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

Weston Twigg - KeyBanc Capital Markets Tom Diffely - D.A. Davidson Patrick Ho - Stifel Nicolaus David Duley - Steelhead David Wu - Indaba Global Research Mark Miller - Benchmark.

Good afternoon, and welcome to the Nanometrics’ Second Quarter 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. [Operator Instructions] Please note that this conference call is being recorded today, August 01, 2017.

At this time, I would like to turn the call over to your host, Claire McAdams. Please go ahead..

Thank you, and good afternoon, everyone. Welcome to the Nanometrics’ second quarter 2017 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 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.

Such statements may be identified by the use of words like believe, expect and similar expressions that look toward 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 2016.

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?.

3D-NAND, DRAM, and Logic Devices. We can safely say this is the most successful new product launch in company history, both in adoption rate and revenue ramp contributions.

As we have discussed previously, and in addition to our investments around OCD, hardware and software solutions, we are investing in the development of an entirely new process controlled product, which is intended to significantly expand our served available market.

Progress on this new system is going well, and we expect to be in our target of our first shipments to our launch partner by the end of the year. As part of this program, we made an initial investment into a certain third party entity to acquire technologies which will complement and accelerate the timing of market of this tool.

We are very excited about the potential of this new process controlled pipeline and expect it to be a key growth driver in 2018 and beyond. Turning to our business outlook by end markets.

Globally, investments of 3D-NAND continue to be strong and we now expect 3D-NAND spending where we have a particularly strong market share to increase from the 2016 record levels and to once again be the largest contributor to our 2017 sales.

While our long term outlook on total spending by Chinese national fabs for 3D-NAND devices has actually increased, with first revenues already recognized in Q2, we believe meaningful contributions and opportunities in this market will be significant part of our 2018 growth story.

DRAM is again quite strong for us this year and is expected to be relatively evenly weighted between the front and back half of the year. Within the foundry segment, we continue to expect significant year-on-year growth with foundry becoming the second largest contributor to our revenues behind 3D-NAND in 2017.

Total foundry revenues are expected to be relatively evenly spread between the first half and the second half, with Taiwan based standard revenues weighted to the first half and South Korea and China based foundry revenues weighted towards the second half.

We believe our experience and market position in OCD for FinFET device structures offers a competitive advantage with domestic Chinese foundry fabs developing those capability, and this opportunity will be a contributor to our 2018 growth story.

In the logic segment, we are encouraged by improvements in the spending outlook for the second half of the year and expect that we’ll see meaningful growth in logic sales, driven by our tool of record position albeit off a small base in 2016 and first half of 2017.

Finally, in the second half of 2017, we expect increasing contributions from our materials characterisation business, driven in part by growth in our CMOS sensor markets, along with continued strength and contribution from our service business.

In summary and in light of the forecast for second half industry investments in markets where we have high participation, we continue to expect a 10% increase in 2017 second half revenues versus our first half business levels.

To sum up our thoughts on the year, whereas 3D-NAND is clearly a major driver of our expected year-over-year revenue growth, continued strength and invested in foundry and DRAM are helping to propel us to record revenues for the year 2017.

In addition, investment in domestic Chinese 3D-NAND fabs has begun, our films business increasing and logic spending is beginning to improve. Simply put, every segment of our business is growing this year, between memory and logic, materials characterisation and service and software and analytics.

For the full year 2017, we expect to deliver record revenues, our fourth sequential year of double-digit revenue growth. Year-on-year growth above the growth rate of 2016 and our fourth sequential year of outperformance versus overall industry spending.

Our 2017 business trends combined with additive contributions from current and planned new product offerings and a prospective growth in spending on laser fab equipment in 2018 not only gives us confidence in closing out on a record year in 2017, but also for strength, further growth, and new records in 2018, driven largely by the following six factors.

First, continued strong spending, transfer of 3D-NAND, DRAM and foundry. Next, the emergence of significant spending from domestic China fab projects. Next, secular growth in OCD for advanced three dimensional device structures. Fourth, share gains in thin film and integrated metrology.

Fifth, initial revenues from our new product platform and lastly, increasing contribution from our software and analytics products.

Turning to our next quarter, similar to other regions in the industry who are weighted towards memory, we expect third quarter shipments to moderate slightly followed by significant growth in the fourth quarter where we expect to achieve a new company revenue record. And with that, our Q3 guidance is as follows.

Revenues of $60 million to $64 million, gross margin of 53% to 54%, operating expenses of $23 million to $23.5 million and earnings per share of $0.22 to $0.31. I’ll now turn the call over to Jeff to discuss our financial results and guidance in more detail.

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.

The P&L metrics discussed are non-GAAP measures, unless I identify the measure as GAAP based. These measures exclude the impact of amortization of acquired intangible assets, restructuring charges, executive search costs and certain discrete tax items. Second quarter revenues were $64.4 million or 9% from the first quarter and up 16% from Q2 of 2016.

Product revenues were $53.6 million, an increase of 11% from the first quarter and up 13% year-over-year. Service revenues of $10.9 million were relatively flat to the prior quarter and up 30% from the year ago period.

By end-market, product sales to the NAND segment continue to the largest contributors at 52% of product revenues, increasing 45% from Q1. DRAM sales experienced the largest growth as compared to the first quarter increasing 73% to comprise 21% of product revenues. Foundry sales remained strong and comprised 21% of product revenue.

IDM/Logic sales were 1% and all other devices and substrates comprised 5% of product revenues. By product type, total second quarter revenues were comprised of 60% automated systems, 16% integrated metrology systems, 7% materials characterization systems and service of 17%.

Our 10% customers in the second quarter included Samsung at 30%, SK Hynix at 23% and Toshiba at 10% of total revenues for the quarter. Our Q2 gross margin of 52.4% improved over 400 basis points from Q1, product gross margins were 52.7% an improvement of 540 basis points from the first quarter.

Service margin declined from the first quarter to 50.6% principally due to lower spares parts sales. Our guidance for Q3 gross margin was 53% to 54% is in line with our financial model of this revenue range and we expect gross margin to be up again sequentially in Q4.

Operating expenses of $22.6 million was below our guidance range, primarily due to the timing of certain R&D program expenditures. For the remainder of 2017, we expect to remain at a similar quarterly expense level as our Q3 guidance of $23 million to $23.5 million with the increase being primarily R&D spending.

Below the operating line, other income was $258,000 consisting primarily of investment and interest income offset partially by foreign exchange losses. Our non-GAAP tax expense for the quarter was $3.6 million or 31% of pre-tax income.

Our tax expense on a GAAP basis also included a benefit associated with the adoption of a new tax accounting standard that now requires the differences associated with the settlement of employee equity earnings that differs from the grant value to go through the GAAP tax rate.

On an ongoing basis in 2017, we expect the non-GAAP tax rate to be approximately 30% and our cash tax rate to be about 18% due to our ability to utilize our deferred tax assets during the year.

Net income for the second quarter was $7.8 million or $0.30 per share, slightly below the midpoint of our guidance range as a result of the revenue coming in at the low end of our guidance range. Turning to the balance sheet. Cash and investments grew to $135.7 million or $5.33 per share.

Day’s sales outstanding declined to 66 days from 73 days in the prior quarter. Inventory increased $5.7 million to $50.5 million at the end of the second quarter with the increase, a result of the [Indiscernible] higher shipments. Cash flow from operations was $7.2 million and free cash flow for the quarter was $5.7 million.

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

Operator?.

Thank you. [Operator Instructions]. Our first question comes from the line of Weston Twigg from KeyBanc Capital Markets. Your line is now open..

Sure, just first question is wondering you hit the lower end of the guidance in Q2, you said you had an analyst tool that pushed out.

I assume that would land in Q3, so I’m just wondering if you can give me a little more color on why you think Q3 revenues why it’s down from June? What are the moving parts?.

Sure, West, this is Tim. Thanks for calling in. The shift is really just a timing of customer spend and where those markets are driving and if you look at where we have the highest exposure particularly in the memory side where the investment in tool deliveries are required, it’s going to be more about weighted toward an buys into the Q4 timeframe.

It’s really just a timing issue and when they on metrology tools..

Okay and that probably helps with the next question. But, how do you have conviction that December would be up so much because by my math you are looking at a very substantial uptick in the December quarter..

It’s the combination of the tools that are being shipped and are subject to revenue recognition and acceptance. The investment plans of our customers, the orders and backlog, we have a pretty good visibility and we see – we have a pretty high level of confidence in that Q4 number..

All right, very helpful. Thank you..

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

Yes, good afternoon. I wanted to dig a little bit to the new Chinese 3D-NAND customer that you have.

I think you mentioned along the way that this is potentially a 300,000 wafer start a month customer and just curious is this still the same buy rate that would be somewhere in the $5 million to $7 million per 10,000 wafer starts of your OCD tool?.

It’s in that area in terms of opportunity. I always say OCD tool although we hope to get captured all but it’s that same range here if there would be.

They are looking at equivalent to second gen 3D NAND devices, those fabs that we build out you know sequentially they have got, they are expected to come into three stages, three 100K fabs each and we feel pretty good about our competitive position and the product offerings and hope to capture a lot of that business..

Okay, so the OCD portion would be roughly $60 million per 100K fab there?.

Yes..

Okay, and then I guess when you look at the 3D-NAND business that you are seeing today, you know when you move from the first, second and third generation are you seeing the addition of OCD orders or how does that play out as far as the transition goes with the impact on OCD?.

So any new capacity kind of tracks to the model we’ve shared with you and to be found on our IR presentation in terms of OCD opportunities for 10,000 wafer starts that captures both the automated and integrated.

There are some additional conversions going on where they taken plain or into 3D-NAND and that will probably track more like 20%, 25% of that total opportunity described in a Greenfield fab, but yes, it’s that we are fighting that model and opportunity is tracking well.

The kind of little variation occurs whether or not they are going into a stack devices versus a continuous 96 pair example. There is a little difference in the OCD opportunity there..

Okay, great. And then when you look at the incremental cost for the new tool that you are developing, I guess it was a little unclear, you said that the – obviously the revenue or the R&D level is going up over the next few quarters, is that a higher rate now.

And you also mentioned there was a third party investment, I didn’t catch that portion of it..

Okay, I’ll let Jeff speak to where you’ll spot it, but we did make an investment in some intellectual property and know how in exchange for exclusivity that ties directly into this tool and the direction we’re taking this tool and allows us to use some parallel development and accelerate the timing of the market and certain features of this tool which strengthens our conviction and belief on where this – the market we’ll be serving and our ability to generate revenues from it.

And Jeff, you can come in where you can spot that..

Yes, you’ll see it on the cash flow. It will be in the investment section where we had an investment and certain assets. When you look at the run rate year-over-year time as you model our R&D, you’ll see that it’s growing a bit year-over-year and it’s almost all related to the new product, that’s where we added our expenditures for the year..

Okay.

Will there be a royalty payments for this technology as well as systems go out the door?.

No, no..

All right. Great, thank you..

Thank you. Our next question comes from the line of Patrick Ho from Stifel Nicolaus. Your line is now open.

Thank you very much. And maybe as a follow up question in terms of regarding the Chinese entry or the penetration into the 3D-NAND. How does that potentially impact your margin profile given that typically new tools or new entrants into new customers tend to have a little bit of a low margin at the beginning.

Your margins were very strong this quarter and the outlook looks good.

How do we account for those new penetration as we look forward?.

It’s a good question but I’m not going to give you all the details for competitive reasons but I’d tell you that we are not seeing any margin erosion. If nothing else, we did see improved margins in that environment because of the technology edge and what we are bringing in that market and the nature of the customers in that environment..

Okay, fair enough.

Second question in terms of the thin-film applications you are talking about, and when do you – can you get a little more specific on what type of application wins you’ve achieved and what are some of the ones that you are looking for say over the six to nine, over the next six to nine months?.

Most of this is an expansion of using our Atlas platform for beyond the OCD applications to also playing the films market. The films, it’s the front end area of the films. Film thickness is the primary area and its very complimentary to what we are in the edge side of the transistor formation..

Great. Thank you very much..

Thank you. Our next question comes from the line of David Duley from Steelhead. Your line is now open..

Just curious for Nanometrics, how much growth should – will you see in the DRAM market in 2017 versus 2016 based on your assumptions for the current calendar year?.

So when you talk about the 2017 versus 2016 in terms of troubled DRAM we see that kind of results flat, flat market for DRAM based on the spending and where the investment pattern [ph] are with our key customers year-over-year..

For flat spend 2017 versus 2016 in the DRAM market?.

Yes..

Would you expect that to be up in 2018?.

I don’t know. The answer as you know it’s very much of a capacity demand balance and its far pricey. We think that there are signs that DRAM spending could be up because of some of the investment patterns, but right now I don’t have any more information on that..

Okay, and as far as the China investments go in memory, would you expect there to be another customer in 2018 or could you take a guess it’s how many customers you think will be spending in the memory area in 2018 in China?.

That’s a good question. We are certainly aware of atleast three investment plans albeit the large investment group, unit growth in China has identified three different location sites and customers have their plan on bringing 3D-NAND capabilities too.

The timing of the other it should on a level, a little uncertain but there is some suggestion that by middle of the latter part of the year that they could start to receive some funding..

Okay.

And final question from me, you talked about this new tool, I know you haven’t really given people the details on that I guess, but could you talk about how big the market opportunity is for you or do you have revenue targets or goals for that tool in 2018?.

I can give you kind of relatively size of the market. And of course we have revenues, goals and objectives but we won’t be speaking to those. We see that market comparable to the OCD market.

We currently serve and so if you look at where our key products serve which is OCD and films which have roughly a similar market sizes that this new tool it will potentially expand our directly served market by about 50% or more..

Okay. Thank you..

Thank you. Our next question comes from the line of David Wu from Indaba Global Research. Your line is now open..

Yes, good afternoon. I have two things, question. One is that the – your larger customer that has been dormant for quite a few years. Is the recent pickup in activity due to their upgrading to analyst free or is there something else? And I have a follow up..

Sure. David, I don’t like there the customer liked to be called dormant, but if it’s certainly the revenues with us have been down. It’s not a conversion to that platform, it’s the business we have seen on the logic side is a continuation of adoption of the current platform that’s tool of record.

That customer also has investments in memory and they are working with newer platforms in their memory area..

Oh I see. The thing I have about -- you mentioned about the current customer you have in Chinese domestic fab, that customer I guess has got a license from expansion, I was wondering can you give us a rough idea about this three different phases of expansion.

You mentioned we are obviously starting on phase I but usually there’s a pause and then followed by Phase II and then a pause and then Phase III.

Can you give us a rough order of magnitude when that different phases get in and out?.

Well I’ll give you a – what I’ll share with you is more about my experience and any stated plans that they have laid out in detail for us, but right now they are looking at building three separate fabs of about a 100,000 wafer starts per fab.

And our experience has been on a 100,000 wafer start fab there is usually two or three phases to populate that fab.

So we would expect the initial investments to go in as the first fab, phase or the first fab and then that usually goes for six to nine months and then they start to populate [ph] that fab before they go to the next fab and break ground on the next [Indiscernible]..

Okay. Thank you..

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

Just discuss the three investment opportunities in China, but you know the forecast for significantly more fabs to come up in China next year.

I’m just wondering are these fabs coming up later next year, why are we only talking about three opportunities here in China next year?.

So Mark, what I was speaking to you specifically are 3D-NAND fabs that we are aware of. There is additional logic fabs being planned and they are all foundry fabs and then there is additional potential investment in DRAM. So then certainly you are absolutely right. There are more fabs planned and I think the question was specifically about 3D-NAND..

And you feel you have opportunity based on a number of days?.

Yes, I mean we think that we are very competitive with our market position and experience. I think we are very competitive in all those areas and we are going to do our best to capture more than our fair of share of business..

What about the Samsung fabs, the Pyeongtaek facility, that’s just started their production and supposed to ramp to some estimates, a million wafer and I’m just wondering that how big an opportunity will that be your biggest opportunity.

And then the final questions what about TSMC, I mean traditionally they tend to buy not so much in the September quarter, do you think sales come back stronger later this year, first quarter next year from TSMC?.

Okay, well so on Samsung, certainly the big story is spending at Samsung. Samsung has materially up – their stated and committed spending on wafer fab equipment. Pyeongtaek being their larger project and Pyeongtaek right now is dedicated primarily to 3D-NAND.

However, Samsung is also spending money on Logic in their S III fab, where you know Samsung is a good customer for us across all the device type, 3D-NAND, Logic and DRAM but we see the primary opportunity and upside for all of that business is in what call P project, or Pyeongtaek project for 3D-NAND.

On TSMC, Mark our current visibility is that TSMC seamless [ph] first half of the year weighted and they are spending and we see as we mentioned during the call we see foundry spending in the second half of this year being driven largely by Korean foundry and Chinese foundry.

And we’ve been looking for some resumption of the spending from – in the Taiwan area in the beginning of 2018 and let’s hope it chases..

Okay. Thank you..

Thank you. And at this time, I’m not showing any further questions on the phone line and would like to turn the call back over to Timothy Stultz for any closing remarks..

Thank you. Before ending this earnings call, I want to offer a brief update on our succession plan in progress. We are well along the search process for our next CEO and have identified several very strong candidates for the position.

Our Search Committee with the help of the full board is working closely with our executive recruiter to reduce the list to two finalists. I am personally pleased with the level of talent and consideration for the position and I am confident the next CEO will be exceptionally well qualified to lead Nano through its next phase of growth and expansion.

Meanwhile, I along with the support of my leadership team and all our employees remain focussed on responding to the challenges and opportunities in front of us, executing in a robust spending environment and profitability growing our business to create incremental stake holder value. With that, I thank you for joining our call and close it..

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..