Claire McAdams - Investor Relations at Headgate Partners LLC Timothy Stultz - President and Chief Executive Officer Jeffrey Andreson - Chief Financial Officer.

Patrick Ho - Stifel Nicolaus Tom Diffely - D.A. Davidson Weston Twigg - Pacific Crest David Wu - Indaba Global Research.

Good afternoon, and welcome to the Nanometrics’ Fourth Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions]. Please note that this conference call is being recorded today, February 07, 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 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 year and our perspective looking forward.

Then, Jeff will discuss our financial results in more detail, after which we will open up the call for Q&A. The press release detailing our financial results was distributed over the wire services shortly after 1:00 PM Pacific this afternoon. The press release and supplemental financial information are also available on our website at nanometrics.com.

Today’s conference call contains certain forward-looking statements including, but not limited to, financial performance and results including revenue, margins, operating expenses, profitability and earnings per share.

Such statements may be identified by the use of words like believe, expect and similar expressions 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 reasons 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?.

Thank you, Claire. Good afternoon, everyone. Today in my prepared remarks I will briefly review some of the highlights of this past year, before sharing views on the current business environment and our outlook for the coming year.

Jeff, will review the financial details of our recent results, and guidance for the first quarter of 2017, before turning over the call to Q&A. Our revenue growth in 2016 reflected a significant market share gains we have achieved over the past two years. On the secular tailwinds are increasing the demand for optical metrology platforms and solutions.

Revenues of $241 million were up 18% from 2015, well outpacing overall industry spending. In 3D-NAND in particular, we continue to benefit from our leading market share and strong positions with every company ramping production of 3D NAND devices.

These customers rely our tools to characterize, monitor and control the processes that enable them to develop next-generation devices, ramped a high volume manufacturing and drive incremental yield.

In 2016, we achieved record 3D NAND sales, nearly doubling from the prior year record in 2015, which also help set a new record for total sales for the memory segment. Our market share gains in 3D NAND also contributed to all-time records in both thin-film and integrated metrology.

And with the expanded presence of our automated and integrated products throughout the fab, in combination with our unique and proprietary NANO-diffract software and analytics capabilities, our customers are able to control process variation across multiple process steps using feed-forward and feed backward with advanced process control strategies.

In 2016 our revenue profile continue to improve with a more balanced customer mix, and strong contributions to our business from NAND, DRAM and foundry logic. As a result, all six of the leading global semiconductor manufacturers are now significant contributors to our business.

Below the top line, our relentless focus on improving operational efficiencies resulted in 2016 marking a financial performance inflection point for NANO. On 18% revenue growth, gross margin improved over 330 basis points, operating margin improved over 920 basis points.

And we delivered incremental gross and operating margins of over 70% and 65%, respectively, well ahead of our business model. We accomplished these financial improvements, while the same time successfully launching two new products into the market, the Atlas III and the IMPULSE+.

While first deployments were to the 1X DRAM market, these new products are gaining traction at multiple additional key accounts and end markets.

In fact, the customer response to these new product launches has been the strongest we've ever experienced for newly introduced product and is expected to lead to overall record shipments for us in the current quarter.

Given the number of first-in fab deployments in our first-quarter shipping plans and the associated delays in timing of revenue recognition on those systems, we expect to achieve all-time record revenues in the second quarter.

With our current visibility in the customer demand and commitments, we also see significant strength going into the third quarter and for the second half of the year and expect the full year 2017 will be another year of out-performance relative to the overall industry and a new record for Nanometrics.

With our growing confidence on our sales pipeline for 2017 and the improving tailwinds of recently announced customer spending plans as a backdrop, I'll share a bit more of our expectations for each of our business areas. In 3D NAND, we expect to continue to benefit from our leading market share positions in 2017.

We see strength in the second half of the year, driven by the timing of our customer’s investments, the timing of revenue recognition on new products, and the entry of new market players, particularly in China. Given our current visibility, we expect the NAND segment will again be the largest contributor to our total revenues for the year.

In DRAM, we expect improved spending in 2017 versus 2016. This should lead to a strong growth year in this segment for us, with revenues relatively balanced between the first and back half of the year and a balance of revenues across multiple customers.

Perhaps the most significant year-over-year growth for NANO in our 2017 will come in the foundry segment, which is expected to be particularly strong in the first half of the year.

Our market share gains in foundry are playing out in all key regions, Taiwan, Korea, and China and with each of our product platforms, including the Atlas III and IMPULSE+ and Thin-Films and OCD.

Overall, our current outlook for 2017 is that we expect to see record quarterly revenues in the second quarter, record annual revenues for the full year and double-digit growth that exceeds current forecast to increase in overall industry spending.

Turning to our business model, we recently published an expanded business model, which exhibits the operating leverage we can achieve in growing revenues to the $500 million level.

We also reflected the improved gross margin profile in our business model, arising from better business processes, operational efficiencies and market leadership driven value-based pricing of our products and services.

We have worked hard to drive operational efficiencies over the past two years, keeping operating expenses essentially flat to 2013 level, while growing revenues in excess of 50% through the same time period. This in turn, has helped us achieve incremental operating margins well ahead of our model.

We will continue to focus our efforts in this area to deliver further improvements going forward, as we believe these results translate directly to shareholder value.

Importantly, stronger gross margins enable us to step up our R&D investments for the development of entirely new technology platforms, targeting emerging or underserved applications that can significantly expand our served markets and contribute to future revenue growth.

Those investments and development activities are already well underway and are expected to meaningfully contribute to our business in 2018 and beyond. Jeff will provide a little more color on our R&D and OpEx plans going forward in his commentary.

Before turning to guidance, as noted earlier, we expect all-time record shipments in the quarter, including record shipments of our newest products, which will be accompanied by delays in revenue recognition, as they are first and fab shipments to multiple customers for multiple [ph] new applications.

Given the associated delays in timing of revenue recognition on those shipments, Q2 is setting up to be a record quarter for us and we expect first quarter revenues to come in at levels similar to the fourth quarter, which it midpoint will be up over 23% over the first quarter of 2016.

With that our Q1 guidance is as follows, revenues of $56 million to $61 million, gross margin of 51% to 52%, operating expenses of $21.6 million to $22.2 million and earnings per share of $0.19 to $0.26. I'll now turn the call over to Jeff to discuss our financial results and guidance in more detail. Jeff? Jeffrey Andreson 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.

The P&L metrics discussed are non-GAAP measures, unless I identify the measure as GAAP base. These measures exclude the impact of amortization of acquired intangible assets, restructuring charges and certain non-cash tax items. Starting with a summary for our full-year revenue drivers for 2016, total sales were $221 million, up 18% from 2015.

Product revenues increased 20%, while service revenues increased 11% from 2015. By end-market, product sales to NAND segment nearly doubled, as compared to 2015 and comprised 51% of product revenues for the year. DRAM revenues increased 18% from 2015 and comprised 19% of product revenues in 2016.

The foundry segment comprised 18% of product sales, down from the prior year due to the timing of customer investments and process control metrology, the remaining 12% of product sales were to IDM logic, and other devices and substrates. By product type, automated systems sales grew 17% in 2016, and comprised 58% of total revenue.

Integrated metrology system sales comprised 20% of total revenue, growing 34% year-on-year to a new record. Materials characterization sales were similar to the prior year comprising 6% of total sales, with the remaining 16% on service. Our 10% customers for the full year included Micron at 20%, Intel at 18%, SK Hynix at 15%, and TSMC at 10%.

We now have meaningful positions at all six leading semiconductor manufacturers with the remaining to following to just under the 10% level for 2016. With 18% revenue growth, gross margin increased over 330 basis points to 52.3%, aligned with our improved business model.

Operating expenses were $85 million, up about 2% from the prior year and our operating margin for the year was 14%, up over 920 basis points from 2015. As Tim mentioned, incremental gross - growth and operating margins on the additional revenues in 2016 were over 70% and 65%, respectively, well ahead of our model.

Free cash flow generation for the year was $41.7 million and we added approximately $47 million in total cash and investments to the balance sheet during the year. Turning to the fourth quarter, fourth quarter revenues were $59.2 million, up slightly from the prior quarter and up 39% from Q4 of 2015.

Product revenues were $48.8 million, down slightly from the prior quarter with increase system shipments, offset by a lower level of upgrade sales. Product revenue increased 45%, as compared to Q4 of 2015. Service revenues were a record $10.4 million, up 14% from both Q3 and the year ago period.

By end market, product sales to both NAND and DRAM segments were similar to Q3 and comprised 43% and 22% of product revenues, respectively. Foundry segment increased to 22% to comprise 25% of product sales with IDM logic, and all other devices and substrates comprising the remaining 10% of product sales.

By product type, total fourth quarter revenues were comprised of 62% automated systems, a 11% integrated metrology systems, 9% materials characterization systems and service of 18%. Our 10% customers in the fourth quarter included SK Hynix at 19%, TSMC at 16%, Samsung at 15% and Intel at 14% of total revenues for the quarter.

Our Q4 gross margin was 52.3%, down slightly from Q3 as expected, due to a lower mix of upgrades during the quarter. As a result of the lower upgrade sales, product gross margin was slightly lower at 53.3%, where service gross margin improved to 47.5%.

For the first quarter 2017, we are guiding gross margin in the range of 51% to 52%, which is slightly below our target margin at this revenue level, due to less favorable product and customer mix, compared to the fourth quarter.

For the full year of 2017 we are continuing the drive efficiencies and cost improvement initiatives and remain on track to meet our target model performance of 53% to 54% gross margin at the $250 million revenue level.

Operating expenses of $21.9 million were above our guidance range of $20.8 million to $21.4 million, primarily due to higher engineering program cost and variable compensation. For 2017, we are planning to increase R&D spending as Tim noted earlier, we expect to increase operating expenses by about 5% year-over-year.

We recently presented and expanded business model, but the primary changes being a $500 million revenue model and improved gross margin profile, which in turn allows us to invest in additional R&D program that will drive continued revenue growth in the future, while improving operating margins as revenue increases.

Below the operating line, other income for the fourth quarter was $223,000 and was primarily interest income in the quarter. Our non-GAAP tax expense for the quarter was $1 million or 10.5% of pretax income. This was lower than expected due to the timing of a favorable adjustment to our US tax and was equivalent to about $0.02 per share.

Our tax expense on a GAAP basis, included a reversal of a deferred tax asset allowance, for the US, UK and Israel entities and amounted to an $18.4 million benefit equivalent to $0.72 per share in the quarter.

On an ongoing basis in 2017, we expect our tax rate to be approximately 30% and our cash tax rate to be about 12% due to our ability to utilize our deferred tax assets during the year. Net income for the fourth quarter was a $8.4 million or $0.33 per share.

Turning to the balance sheet, cash and equivalents increased $11.5 million to end the year at $130 million or $5.20 per share. Days sales outstanding decreased to 60 days from 63 days in the prior quarter. Inventory decreased $2.4 million to $41.3 million at the end of the fourth quarter.

Cash flow from operations was a $11.6 million for the quarter and $45.7 million for the year, free cash flow for the quarter was $10.9 million and $41.7 million for the year. And with that, I'll turn the call over to questions.

Operator?.

Thank you. [Operator Instructions] Our first question is from Patrick Ho with Stifel Nicolaus. Your line is open..

Thank you very much. And Tim first off, congrats on the quarter and the strong 2016 results. As I look at your thin-film opportunity, you've talked about market share gains.

Can you discuss first I mean, 2016, which mark you know, which application you saw last year and as you look for – as you look at 2017 as a whole, where do you expect additional gains to occur?.

Hi, Patrick. And thanks for call, thanks for the comments on the quarter. You know, last year, our business is been heavily driven by 3D-NAND as you know, and continue to gain there - strengthen that market. The films business has grown pretty dramatically and although it started off at a slower number.

And so we see a lot of opportunities to increase our position and the contribution from the films business itself. And you know, in terms of the rest of the products, we've got some opportunities in DRAM that we're pursuing and we have some additional share that we're going to go after in foundry.

So we think that there is a lot of Greenfield area for us to continue to increase the contribution revenues in the lowest outperform the industry..

Great. And maybe as a follow-up question for either you or Jeff, the services business saw an uptick in the fourth quarter, which may be just seasonal aspect, but longer term as you've made the share gains over the last few years.

How do you look at services both from a revenue opportunity and maybe more importantly from a margin and earnings contribution on a going forward basis?.

Hey, Patrick, it's Jeff. Yes, I mean, we typically feel a little more of spares [ph] towards the end of the quarter. So that was some of the reasons why the margin was pretty strong. We're also seeing a higher level of utilization of the workforce, which is something that as you know, we dipped down a few quarters ago and we're going to grow back into.

Long-term you know, we want to see this mid-40s and above. It's a pretty good driver. It should grow you know in excess of our installed base because I think we're still catching up a little bit, but it had a reasonably strong year. I think next year we think it will be a stronger level of growth than we saw actually this year..

Patrick, I'd also add that, we've got a lot of tools that we've been pulling out over the last couple of years that are coming off warranty. You know it's a captive market for us.

We have a pretty significant focus on – maybe give you an incremental contribution from service and as Jeff said, we do have some seasonality, but Q4 was still an all time record for service and the margins are quite respectful and I think that we can continue to improve in that area..

Yes. And maybe as a follow up to that, I guess, what kind of wanted to get at is, you know, given all the share gains and growing core installed base.

How are you keeping the customers on your service program versus them you know going out to potential third-party vendors, what's been the strategy there to keep them on your services business on a going forward basis?.

That’s a good question. The first one is generally its difficult to find third-parties, these are pretty specialized piece of equipment and with uniquely trained folks at service.

But we also put a fair amount of energy and that added to staff to look at our service products, we're trying to combine some value to our customers beyond PMs where our service - service performance prior the end, upgrade potential or even [ph] value for us to gain more service contracts, and more service revenues from our installed base..

Great. Thank you very much..

Thanks, Pat..

And your next question is from Tom Diffely of D.A. Davidson. Your line is open..

Yes, good afternoon.

First, just history question, what was your previous record for shipments?.

$64 million..

Okay..

I am sorry, did you – you asked difference to revenue?.

Will, revenue was 64.4 right?.

Right..

We don't announce shipment dollars – we don't announce shipment dollars. So….

Okay. Not even on historical basis? Not even on a historical basis? All right, let's get back to the business then.

So 3D-NAND obviously extremely strong in the first half of year, I sound like you said that the strength continues into the second-half, are your comments basically that it just stays stronger or do they grows in the second-half?.

Yes, we think it’s more of a 40-60 split between first half and second half. So it’s still a strong number in the first half, but we see an uptick in the second half for the NAND market product..

So why do you think you see a little bit different timing in some of other larger players, just for the NAND market?.

I don't know what - where their timing comes from.

We look at the way – if you look at the way our tools are purchased, typically the process control tools come in a little ahead of the process tool, so if you are comparing this you know, commentary from the process equipment commission [ph] you'd expect just to have a bit of a forward lead on that, as….

Yeah….

That’s what you compared us to and we've discussed some good positions in some fabs where they are adding capacity and they are expanding the – looking at some Greenfield areas, but it’s all on the upside for us..

Okay.

And you mentioned China as well, is that domestic Chinese players or is that a larger international companies in China?.

That’s a good question. We will be breaking out Chinese – when we speak to China, it will be the national companies. The multinationals are usually exhibited to the core companies..

Okay. All right.

And then just talk about some – you demonstrated some really strong leverage in the model on a year-over-year basis, was there anything unusual, as far as you know, mix or costs in either one of those quarters that you referenced?.

You're talking about in Q4?.

Q4, yes..

Well, Q4, I mean, Q3 was a really strong upright quarter, so the upgrades were down a little bit and the margin was above the range we gave you, again, as Tim talked about our relentless drive for operational efficiencies, we saw some favorability in our warranty and that’s what kind of pushed us up and over that range.

And then, as we talked about the mix will be less favorable in the first quarter, which is why it’s back in a similar range, as we guided going into the fourth quarter..

Okay. But the leverage is down either basis, it seems like a fair compel….

Yes, I think as we said, I think we're tracking well around model. We obviously raised the gross margin number. And so I think we're on track..

Okay. And finally, I had a little product question, it.

I will probably question, the year was traced [ph] like you started with DRAM first, was there a reason to start with DRAM and has its steps gone to the other segment as well?.

Yes, that’s a good question Tom. The reason we start with the 1X DRAM is because one single customer was our launch partner, they wanted it for that application. We work very closely with them to be able to speck out and bring the product to market.

Once we got it through their account – through that account, cut the installation and sign off, then we were – we've got confident to deploy them to other accounts and for other applications..

Great. Thank you..

Thanks. Your next question is from Weston Twigg of Pacific Crest. Your line is open..

Hi. Thanks for taking my question. I have a couple actually. First, just wanted to come back to China, you said you did expect strength in the second half from China memory NAND -related and then you said that this is from domestic Chinese companies, more Greenfield fab.

I am just trying to make sure I understood all those pieces, because it sound like what you are expecting is some of these new projects that have been announced to actually start equipping later in the year is that right?.

That's correct. We do expect some equipment going into some of the recently announced fabs..

Okay. Good, very helpful. The other question I had was just on the model for 2017. You did raise your target model recently with higher OpEx, you talked about using R&D IRD develops and projects on the call today. But the gross margin does seem to be one of below the model, I know, you said it should improve on mix.

But do you think there is a chance that at this $259 level in 2017, they might be running a little bit below your target model performance or do you think you'll be in line with the model from a operating profit perspective?.

Yes, I think will be in line with the model. I think - I think you know how Tim I have run this and that we're pretty prudent. We wanted to raise - when we get confidence that were running much better in gross margin, we raised that data, so we can invest in R&D. So I think we are tracking.

We have programs in place and we're continuing to drive the programs we had this year, as well as new efforts in the next year. So I think for the year it will be fine. As we've said, mixing kind of shift us 50 basis points or so, but I think we're going to track as well for the year, this time for the year..

So what if I add to that, what we - we put a lot of energy into our supply chain, in addition to our operational efficiencies, again, our supply chain line when we cut this new product that’s going out, pricing is much more aligned to value and I think that the combination between pricing, direct costs and indirect costs that were good real advisors of those margin target..

All right, very helpful. Thank you..

Thank you. [Operator Instructions] Our next question is from David Wu of Indaba Global Research. Your line is open..

Good afternoon. Just I want to clarify the – when I look at your SG&A in the fourth quarter they moved pretty sequentially.

I was question whether this was due to variable compensation and you do a one-time adjustment at year end as opposed to doing it on a quarterly basis?.

Now we had some variability in the quarters, but on the SG&A, but we did see a slight uptake in dot com [ph] but some of that is just the timing of when we have some of our corporate DNA type expenses. For example, the audit and things like that..

Oh, I see.

As far as calendar '17 is concerned, I was curious about how much of the shipments - rough order meant to that when you're talking about that shifting from revenue recognition Q1 into Q2, are you talking about $10 million and above or below that?.

So we don't – we're not going to give you that, this is Tim, David, thanks for calling in. We won't give that specific, but as I said it is record shipments for us and we are guiding that. We expect Q2 to be all-time record revenues and then we expect the second half of the - on par or even stronger than the first half.

So things are lining up well and this is just getting new products to market. One of the primary difference is when you send a new product into a new fab for a new application we have to go through to the full customer acceptance before we do revenue recognition.

Once we have an established position in a fab it’s going to the same fab, to the same application then its revenue on shipments. So the lead like on that could be anywhere from six weeks to couple of months..

Oh, I see.

If I would look at - look at your second quarter revenue, whatever the number is, would that be the peak quarter for the year, because not only would it take care of Q2 demand, but also Q1 deferred revenues with the second, third and fourth quarter revenues recognition be higher than Q2?.

So I'm not going to call out whether it will be the peak quarter, David. But I will do that if you take the current guidance for Q1 and you take our inferred guidance on Q2 and I combining as the first half and that we're expecting that the second half will be at least as strong as the first half, than that wouldn’t leave you with a peak quarter..

Okay. Last question I will try this one, there is a lot of talk about lower tax rate and I know you tax loss carryforward, but if the current administration implement a retroactive hope for tax reduction going back to January of this year.

What kind of tax rate should we expect out of NANO?.

David that’s a good question, I don't have an answer for. I mean, all we can do is tell you what we see today, with the logs we have today and what in place. What I would tell you is that, the bulk of our profits are generally US driven and so any reduction in the US tax rate would certainly be beneficial for us.

But you know I - we still have a fair amount of our profits off shore, which in fact unless the rates change significantly. You wouldn’t necessarily bring that cash back to the US. But anything that our president is to do to lower tax rates will be beneficial to us, should he do it..

So, David, I would also add that, since we pay near the statutory rate, we as a smaller company will benefit probably disproportionate to some of the other companies in the industry who already have advanced tax strategies in place..

Oh, I see.

The statutory tax payment US earning?.

Yes..

Okay. Last one is there is lot of speculation about wedding plans in the future between you other company.

What is your attitude towards M&A?.

So our attitude remains unchanged. We believe that there is consolidation that does occur in the industry. We continuously look at ways to create incremental shareholder value, if something like that is appropriate for the company and shareholder value, we are open-minded about it.

But right now we're re really focused on growing this company and creating value in a organic fashion..

Thank you..

Thank you. At this time, I see no other questions in queue. Let's turn the call back to Dr. Stultz for any for any closing remarks..

Well, thank you for joining our call today. 2016 was a very good year for Nanometrics and we expect 2017 to be even better. And say with deep gratitude that our accomplishments are directly tied to the terrific team of employees and business partners who make it happen each and every day. With that, we'll end our call..

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect..