Timothy Stultz - President and CEO Jeffrey Andreson - CFO Claire McAdams - Headgate Partners LLC.

Patrick Ho - Stifel, Nicolaus & Co. Thomas Diffely - D.A. Davidson & Co. Mark Miller - Benchmark Company Weston Twigg - Pacific Crest Securities.

Good afternoon, and welcome to the Nanometrics’ Fourth Quarter and Full Year 2015 Financial Results Conference Call. A question-and-answer session will be held at the end of the call. Until that time, all participants are in a listen-only mode. Please note that this conference call is being recorded today, February 2, 2016.

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’ fourth quarter and full year 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 year’s highlights 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 Web site 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 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, shift in timing of orders or product shipments, changes in product mix, our ability to successfully realize operating efficiencies and the additional risk factors and cautionary statements set forth in the company’s Form 10-K on file for fiscal year 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 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 will speak to our key achievements and highlights for 2015, which set the stage for continued expansion of our revenue opportunities and operating leverage as we enter the new year.

Then conclude with our specific guidance for the March quarter. Following my prepared remarks, Jeff will provide additional details on our financial results, after which we will open the lines for Q&A. 2015 was an important year for Nanometrics, one in which we demonstrated our success in winning meaningful positions in multiple key customer accounts.

Revenue growth once again outpaced in the overall industry and the flow through leverage of our improved financial model. Revenue grew by 13% and gross margin improved by 175 basis points, while at the same time we lowered operating expenses year-over-year.

The result was over 70% flow through to operating profit on our incremental revenues over 2014 and a return to profitability. As we highlighted in our earnings release, 2015 was a year of many new records. Not just records for record sake but new levels of performance, which are the fundamental foundation for future growth and breadth of our business.

Importantly, during the year, we realized incremental contribution as share gains among multiple end markets, multiple customers and multiple products. We achieved new record sales for the foundry end market, which has been a key strategic focus for the company.

Foundry sales were up 74% over 2014 and comprised a record 33% of total product revenues for the year. Notably, TSMC, the world's leading foundry, became Nanometrics' largest customer for 2015. We saw record 3D NAND sales following competitively won tool-of-record positions at each of the four leading memory companies ramping 3D NAND devices.

3D NAND sales were up 50% from already strong sales in 2014 and drove another growth year for overall sales for the NAND market. And Micron, the world’s second largest memory company, became our second largest customer in 2015.

We reported record integrated metrology sales, which more than doubled in 2015 following strong sales growth of 34% in the prior year.

Our integrated metrology market share gains were achieved across multiple customers, primarily in 3D NAND and we believe we have more than doubled our integrated metrology market share from about 15% in 2013 to approximately one-third of the market in 2015.

We achieved record sales to three customer accounts in 2015; TSMC, Micron and Toshiba who each comprised at least 10% of our revenues and became three out of a total of five 10% customers for the full year adding to our legacy large customers Samsung and SK hynix.

This was the first time in Nano’s history that we have had such a strong revenue contribution across so many key customer accounts.

All of these record achievements culminated in revenue growth, which outperformed overall spending on wafer fab equipment or WFE, and helped us deliver against our promise to demonstrate improved financial performance and a return to profitability.

Briefly touching on a couple of highlights for the fourth quarter, we achieved record sales from Toshiba in Q4 as our OCD technology played a key enabling role in the 3D NAND ramp.

We also achieved a fifth consecutive quarter of sequential gross margin improvement even on lower sales volumes, as we benefitted from favorable product mix and improved operational efficiency in the quarter.

Our normalized quarterly operating expenses also declined meaningfully, due to a strategic reorganization and reallocation of resources focused on our greatest revenue growth opportunities.

We believe our continued focus on improving our cost structure through organizational development and improved operational efficiencies will help deliver further improvement in margins and increased profitability for 2016. In the year ahead, we expect to continue to benefit from the industry’s inevitable migration to 3D devices.

Foundry logic’s adoption of FinFET transistors and flash memory shift to 3D NAND architectures drove the majority of our revenue in 2015.

For 2016, we expect to further benefit from our recent share gains in foundry and 3D NAND as next-generation FinFET devices are developed and investments in 3D NAND continue to extend; even more so now that a fifth manufacturer is entering the 3D NAND mix, one where we already enjoy a tool-of-record position.

DRAM, which has long been a stronger for now tapered off in the second half of 2015 but is still expected to contribute meaningfully to our revenues in 2016. And IDM logic, which historically was a strong contributor to our business but has been weak of late is saving up to begin a recovery in the latter part of 2016 or early 2017.

While we are proud of our progress in share gains, growing our footprint at key accounts and our overall market share position we still have plenty of room left for further growth, outperformance and improved business results.

Demand for OCD metrology in particular is increasing that each technology node and across all device types at a rate greater than most other areas of WFE.

There are still significant opportunities for us to gain additional market share and expand our footprint within the key accounts we have recently penetrated, and there are very large opportunities for us to develop in the used cases and expanded applications for our metrology platform, solutions and core technologies.

Based solely on the near-term organic growth opportunities ahead of us, we believe we can exceed $300 million in annual sales when supported by a continued healthy spending environment and WFE growing to a $35 billion range.

Turning to the current quarter, Q1 represents the beginning of a recovery from the Q4 pause with expected growth continuing into the second quarter. And though it is still too early to speak with much clarity, we currently believe the second half of the year may come in a bit stronger than the first.

Importantly, when we think about the three core tenants of our financial story for 2015; revenue growth outpaced in the industry, gross margin expansion and reduced operating expenses, we fully expect these same three themes to beneficially play out for us in 2016.

To sum it up, our successes in new account penetration and market share gains are the foundation for continued industry and competitive outperformance while providing a more balanced and stable revenue source model.

Technology and manufacturing trends or incrementally increase in the demand for our process control tools and solutions, which have the ability to address the most advanced device technologies today and for device generations to come.

And our financial performance is expected to continue to meaningfully improve as operational efficiencies and leverage in our business model deliver improved margins and high incremental flow through to the bottom line. With that, our guidance for the March quarter is as follows.

Revenue is up 3% to 12% to between $44 million and $48 million and on a non-GAAP basis, gross margin of 49.5% to 50.5%, operating expenses of $20.5 million to $21 million and earnings of $0.01 to $0.09 per share. I will 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’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 segmentation information by product, end market and geographic region is available in the Investor Section of our Web site.

Fourth quarter revenues were $42.7million, down 7% from Q3 at the high end of our guidance range and up 8% from Q4 of 2014. Product revenues declined 9% to $33.3 million compared to $36.4 million in the prior quarter and service revenues of $9.4 million increased 2% from the prior quarter.

By end market, nearly 90% of product revenues in Q4 were to the memory and foundry segments, a similar profile to the prior two quarters, and particular NAND sales represented 43% of product revenues and consisted primarily of 3D NAND shipments.

As Tim discussed earlier, the company had record 3D NAND shipments in 2015 and these comprised over 80% of our NAND product revenues for the full year. For Q4, DRAM sales declined as expected and comprised 5% of product revenues. Foundry sales increased 40% from Q3 and comprised 41% of product revenues.

Logic sales comprised 5% of product revenues and all other devices and substrates comprised 6% of product revenues. By product, total fourth quarter revenues were comprised of 49% automated systems, 24% integrated metrology systems, 5% materials characterization systems, and 22% service and upgrades.

Our 10% customers in the fourth quarter included Toshiba at 27%, TSMC at 21% and Micron at 10% of total revenues for the quarter. For the full year, our 10% customers were TSMC at 19%, Micron at 16%, Samsung at 13%, SK hynix at 11% and Toshiba at 10%.

For the remainder of our revenue segmentation for the full year, please refer to the supplemental information file located on the IR page of our Web site. 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 and restructuring charges. Our Q4 gross margin was 49.8%, up 10 basis points from the third quarter and represents another sequential quarter of gross margin improvement.

Gross margin exceeded the upper end of our guidance and our target model at the sales volumes due to a favorable product mix this quarter.

Product gross margin increased 130 basis points to 48.5% from the third quarter largely due to better factory absorption and a more favorable product mix, while service gross margin decreased to 54.5% and from 59.5% in the third quarter due primarily to lower upgrade sales.

Going forward, we have a published target financial model that shows 50% gross margins at the $50 million quarterly revenue level. We’ll be slightly ahead of that model for Q1 again due to product mix, but would direct you to our target financial model, which is in our IR presentation posted on our Web site for modeling the remainder of 2016.

Operating expenses of $20.5 million were near the high end of our guidance due to the timing of R&D program expenditures but represented a $400,000 reduction from Q3 due to the cost savings from our recent restructuring.

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 and variable compensation programs.

As we look at 2016, and depending on the levels of profitability and variable compensation, we expect quarterly operating expenses to normalize in the $20 million to $20.5 million range with the back half of the year being at the lower end of that range. This equates to another year-over-year decrease in total operating expenses expected for 2016.

Our GAAP operating expenses for the fourth quarter include $1.3 million of cost associated with the restructuring of the company completed in the fourth quarter. The goal of the restructuring was to better align our cross-functional organizations and overall resources as part of our effort to improve our operational efficiency.

Other income was $44,000 in the fourth quarter. Our tax rate for the quarter was approximately 800 – tax expense was approximately $800,000. Our quarterly tax expense for 2016 is expected to be in the range of $750,000 to $800,000 each quarter and is associated with the profits in our foreign entities. Net income for the fourth quarter was breakeven.

Turning briefly to the balance sheet, our cash and investments at quarter end were $83.1 million or about $3.40 per share. Days sales outstanding increased to 80 days from the prior quarter due to the timing of the shipments in the quarter.

Inventory increased $700,000 to $50.6 million at the end of the fourth quarter, due to the timing of our early Q1 shipments. With that, I’ll turn the call over to questions.

Operator?.

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

Thank you very much and congratulations first on a really nice year.

Tim, as you look at the industry as a whole, particularly on the NAND flash side of things, how do you see the spending trends for 3D NAND this year given that it looks like foundry and logical be a little more second half bias? How do you see 3D NAND playing out particularly with the addition of a new fab in [indiscernible] and China?.

So, Patrick, first of all thanks for calling in and the comment on the year. We’re pretty happy with it. I think 3D NAND still got legs. We see strength in the 3D NAND on spending. We now have five participants. We, as I mentioned during the script, one of the newest entrant is a place where we already have an established tool-of-record position.

I think that there’s some expansion spending that’s going to occur and I think is going to extend as they add multiple layers onto the existing structures..

Great.

Maybe as a follow up to that, as they’re expanding due to the layer increases, does that necessitate new tools on the OCD metrology side of things or can they leverage their existing core capacity for say 32 layers for 48, or do they also need to incrementally buy OCD metrology as they transition?.

Yes, I think it’s more the latter. As they go to these increased number of stacks and some of the strategies that they’ve described to us that the new stacks going up to 100 pairs or more will drive increased intensity on spend for OCD..

Great.

And final question from me on the foundry logic side, as the industry starts to move towards 10 nanometers, what’s the capital intensity increase you see from the industry shift 16 to 14 to 10 nanometers for you on the OCD metrology side?.

Yes, it’s a good question and actually I refer anyone that wants to, we have a capital intensity sheet that’s in part of our IR presentation that kind of breaks out by device type and technology node. But typically we’re seeing anywhere from 15% to 25% depending on whether it’s a device or the next node.

I’ve kind of targeted it in the 20% area when you start thinking about going from 16 to the 14 and then 10 and 7..

Great. Thank you..

Okay, Patrick..

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

Yes. Good afternoon. So maybe first some questions on the leverage and the model.

What is your view of the incremental gross margin from that 50 and 50 note you had earlier?.

Tom, it’s Jeff. Our long-term model is 50% to 60%. We’ve obviously been above that because we’re really seeing a lot of leverages, the factories got more full. I’d say that we’re still probably in the near term kind of looking at the higher end of that range..

Okay.

And then I was going to ask you – when you have these quarters where the mix increases or decreases the gross margin, is it really driven by the product you’re shipping or is it the customer you’re shipping to that’s the biggest determinant to that?.

It’s primarily the product. We had some shipped between two products that have just a little bit of a difference in gross margins. And when you kind of multiply out those numbers, they’re pretty small numbers at the end of the day. So one tool margin versus say the materials characterization or something that will have a little bit different margin.

And so they just shift inside the quarter..

Okay. And then also you talk a lot about how the upgrades are very good on the margin front.

What is your view kind of the long-term contribution of upgrades to the overall model?.

Are you talking about revenue level or --?.

Just revenue, yes..

This year was particularly good. I don’t know that we see a particularly large decline or uptick – I mean we’re obviously focused, as Tim talked about, and some of the investors on growing some of the software in data analytics but we’re very early in that stage. That could change the profile of the product mix..

Tom, I’d add too that as we receive increased pressure from all of our customers about tool reuse, it does open the door for additional upgrade opportunities as we think about upgrading tools and software and capabilities. So we – they close one door and they open another window and we push pretty hard on that..

Okay.

Is there a rule of thumb where if they’re going from, call it the 2x node down to the 10-nanometer node that you need to upgrade a tool, how does the upgrades come about?.

Well, the upgrade discussions are across our fleet. And there’s some tool reuse and some of it – where you see the highest impact of tool reuse is actually on the development side much more than on the capacity and production side.

So once they have a suite of tools that they’re using in their development lab, which is a fair number of tools and when you first penetrate the account, they will continue to use that toolset to go from one node to the next.

And then what we look for is the incremental tool sales driven by the increased capital intensity or I should say OCD intensity going from node to node. And then within those toolsets, it depends on what the utilization rate is of the fab that they currently have and which tools are available for upgrade..

Okay, that makes sense. And then Jeff, you talked a little bit about the reorg. You got a little leverage from that.

Were there any specific product lines that were maybe dropped or won’t be a focus going forward?.

No, there was no product lines dropped. We did some organizational alignments where product lines were combined under executives and we did the same thing in some of the cross-functional organizations just to streamline certain functions in the company..

Okay. And then finally Tim, it sound like when you talked about the logic versus foundry, it sound like maybe logic was a little bit further out than foundry.

You said maybe it pushes into 2017, is that true?.

Yes, and I think that’s the uncertainty of the one big logic company out there and the timing of their move from 10 and then some of their investments in 7 where tool-of-record is not a competitive situation.

But there’s certainly been some variation in the timing of where their investments are going to take place and when we would expect to be placed in the tools into those fabs. And so my dialogue is really – reflects our uncertainty in terms of the way their numbers change and/or their outlook changes..

Great. Okay. Well, thank you, guys..

Our next question comes from the line of Mark Miller from Benchmark Company. Your line is now open..

I’d like to extend my congratulations on your successful year.

Was just wondering as we progress down the notable transitions in terms of legacy equipment you have placed at your major sites, when does this equipment, either because of late source and the need for upgrades or detector upgrades become an opportunity for you either through upgrades or replacement?.

Mark, I want to make sure I understand the question.

You’re asking about how – I think what you’re asking is how many nodes with a toolset survive through before they either have to replace it or upgrade it?.

That’s correct..

Okay, all right. So what we’ve seen is that’s very customer specific. We have one particular customer that is notorious in their copy exact strategies, which sticks with the platform through 3 and even maybe 4 technology nodes. And in that, because they’re sticking with that platform, they put a lot more emphasis on tool reuse and upgrades.

We have other tool companies that are pushing the forefronts of the technology where they need the latest and greatest.

And even though upgrades maybe available and tool reuse is certainly part of the dialogue, they want the newest technology or the newest detectors, newest light sources and so on and they buy all new tools right at the frontend of our product launches.

So you’re going to see that – it really depends a lot on the competitive environment, what technology they’re investing in and what their corporate strategy is..

You mentioned expanding applications, I was wondering which would be the most imminent new opportunity in that area for you?.

Well, I won’t tell you the specific ones but I will speak specifically to application space and that is our optical techniques with the ellipsometry, interferometry and scalarometry lend themselves not only to the OCD or critical dimension but you start thinking about other places where this type of measurement can contribute, and that would include in the litho space and the overlay space and the film space.

And our fundamental technology can do this. Our focus has been OCD. But I think we can leverage the platforms and develop applications to address some of those other markets..

And finally as NAND flash progresses in terms of an increase in layers, do you have to do any software modifications? Are there any upgrades or can the current tools handle the additional layers without any problem?.

There are upgrades required. There is some software – there is always software upgrades that we’re looking at as the models become more complex.

But actually there’s other hardware modifications as we deal with higher aspect ratio structures, deeper cavities we need to measure into, more layers we have to measure through and then the overall feature size. So the roadmap to address next generation and +2 3D NAND includes both software and hardware modifications and improvements..

Can you put a dollar figure in terms of the opportunity per tool?.

I’m not – what do you mean the opportunity per tool?.

In terms of the upgrade, do you charge extra for the upgrade or is that part of the original package?.

Oh, no. All upgrades are charged and we charge for upgrades. We charge for our software, we charge for the hardware, we charge for insulation and recipe development on those – with that new platform. But no, I can’t give you a specific tool amount but we get a blended.

It’s a good number, it’s got a good margin and we like to complement that with new tool sales..

Is that going to grow this upgrade revenue as a percent of total sales year-to-year?.

We would like it to. We’re driving hard on that. I think as our installed base continues to grow, as the technology nodes stretch out, as investments – if you look at the investment strategies within a given fab in some areas are actually muted, then I think that the upgrade opportunity is increased.

And we have a dedicated resource inside that’s really driving that and it’s part of our whole product lifecycle planning process..

And I assume the upgrades are at or above total margins for the firm?.

Yes, they are..

Thank you..

You bet..

Thanks, Mark..

Our next question comes from the line of Weston Twigg from Pacific Crest Securities. Your line is now open..

Hi. Thanks for taking my questions.

First, just wondering on the tax situation in 2017, can you give us an idea of how far you are to the NOLs and what’s left and what you think the carry-forward might be for 2017?.

Yes, well I don’t think it’s going to come back in 2016, it could come back in 2017 depending on the back half of the year. So it’s kind of too early to tell. So if you’re going to model, I would probably model it coming back sometime in the second half of '17..

Okay..

I mean keep in mind the more important number is the cash tax number and regardless of when the accounting transaction comes back on the books, we still will be able to use the NOLs. They’ll be back on the books, right. So the cash tax rate will stay still down in this level we think..

Through 2017? Okay, got it. And then similarly, OpEx – I know you said refer to the target model here, but they were quite low it sounds like in the back half of 2016.

And I’m wondering in 2017, do you expect to keep it at more of a static level like you’re doing this year or fluctuate it a bit more with revenue?.

I don’t think it will fluctuate with revenue, it will fluctuate with investments we make either in new product development or if we expand somewhere. We don’t believe we need to have a significant amount. I think if you look at the model, it grows some but not nearly as fast as revenue for example.

So I think you can look at the model to really guide it, because we’re going to manage to that as well..

Got it. Thank you very much..

Wes, this is Tim. I would also add that the variable component of OpEx against revenues is on the order of 1%. So anything else we do has to do with, as Jeff said, investments. We’ve got the infrastructure in on – the global infrastructure is in place to take care of all the new accounts.

So we’ve got leverage both organizationally as well as operationally..

Very helpful. Thank you, guys..

You bet..

Thanks, Wes..

I’m not showing any further questions at this time. I would now like to turn the call back over to Mr. Timothy Stultz..

Thank you. 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. Thank you..

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