3 million of cost associated with the restructuring, the company executed in October.

The goal of the restructuring was to better align across functional organizational and business units as part of our effort to improve our operational efficiency.

Other income and expense included a favorable foreign exchange translation adjustment of approximately $300,000 equivalent to $0.01 per share as compared to $350,000 unfavorable adjustment equivalent to $0.01 per share in the previous quarter.

A tax expense for the quarter was also higher than our guidance due to the higher level of service profitability in our non-US regions. A quarterly tax expense for the fourth quarter is expected to be approximately $700,000. Net income for the third quarter was $1.3 million or $0.05 per share.

Turning briefly to the balance sheet our cash and investments at quarter end were $84.6 million or about $3.50 per share. Day sales outstanding decreased to 74 days.

Inventory increased $6.8 million to $49.9 million at the end of the third quarter due to the timing of systems, which require acceptance per revenue recognition and the timing of our Q4 shipments, which required incremental inventories for the customer's delivery needs. And with that, I’ll turn the call over to questions.

Operator?.

[Operator Instructions] Our first question comes from Patrick Ho of Stifel Nicolaus. Your line is now open..

Thank you very much. Tim, first a big picture question in terms of your integrated versus your standalone business, you've noted the improvements on the integrated side.

Do you believe you're seeing any secular trends towards these integrated systems or do you think the system is more of a customer or product kind of specific trend?.

Patrick, thanks for calling in. With regard to whether we're seeing adoption in the secular pattern, most of the success we’re seeing increased demands coming out of 3D NAND. So we're seeing a broad adoption across all the customers in that particular sector..

Great, and maybe in terms of the current business environment, you noted that you’re seeing similar trends going into the fourth quarter, what are the specific foundry investments that you’re seeing for the December quarter? Is it still for the leading edge or are you getting any potential like I guess more mature technology node investments..

That’s a good point because if you look at our revenue and revenue trends against some of the other folks in the industry, we don’t participate in the -- we haven’t participated in the older technology notes like 28 nanometer.

All of our wins are share gains and our tools are going into the advanced nodes of 16 and some 10 and a little bit of the R&D beyond that. So all of our business in the foundries is the front end of the technology curve..

Great, thank you very much..

Thank you. Our next question comes from Tom Diffely of D.A. Davidson. Your line is now open..

Yeah, good afternoon.

So first Tim on the higher percentage of the high margin upgrades, you said you’re a little surprised I’m wondering what happened there and are these upgrades in lieu of new systems?.

So a good question Tom. No there wasn’t -- those were not in lieu of new systems, it was in cannibalization of the business, but these do come in large groups as I mentioned at different times and so when we get an upgrade request, it will be for multiple tools.

The magnitude of that request is higher than we had originally forecast and so it complimented our margin and our revenue contributions nicely. Tom, the other thing is they were software upgrades, so they carry a pretty high margin..

Okay, how much lead time do you typically have for something like this or I guess if it software, how much lead time at all..

Yeah, there is really not much. There may be a little lead time if there is hardware tied to it. This was almost peer software so, it’s a pretty quick ask and quick response..

Okay.

And then obviously some very nice margin progression over the year, at this point do you think your operations are in pretty good shape into the models you just need to get the topline growth to finish it out or is there more to do on the margin specific items?.

I’ll speak a little bit to what I think we can do and I'll let Jeff add any other color. So we're far from done.

I think we're very close to the kinds of numbers we’ve been talking to in terms of the 50 and 50 model that we've spoken to that if we were at those revenues levels, I think you would be seen those margins, but there is still things we're doing. We're putting a lot more emphasize on our supply chain management.

We’re trying to get reducing our cogs through our partnerships. We’re looking at factory efficiencies on the floor to reduce our cycle times. We’re looking at better management of our inventory.

We're looking at our installation and warrantee activities and see what we can do reduce sell cycle times and all of those contribute to margin improvements maybe not as some bigger steps as we’ve been taking, but they're all incremental to what we're doing?.

Yeah, the only thing I would add Tom is I think you’re right. The factories are running at relatively high level and that we’re not going to get a bunch of leverage out of just overhead most of what we’re working on now are incremental improvements that Tim described..

Okay. Great and then I guess on the same line is there a meaningful difference in margins -- product margins when you go between NAND and DRAM and foundry and logic..

Not enough to talk to, most of our products -- it was a time when there was a fair amount of disparity in the product margins, but we've done a pretty good job of bringing them all up or getting closer to our model. So our Atlas platforms, sample platforms they're doing well and obviously the software makes a move on it.

But we're getting close to where we could have been and where we would like to be, but then we've got more that we can get out of the system and the way we go about at these products..

Okay, will volume discounts be the largest factor going forward..

No I don’t think so. In terms of volume discounts against our get supply chain..

The volume discount of your customers as far as your margins go on tools..

We do a pretty good job of resisting that. We've got -- the forces that our primary competitor also does a good job of resisting that.

So we operator under a good umbrella there and I haven’t seen -- the conversations can be difficult, but there aren’t a lot of alternatives and when you're tool-of-record where you don't have to hold up the tent on those conversations. So I think we're doing pretty good..

Okay. Great. Thanks for your time..

Right..

Thank you. Our next question comes from Mahesh Sanganeria of RBC Capital Markets. Your line is now open..

Good. Thank you very much. Sorry I might have missed something. I was running between couple of earnings.

Tim just on the overall how you see the next year shaping up? I know that the visibility is hard to get, but in terms of the thinking broadly and foundry and logic and NAND and DRAM what are the puts and takes on various segment for next year?.

Yeah, that’s a good one and we don’t have a lot more visibility than you do. In fact I think you do a better job at this than a lot of people but when I look out there if you look at some of the commentary as well the talks with our customers we see some foundry opportunities that continue to go forward.

There is some uncertainty about the timing of DRAM until that market goes -- improves some logics spending by one of key customer is going to be tied much more to what happens with Apple products and who wins that business. And then the advance technology nodes in our advance logic is kind of a latter year activity.

The good news for us is where tool-of-record position in all of those areas we're tracking with their spending and there is a couple of areas where we're trying to expand our footprint.

I think if I stand back right now, we tend -- we see year-on-year, we don’t see huge changes in the WT capital spend between '15 and '16, but it’s pretty early for us to be giving that with any more color than you probably already have..

And so just along that line I would think that -- it seems like that this year turned out pretty negative in terms of foundry and logic spending or IDM spending and so I think the bar is pretty low from foundry and logic spending.

So that should even if the overall WFAs is flat, that should grow and that should benefit you both two ways, one the market share gain in foundry and your exposure to logic foundry, is that a good way to look at..

Yeah, I think it’s a reasonable way. I think the way I look at it is that there is certainly upside to where we've been and where we've been tracking on the events logic. That’s been a real as I mentioned during my script, that’s better real drag on our revenue story and we're -- as you said it’s a pretty low bar.

So I think that it's reasonable to assume that should improve going into next year. On the foundry we're tracking with record foundry revenues record customer TSMC has just been a traffic customer for us. So that talks to our footprint and as they invest in the next nodes we hope to carry that forward. So we think that that will track nicely.

3D NAND has been really great. We've got -- everybody that makes up 3D NAND has adopted our tools in tool-of-record. So that is the timing of the extension of those -- of their capacity in going to the next node of incremental layers. And I guess the one that we're all looking at was DRAM carry just nicely up to this point.

It’s whether or not you have a one or two quarter softness in DRAM spending going forward..

Okay. That’s very helpful and one last question on the 3D NAND, we have several new fabs starting and maybe even new supplier online.

It this is a very generic question, when you start a new fab or if you have somebody entering the market, typically I would think that they would start with a pilot kind of line and get the yield learning before they pan out mass production.

Is that a reasonable way to think or you think that two or three new fabs coming, they're going to be aggressive at the get going and you're going to see something big in the first half of next year?.

Its, kind of a customer specific question. I think it depends on where they are. Couple of the customer get their pilots going in the older fabs.

They’re working on it right now for next generation and so when we start tooling up the new fabs, they’re really ready to launch it and what you’ll see is incremental capacity added in steps whether they go 30k and then 30K and then maybe 40K wherever it depends on the size of the fab.

As you said there is one new entry and that’s going to having to learn a little bit more about how to make these devices and how to produce some and I think that that one will probably be a slower start.

For us one way to look at it that's important Mahesh is that generally the front end load, the procurement of the metrology tools and process control tools at the beginning of fab to both qualify tools as well as to get the yield moving and we usually benefit a little earlier in that whole sequence against other WP expenditures on processing capacity..

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

You bet..

Thank you. Our next question comes from Weston Twigg of Pacific Crest Security. Your line is now open..

Hi, thanks for taking my question.

First just wondering on the service revenue line, do you expect that to be down again in Q4 or is the decline mostly product driven?.

Most of it is the upgrades. We actually -- we’re not planning on any significant declines in the core side of the business..

Okay.

So the product revenue would be more flattish?.

Talking about the split between products and service?.

Just wondering where most of the decline comes from in Q4..

Yeah, it will come primarily from the product side. There will be some decline for the upgrades that we saw this quarter..

Okay, Also wondering maybe if you could talk about the impact of your relationship with DRAM with respect to the correct merger, I know that you’re doing some integrated metrology programs crack doesn’t necessarily have a directly comparative product, but I don’t know if you can give us any context or color on that relationship and if you had any customer discussions regarding that merger..

Yeah, so it’s a good question, but it actually -- the answer is the relationships with the end user. So when you look at our integrated metrology adoption tool record positions, it's the customers that’s made those determinations and with the primary engagement we have with the OEMs is making sure that our platform has been qualified on their tool.

But we sell directly to the customer. We support directly with the customer. We work with them on process and process control with the customer..

Okay, so you don’t expect any impact to your business, that makes senses, but maybe a bigger picture looking at just your growth it hasn’t accelerated as much as you needed it to be consistently profitable meanwhile your big competitor is getting bigger as they merge with them.

So big picture how do you mange that situation? Do you feel like you undersized and then is there a solution other than waiting for customers to spend more money..

Well, we're David and they're Goliath, there is no doubt about that. We try to be more nimble. We try to find those opportunities that are either unreserved or an opportunity for us to bring some technology to the market. We’ve done pretty successful in taking market share in our served markets away from them.

With regard to what’s going on right now, there is -- we’re hopeful that they're going to be busy integrating and solving the acquisition issues while we're busy going after our customers and seeing what else we can do to gain some additional share..

Okay, that’s fair. Do you feel any -- do you feel compelled to more closely partner with applied or Tokyo Electronic as opposed to LAM given the merger and maybe try to come over some holistic solutions that would reflect something similar to you talk about..

Yes, I don’t have a good answer for you on that. Right now we’re pretty agnostic to who we work with because it is a customer driven area. Clearly if for some reason the LAM and KLA merger resulted in them trying to do some internal development that would be competitive to what we're do.

As you know KLA is not an integrated metrology nor sets you for process, but if that evolved in that direction, we certainly would have to look for alternative ways to participate in that market..

Okay. Very helpful. Thank you..

[Operator Instructions] Our next question comes from Mark Miller of Benchmark. Your line is now open..

Good afternoon. I am just wondering in terms of technology especially with the XPoint starting to come to the market.

Does it -- any technology challenges or opportunities do you see especially in regards to XPoint?.

The XPoint are cross points I know what you want to hear. We see that as a pretty neat device. It's got some interesting metrology requirements, process control requirements and were tool-of-record with both Micron and Intel. So we see -- we're working on that device.

We're helping to solve some problems and we see a chance to expand our application space based on it. We also see trends in logic devices as they go from Fin Fed to gate all around and we see additional opportunities as they increase the number of payors in the NAND.

So from our side all the device structures and architectures going forward are creating incremental opportunities for us..

What about the transition at 10 nanometers? When do orders really start to ramp there?.

Ramp is a good question. Orders are occurring. We're shipping tools. They're being used. I think that the timing is kind of -- it depends on where you're looking at which one, but if you do look at the two leaders in there, it's kind of a midyear type of thing before you're going to see some significant high volume manufacturing in that area..

And just a couple housekeeping, I missed the percentage of sales to Micron?.

It was, hold on one second, Micron was 14%..

Did you buy any shares back this quarter?.

We did not..

Thank you..

Thank you. At this time, I am showing no further questions in the queue. I would like to turn the call over to Timothy Stultz for any closing remarks..

Well, thank you once again for participating in our call. A special thanks and continued appreciation to all our employees and business partners whose passion and commitment to our mission and business objectives are helping to drive a better Nanometrics each and every day. With that, we conclude our conference call for today. Thank you..

Ladies and gentlemen, thank you for your participation on today’s conference. This concludes your program. You may now disconnect. Everyone have a great day..