Claire McAdams - ‎Managing Partner, Headgate Partners LLC Timothy Stultz - President and Chief Executive Officer Jeffrey Andreson - Chief Financial Officer.

Thomas Diffely - D.A. Davidson & Co. Patrick Ho - Stifel, Nicolaus & Co. Weston Twigg - Pacific Crest Securities Mark Miller - The Benchmark Company, LLC. Graham Tanaka - Tanaka Capital Management, Inc..

Good afternoon, and welcome to the Nanometrics’ First Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] A question-and-answer session will be held at the end of the call. Until that time, all participants will be in a listen-only mode.

Please note that this conference call is being recorded today, April 26, 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’ first quarter 2016 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 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.

Such statements may be identified by the use of words like believe, expect and similar expression that look towards future events or performance.

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 2015.

Nanometrics disclaims any obligation to update information contained in any forward-looking statement. During today’s call we will also refer to financial measures not calculated according to Generally Accepted Accounting Principles.

Please refer to today’s press release for an explanation of our reason for using such non-GAAP measures as well as tables reconciling these measures to our GAAP results. I will now turn over the call to Tim Stultz.

Tim?.

revenues up 9% to 20% to between $52 million and $57 million; and on a non-GAAP basis gross margin of 51.5% to 53%; operating expenses of $20.6 million to $21.2 million, and earnings of $0.21 to $0.30 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 segment information by product, end-market and geographic region is available in the Investor section of our website.

Additionally, we have made a change to how the company is reporting upgrade sales and cost of sales. Upgrade sales were previously reported as a component of our service revenue and will now be reported as product revenue, which more closely reflects the nature of upgrades being performed.

All comparable prior-period amounts discussed on this call and in the supplemental financial information file on our website have been recast to reflect this change. Please refer to the supplements for all historical comparisons made on the call today.

Fourth quarter revenues were $47.5 million, up 11% from Q4 at the high-end of our guidance range and down 6% from Q1 of 2015. Product revenues were $39.2 million, up 17% from Q4 and 9% lower than the first quarter of 2015. Service revenues of $8.3 million were down 9% from Q4 and up 11% from the first quarter of 2015.

By end-market, 52% of product revenues were in the NAND segment which grew 43% over Q4. And at this point it’s predominantly comprised of 3D NAND. DRAM increased to 20% of product sales, while foundry declined to 19%. Logic was 4% of sales and all other devices and substrates comprised 6% of product sales similar to last quarter.

By product type, total first quarter revenues were comprised of 60% automated systems, 18% integrated metrology systems 5% materials characterization systems and the remaining 17% was service.

Our 10% customers in the first quarter included Micron at 26%, SK Hynix at 17%, Intel at 16%, Toshiba at 12%, and TSMC 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 and restructuring charges. As a reminder, all references made to revenue and gross margin on this call reflect the reclassification of our upgrades to products. It can be found in the supplemental financial information file on the website.

Our Q1 gross margin was 52.5%, up 2.7 percentage points from the fourth quarter and represents our sixth sequential quarter of gross margin improvement. Gross margin exceeded the upper-end of our guidance by two percentage points and our target model of these sales volumes, due to operational improvements and a higher mix of upgrades in the quarter.

These factors primarily benefited our product gross margin, which at 53.9% increased 5.3 percentage points from the fourth quarter. Service gross margin decreased to 45.8% from 54.4% in the fourth quarter due to lower spare sales and a lower level of utilization of our field service workforce.

Operating expenses of $20.7 million were in line with our expectation for the quarter and to lower our full-year operating expense again in 2016. For Q2, we are guiding a level that exceeds the $20 million to $20.5 million range we expected to be within next quarter due to R&D activities related to our recently launched atlas 3 Atlas III platform.

As we look at the full year 2016, and depending on the levels of profitability in variable compensation, we expect quarterly operating expenses in the second-half to normalize in the $20 million to $20.5 million range, resulting in a year-over-year reduction.

To comment further on the operational efficiencies and margin improvements we are achieving at this performance inflection point, at the midpoint of our Q2 guidance the first-half of 2016 will be similar revenue-wise to the first-half of 2015, but with over four percentage points of improvement to the gross margin and over five percentage points improvement to the operating margin, resulting in at the midpoint in near doubling of operating profit on roughly the same revenue volume.

Below the operating line for the first quarter, other income was $117,000 as a result of foreign exchange gains. Our tax expense for the quarter was approximately $380,000 and was lower than expected due to a favorable adjustment of approximately $500,000 or $0.02 per share.

For several quarters, I have provided dollar-based ranges for our tax expense. But given the improvement in our outlook we will now be subject to a minimum level of U.S. tax.

Given this our quarterly tax rate for the remainder of 2016 will be in the range of 17% to 20% per quarter, depending on the level of profitability with Q2 being at the lower-end of the range. Net income for the first quarter was $3.9 million or $0.16 per share.

Turning briefly to the balance sheet, our cash and investments at quarter-end were $83.3 million or about $3.42 per share. Days sales outstanding increased to 84 days from the prior quarter, principally due to the increase in deferred revenue billings that will be recognized as revenue in future quarters.

Inventory increased $3.4 million to $54 million at the end of first quarter. The increase was driven by incremental inventory needed to support the higher level of revenue in Q2.

The initial builds of our new Atlas III platform as well as an increase in the number of first-in-fab systems requiring acceptance in order to recognize revenue for our policy. The increase in deferred revenue was also mainly attributable to the initial Atlas III shipments and first-in-fab systems requiring acceptance.

And with that, I’ll turn the call over to questions.

Operator?.

Thank you. [Operator Instructions] And our first question comes from the line of Tom Diffely with D.A. Davidson. Your line is now open..

Yes, good afternoon. So first on the really strong 3D NAND business, you talked about how some of these other drivers are going to continue or startup and drive growth in second-half of the year.

What is your view for 3D NAND specifically in the second-half of the year? Is it just a slug that’s going through that’s going to be qualified, and then have to move on to the other stuff or is this 3D NAND going to continue on?.

Hi, Tom, yes, this is Tim. We see 3D NAND spending continuing. It won’t be as strong as what we’ve seen in the front-half. But there’s additional investments are going to be made. And we should participate in that, but we need little of the support from - on DRAM and the foundry to give us a stronger second-half than the first-half..

Okay.

And it looks like, obviously, with record orders from three customers, are you still engaged with the other two players in this space and do you expect them to spend this year as well?.

Yes, we have tool-of-record positions with all five of the 3D NAND manufactures. And in fact, we have a really good market position across there and we are participating in all of the fab installs ramps and next generation development..

Okay.

And then the record bookings in the first quarter for 3D NAND, most of that revenue is going to be in the second quarter, is some of it pulled into the third quarter as well?.

It’s across multiple quarters..

Okay.

All right and moving to the product, the new Atlas III launch, what is I guess the key data-point of the Atlas III going forward? Is it the cost of ownership improvement or is it through just a technology improvement of what you can see? Is it pricing? What is it that makes you most excited?.

Yes. It generally has to be all of those things to bring a successful product. Cost of ownership is always - there’s always a lot of pressure on us to deal with cost of ownership.

But first and foremost, it’s the technology performance, it’s the precision, signal-to-noise, resolution, repeatability and ability to measure - bring fidelity to the measurements of very small geometries. On top of that, we clearly have to deal with the productivity and the cost of ownership..

Okay. And so, I guess, in cycles past you’ve had - I don’t want to say issues, but you had some growing pains as you ramped up a new tool.

At this point is this one, where you wanted to be from a margin point of view?.

That’s a great question and you’ve got a long memory. Yes, actually we - as you know, we did hiccup on one major product launch. We’ve got - I believe we got our act together. We’ve got a more robust new product introduction business process. Our manufacturing, service and commercial teams have been working closely together.

There’s always going to be a little bit of margin pressure when the very first tools go out just due to operational efficiencies and first builds. But this product is going to come out, hit the ground, running and it will be a nice contributor to both revenues and gross profit..

Okay, great.

And then, finally, when you look at the upgrades that really help from time to time with high margin, what is your outlook for the next few quarters from an upgrade point of view? I know that it can be quite lumpy?.

Well, it is lumpy. In the first quarter they were pretty strong. I think our - I think we see year over year, we see potential growth, but they are lumpy. I mean, I wouldn’t want to give you too much specifics, but they won’t be as big in Q2 as they were in Q1..

Okay, great.

That’s fully absorbed though in your guidance?.

Yes..

So, Tom, one other thing I’d point out is that Jeff mentioned earlier on how we are accounting for upgrades. And I think it also reflects what’s going on in our commercial environment that I will say historically upgrades have been more of an opportunistic sales.

We looked at the installed base and looked for opportunities to sell software or hardware to existing accounts. Right now, the upgrade strategy is much more tied to the front-end of the commercial operations. When we are selling products, we are also selling the roadmap and we have an upgrade strategy tied to it.

And so, it’s much more of product sales activity than it was a post-sales service activity. That both explains why we’re changing the accounting. But it also shows a strength in relationship between what we are telling the customers, what we are delivering, and when we’ll deliver it.

And so, with all the pressure on tool reuse, it’s very important to have a very good and strong upgrade strategy to carry those tools forward..

So can you upgrade an Atlas II to make it like an Atlas III or is it a completely different hardware piece?.

Yes. We can do. We have upgrade strategies for some of our installed tools..

Great, all right. Thank you..

Okay..

Thank you. And our next question comes from the line of Patrick Ho with Stifel, Nicolaus. Your line is now open..

Thank you very much and congrats on the nice quarter. Tim, you talked about in the past market share gains across many different customer segments like foundry and NAND flash. Can you just give a little bit of color in terms of your products? And what I mean by that is, say, your automated systems are integrated.

I’m assuming you’ve gained share in both of those areas.

But can you give a little bit of color on, I guess, how you gain in both of those product segments?.

Sure, Patrick. I’ll see what I can answer. I mean, you’re right, at the outset we’ve gained share on both the automated Atlas platforms as well as the integrated. We’ve gained share across multiple product types where in the - in particular, in the foundry and the 3D NAND. 3D NAND has been very strong.

I would say, on a percentage basis, starting with a slightly lower basis number, the integrated metrology share gains have been larger as in perhaps the percentage than the other. But the revenue contribution on the automated is much more substantial with almost three times the ASP on product on product..

Great, that’s helpful.

And maybe looking at both the margin improvements you’ve made today and the ramp up of the Atlas III and may be following up from Tom’s earlier question about, I don’t want to say the hiccups in the past, but what have you done this time around in terms of your manufacturing operations to prepare for this expected ramp over the next couple of quarters that you’re projecting.

How do we get confidence that on the manufacturing side you’ll be ready to meet the increasing demand?.

So it’s a good question. I mean, once again, thank you for having a wonderful memory of bad times for us. But we really have changed the way we run our process. We’ve got much more robust business processes. The tools - we’re into double-digit building of the Atlas IIIs already and they’ve built in the manufacturing environment.

We did a really smooth handoff between the engineering and the manufacturing organization. We also engaged our service and applications groups in this handoff. We learned from our lessons in the past. And I’m very confident that you’re going to see a very smooth transition as we ramp this product..

Great. Thank you very much..

Thank you. And our next question comes from the line of Weston Twigg with Pacific Crest Securities. Your line is now open..

Yeah. Hi, thanks for taking my question. I just wanted to dig in to the gross margin a little bit. On the last quarter, I think you said that we should be using the target model, which would be around 50% gross margin and $50 million revs. You’re running well ahead of that.

And just wondering if this is a number that we can use moving forward this higher level or if you think there is a risk that maybe comes back down toward the target model?.

Well, West, it’s Jeff. Some of the growth obviously is mix related with the upgrades growing faster or larger in the quarter. But I think what we’re seeing is some of the operational efficiencies that we’ve been driving now for a year in change early starting to bear some fruit.

So we do believe we can kind of stay a little bit ahead of this with these revenue volumes. But just noting that product mix can swing 50 basis points up or down within the system sales..

Okay. That makes sense.

And then, maybe just moving forward since you’ve taken the upgrades out of the service line, should we use that 45% to 46% gross margin on the service line moving forward?.

Well, I think that - I think the more normal gross margins in service are probably between kind of 45s and low 50s, we’ve said before. So I think it can improve a little from here obviously. And then, some of this is - in Q1 you just get a lot of holiday effect of utilization..

Okay. And then, just finally, you said you’re working on further improving the financial model, but you didn’t upgrade or update the target model.

Can you give us an idea of when you might have an opportunity to update that model or when you have confidence in giving us some, maybe some improved forecast numbers?.

Yeah, I think what we meant to say is we - I don’t, we’re not ready to update the model, but we’re continuing to work on all the operational efficiencies, supply chain savings that we can do to continue to drive that operating model.

And I think if we get confidence so we can stay above it and will recast if that’s - we’re not planning to do that right now. But there are more efforts that we think we can bring to the table on the operational side..

Okay, sounds good. Thank you..

Right..

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

Congratulations on your quarter and your efforts to improve your margins. I just was wondering, you talked about share gain, I was just wondering in the area of CD-SEM, that technology is reported to be running out of steam.

What are you seeing there? Are you capturing more shares from that other technology?.

Yes, Mark, we do see that. There are technological limitations to the CD-SEM, as we start to shrinks in thinner films, and also the performance and productivity requirements. So I think that OCD will continue to take share in the CD market away from the CD-SEM..

Do you feel that’s accelerating now? Is it running at the rate you expected?.

I don’t know - I wouldn’t say accelerating. I think it’s been pretty steady. It may accelerate as we get down to some of the 7-nanometer, 5-nanometer or the gate all around.

Right now, it’s been a pretty steady shift as more customers adopt OCD, become comfortable with the technology and the model, and then, and deployed from one generation to the next..

I am wondering, what’s given yours, whether it’s quoting activity or your expectations for improvement. Most people have been pretty down about DRAM, but you are expecting that to come up and compensate for some of the slower growth in NAND in the second-half.

What’s give you optimism there? Are you seeing quoting or is it just the transition to the 1X nanometer nodes or what’s your feeling there that that could be some upside there?.

It’s primarily based on our direct conversation with our customers, the roadmaps and planning that they have; the FAB investments they’re making. It certainly turns into quotes and bookings and backlog that we track. But I think people have - it depends on also where you are in that cycle, Mark.

With metrology, they use metrology to bring in a fab, they qualify tools to do the ramps, to tweak on yield. And we get the benefit in a variety of those areas. And we continue to see the - we’ve had our stronger DRAM than some of the other companies have reported in the last couple of quarters.

And we think in the second-half it’s going to be continuing to help us..

You also mentioned potential upside in logic. Now, we’ve been hearing from another equipment manufacturer that they are seeing more at the 10-nanometer node, more people expecting - expanding capacity to 28-nanometer and instead they are expecting the 7-nanometer to be the big ramp for 3D. I’m just wondering what’s your viewpoint on that..

So I probably should separate those two, Mark. When I talked about upside in logic, it’s somewhat advanced logic, so really talk into the SOC manufacturer, the IDM, which has been sliding now for us, which we’ve got a very strong tool-of-record position.

But their development of the - going from 14-nanometer to 10-nanometer has been pushed out with a lot of tool reuse. We are hoping to see - we would like to see a little bit of recovery towards the end of the year, but we don’t know for sure.

And speaking more specifically to what you were referring to, the 10-nanometer, 7-nanometer, that’s more of a, I believe, a foundry question. And our feeling is that 10-nanometer is going to be a good node. We are seeing most of our business and discussions around 10-nanometer. 7 and 5 are out there and we are working with them.

But I know at least one company has talked about leapfrogging 10 and jumping right into 7. We see 10 as a good solid node. And we think we are going to enjoy a nice contribution through our revenues from 10-nanometer..

So it’s still too early to say whether 7 would be actually bigger than 10 for NAND?.

You mean for foundry logic?.

I am sorry, for foundry logic..

Yes. I think it’s a little early on that. I think chances got to play out. Lot of this is going to be driven by the fabless and what they need in their performance, and how well they come up the yield curve. As you know, there’s been scope in a lot of investment, the 28.

But I think 10 - I mean it really - it also ties in the strategy that EUV, what they’re going to do on critical layers. But I wouldn’t shortchange what the opportunities are in 10-nanometer. Right now, it doesn’t look like a stub period for us. We think it’s a solid node..

All right, you just gave me another thought. What about EUV, I mean, that’s been controversial so long in coming.

Do you think that finally arrives at 7 or beyond 7?.

Yes, whether it’s at least one customer talking about, one or two critical layers with EUV. We’ll have to see how well that’s deployed into HVM. I think most of the EUV that you are going to see is going to be played out more on the 5-nanometer.

And even in that case it’s only going to be in a couple of layers, where they have either triple or quadruple patterning. I think immersion will still be used for the majority of the layers. So I don’t think there’s a huge market shift in terms of the demand for products like ours in either case..

Thank you..

Thank you. [Operator Instructions] And our next question comes from the line of Graham Tanaka with Tanaka Capital Management. Your line is now open..

Congratulations, Tim and Jeff, great quarter and outlook. Just it seems like a bit of - a sort of a non sequitur almost between what you guys are looking at and seeing versus a lot of the other providers. And I’m just wondering how much of this is the new product cycle and just [hitting and stride] [ph] or is it mix or what else is it? Thanks..

Yeah, Graham, good to hear from you, yes, we realized that there is a couple of points where we seemed to be contrarians. But we were - we are kind of used to be in that place. We were contrarians when people were expecting certain amount of spending in IDM advanced logic, and we didn’t think that was going to occur and it didn’t.

A lot of our performance is all about share gains and being with the leading edge areas. For instance, a lot of customers or a lot of competitors are still counting on revenues going into 28-nanometer in foundry. And, as you know, we don’t have a position in 28-nanometer, everything we do is beyond there, the 14, the 10, the 7.

Everything what we do on the NAND part of the business is of 3D NAND. So we’re doing the new fabs, the new ramps. We’re tidying on the early stages. We’re tidying on driving the yield. And over the last years we worked very, very hard to make sure that we had a balanced revenue customer mix that gave us much more balanced revenue.

We’re not overly waited any longer in just memory or just DRAM or just advanced logic. And so, we get the multiple contributions which smoothes out our revenue outlook and gives us a lot more confidence in the second-half..

That’s really great. The other thing is a bit of a surprise, and what I’m surprised is the margins. And, I guess, I was trying to understand the new Atlas IIIs higher margin.

If we didn’t have the Atlas III in the mix, are you still seeing higher margins?.

So the first thing is there is no Atlas III in the margin at all. We should be in the Atlas IIIs. They’re going into our - we have not hit the point of revenue recognition on the Atlas IIIs, or in multiple - we shipped multiple tools to one customer. We have other ones going out.

But all that margin improvement is in with our current product line and it’s mostly driven by our operational efficiencies. We’ve put a lot of energy into making sure we can reduce our installation warranty expenses. We work on our supply chain. We work on our cycle time.

So that’s just having our shirt sleeves rolled up and doing a better job inside the factory with the existing product line..

The Atlas III - congratulations, again, it’s really critical to get to the key platform going in place solidly.

How long is that product cycle versus the product cycle, [do you know] [ph]?.

The cycle between Atlas III and previous line?.

Lifecycle of the product, the….

Well, the lifecycle of this product is generally a year-and-a-half to two years in terms of by that time we got to introduce the next generation. The product itself will be out there for three to four years.

We actually had a little longer - if you look at the time since we introduced the Atlas II, the Atlas III that was a little longer than our normal cycle. We have put a lot more energy into the development. Some of the technical challenges were steeper than they were in the past.

But kind of the rhythm you’d like to have is to have a new product cycle, at least a significant upgrade at each technology node. The customers expect that from us..

Congratulations again. Thanks..

Thank you, Graham..

Thank you. And I am showing no further questions at this time. I would like to turn the conference back over to Mr. Tim Stultz for any closing comments..

Well, thank you once again for participating in our call. And special thanks and continued appreciation to all of our employees and business partners, whose passionate 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 participating in today’s conference. This does conclude today’s program. You may all disconnect. Everyone, have a great day..