Good afternoon and welcome to Nanometrics First Quarter Financial Results Conference Call. A Q&A session will be held at the end of the call. Until that time, all participants on listen-only mode. Please note that this conference call is being recorded today, April 30th, 2019.

At this time, I would like to turn the call over to your host, Claire McAdams. Ma’am, please go ahead..

Thanks, Justin. Good afternoon everyone. Welcome to the Nanometrics first quarter 2019 financial results conference call. Speaking on today's call are Dr. Pierre-Yves Lesaicherre, President and Chief Executive Officer; and Greg Swyt, VP of Finance and our Principal Financial Officer.

Shortly, Pierre-Yves will provide a recap of this quarter and our perspective looking forward. Then Greg 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 P.M. 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, earnings per share and expected market demand.

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, shifts 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 2018.

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 Pierre-Yves..

Thank you, Claire and good afternoon everyone. Thanks for calling in on this very busy earnings day. Nanometrics continues to operate with strengths and profitability in the current downturn in industry spending.

Our first quarter results reflected a somewhat different revenue mix compared to our forecast, resulting in revenues of $67.1 million at the higher end of our forecast. Our gross margin of 52.5% were at the lower end of our forecast.

The shift in product and customer mix took place very late in the quarter and as the higher-margin business will instead materialize in the current quarter, we expect to snap back in gross margin into Q2. During the first quarter, our outlook strengthened in the second half, which we expect will be up 25% to 30% from the first half.

As such we made the decision to continue our level of R&D expenditure in Q1 in support of our longer-term strategic objectives. In combination, in spite of the higher revenue level versus forecast, earnings came in at the lower end of our forecast at $0.19 per share.

It is important to note that the decision to maintain our level of R&D investments in Q1 reflect the stronger outlook for the year compared to our last earnings call.

Our increase confidence that our revenue from the memory market have stabilized and will begin to recover from their Q1 low point, and a very strong second half forecast for the foundry, IDM and other device markets.

The highlight of our first quarter was a successful introduction of the Atlas III+ which is the latest version of our flagship automated Optical Critical Dimension or OCD system.

The Atlas III+ has rapidly gain traction with the world's leading semiconductor manufacturers with first quarter revenue is recognized from multiple customers across both memory and logic application and in both development and high volume production environment.

With significant enhancement to the company's proprietary, ellipsometry and reflectometry technologies, the Atlas III+ provides industry-leading metrology performance with increased productivity, sensitivity and accuracy.

Another highlight was the award received at Photonics West in February by 4D technology which we acquired in November of last year. The 4D InSpec XL defect inspection gauge received the SPIE 2019 Prism Award in the test and measurement category.

The Prism Awards for Photonics Innovation event is a leading international competition that honors the best new photonic products in the market. The 4D InSpec XL won the award for its utility and importance in making instant, qualifying 3D measurements of surface features for manufactured parts.

Also in the first quarter, we announced a new stock repurchase program. Through 2018 the company has completed $80 million in stock repurchases and in March 2019 we announced a new $80 million plan.

Following the company generating over $100 million in cash flow from operating activities last year, the management team and Board of Directors expressed confidence in the company’s future growth prospects in announcing this new program.

The new buyback plan was announce at the onset of our blackout period in March and as such we have not yet purchased shares against the new plan, but expect to make opportunistic share repurchases in support of our continued commitment to returning capital to our stockholders. Now, with some more detail regarding our first quarter results.

Our first quarter revenue reflected a balance contribution from the memory and non-memory market. After more than 50% quarter-on-quarter growth in the prior quarter first quarter revenues from the foundry, IDM and other device markets grew nearly 40% sequentially and contributed 50% to product revenues in Q1.

Now, while we saw a significant sequential decline in memory sales, which represented the other 50% of product revenues in Q1, our current forecast indicates that the March quarter is expected to be the low point for our memory business in 2019. We are not forecasting a significant rebound to occur from our memory business this year.

However, with the modest recovery expected above Q1 levels in the current quarter and planned spending on the next technology nodes, as well as domestic China project spending, we believe that our member business has stabilized and will improve in the second half of the year.

For Q1, driving the 50% contribution of memory to our product sales where NAND contributing 30% and DRAM the remaining 20%. We should note here that we report all emerging memory technologies within the NAND segment. Our expectations for year-on-year revenue decline in both DRAM and NAND are consistent with industry consensus.

In contrast, our expectation for year-on-year revenue growth is very significant for the foundry, IDM and other device markets. While we expect a sequential decline in these segments during Q2, we expect strong growth to resume in the second half of the year.

For Q2 specifically we expect gross margin to snap back to levels above our target model range for the expected revenue level. With revenue growth in the second half of 2019 expected to be up significantly from the first half we expect to deliver gross margin performance at or above our target for the remainder of the year.

To summarize our drivers for second half growth, which with our current visibility we expect will be 25% to 30% stronger than the first half. First, as mentioned earlier we believe the first quarter represents a low point in our memory revenues this year.

The stabilization in our forecast and modest recovery expected from Q1 level reflects continued technology investments in conversions and pilot lines as well as project spending in domestic China. Second, our outlook for second half strengthened the foundry, IDM and other device markets has improved since our last call.

Third, we expect increasing contribution from our other end markets in the second half such as those addressed by 4D technology and our material characterization business, as well as from service. In total our expectation is for a modest year-over-year decline in total sales consistent with the stated objective to outperform overall WFE.

We also expect to grow profits faster than revenues in the second half of the year consistent with our objective to deliver significant operating leverage as revenues rebound.

For the remainder of 2019, we expect will deliver gross margin performance at or above our financial model target and we are continuing our R&D investment in support of future growth. We have a robust pipeline of new products under development.

During the last three years we've been developing new platforms and technologies to address new applications for the next generation of devices.

More recently our customers have been eager to see more performance and productivity enhancements from our flagship product and therefore for 2019 our product introductions are been privatized towards these new launchers which demonstrate increased capabilities in our core product.

The early success of the Atlas III+ launch with rapid adoption by multiple customers is clearly a testament to our innovative and industry-leading solutions. We expect to build upon today's announcement of the Atlas III+ with additional future revenue growth drivers.

Our strategy is to complement industry-leading revenue growth with strong operational execution, margins, cash flows and balance sheet efficiency and we are firmly committed to creating shareholder value as we drive toward our revenue growth and profitability target in 2020 and beyond.

Turning to our guidance for the second quarter which is for revenues of $61 million to $69 million which at the midpoint represents a 3% decline from Q1, gross margin of approximately 55% plus or minus 1%, operating expenses of $29 million to $30 million, and earnings per share of $0.13 to $0.28.

I’ll now turn the call over to Greg to discuss our financial results and guidance in more detail.

Greg?.

Thank you, Pierre-Yves.

Before I begin my prepared remarks I’d like to remind you that a schedule that summarizes GAAP and non-GAAP financial results discussed on this conference call, as well as supplemental revenue segment information by 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 identified the measure as GAAP-based.

These measures exclude the impact of amortization of acquired intangible assets, costs related to acquisitions, severance and executive search and transition, as well as search and discrete tax and other items.

As Pierre-Yves mentioned earlier, our first quarter revenues were $67.1 million, a decrease of 13% from the prior quarter and 18% from Q1 of 2018. Product revenues were $53.9 million, a decrease of 16% from the prior quarter and 24% year-over-year.

Service revenues of $13.2 million were flat to the prior quarter and were up 17% year-over-year contributing 20% to total sales for the quarter. By end market product sales to the NAND segment were 30% of total product sales. DRAM sales were 20% and all foundry, IBM and other device sales contributed the remaining 50% of product sales.

Our 10% customers in the first quarter are SK Hynix, TSMC and Intel. Our Q1 gross margin of 52.5% decreased 320 basis points from the prior quarter and was that the low end of our guidance – low end of our gross margin range due to late quarter shifts in product and customer mix and the timing of higher margin products that will revenue in Q2.

These factors affected product gross margin which was 53.7% below our target range, but our service margins improved to 47.5%, an increase of 320 basis points from the prior quarter. For the second quarter 2019, we are guiding gross margin to 55% plus or minus one percentage point.

Operating expenses of $29.6 million were down 1% from the prior quarter but came in higher than our guidance range. Given the outlook for the year strengthened during Q1, we elected to continue spending at our plant engineering levels rather than take actions to defer or curtail any development programs.

We expect our overall operating expenses to average $29.5 million per quarter for the remainder of 2019. Our non-GAAP tax expense for the first quarter was $1.1 million or 19.6% of pretax income, in line with expectations and we continue to forecast our non-GAAP tax rate to be in the 19% to 20% range for the remainder of 2019.

Net income for the first quarter was $4.7 million or $0.19 per share based on $24.8 million weighted average diluted shares. Turning to the balance sheet, cash and investments decreased $3.7 million to $148.1 million or $6.03 per share based on 24.5 basic shares outstanding at quarter end.

Day sales outstanding were 61 days, up slightly from 59 days in the prior quarter. Inventory increased $1.7 million to $63.8 million at the end of the first quarter. In Q1 we adopted the new accounting standard ASC 842 lease accounting.

The new standard requires public companies in 2019 to recognize both operating and capital leases on their balance sheet and to distinguish between right of use assets and lease liabilities.

Upon adoption we elected to use all available practical experience and recognize right of use assets and lease liabilities prospectively for all leases that were in effect as of the first day of our fiscal year 2019.

Right of us assets have been categorized into the following pools; facilities, logistic warehouse contracts and IT infrastructure leases. As a result of this implementation we recorded $11.6 million for right of use assets and the associated lease liabilities. There was no adjustment to opening retained earnings related to the adoption of ASC 842.

This concludes our prepared remarks. Operator, we will now be happy to take any questions..

Thank you, sir. [Operator Instructions] Our first question comes from Quinn Bolton from Needham & Company..

Hi, Pierre-Yves. Hi, Greg. Congratulations on the better outlook. Wondering if you could start just with the stabilization and memory and give us a little bit more detail.

Was that sort of across the board? Was it driven by either DRAM or NAND? And any comments you can make about geography would be helpful?.

So it is across both NAND and DRAM. So we’re seeing -- and then from – there’s not really geography dependence at this point in time. So its across the board, across the customer base in NAND and DRAM. Maybe a little bit larger in NAND and then DRAM being maybe a little bit later, but these would be qualifiers..

Okay, great. And then second question just Lamp [ph], on their call last we’ve talked about a pretty good opportunity in their installed base business to upgrade process chambers.

Wondering if you have sort of similar upgrade capabilities to improve the productivity tools in the field? Or are you seeing a stabilization in memory and node conversions to say 96-layer NAND or 1Y DRAM.

Does that -- is that just driving new tool demand for OCD given the increasing intensity of OCD at those higher nodes?.

So, we are seeing growth in our service business year-over-year, and it was even a quarter-over-quarter from Q4 to Q1. But what -- and one of the components of that is the upgrades business. Now, we are different than from lamp in the sense that we don’t have chambers that we replace.

We tend to have a longer cycle in our upgrades in general because our tool doesn’t degrade as a niching or deposition chamber. So are continuing to drive the upgrade strategy and the growth in the installed base business, both the service and the upgrades and we expect that to be a contributor of growth this year over last year..

Great. And just last question, you introduced the Atlas III+ with enhancements, can you give us any more details on what kind of enhancements or these just better throughput or software improvements, any other additional color would be great? Thank you..

Yes. Its pretty comprehensive across the board. So it is as I mentioned improvements in the hardware both the spectroscopic ellipsometry and reflectometry, but its also improvements in what we call chorography stage movements which helps with the throughput as well as some software improvement.

So, it is pretty much across the board improvement and its really a significantly higher value tool for our customers which explains the higher adoption rate that we’re seeing right now..

Great. Thank you..

Thank you..

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

Good afternoon. This is Brian Chin on for Patrick. Thanks. I’ll ask a few questions. Maybe the first question, maybe digging into the outlook that you provided for second obviously very constructive.

I’m wondering clearly I think there’s a strong lean there toward the foundry and logic additional strength, but Pierre-Yves, could you maybe attribute how much of that say 30, 40 million second half revenue increase might be attributable to memory? Give us kind of some sort of sense to that?.

So for memory we are saying that the memory will be second half weighted. And right now what we’re seeing and of course this could change because there’s still a lot of uncertainty with memory in the second half, especially if you look at Q4.

But what we’re seeing today is maybe the wait for the years would be for memory specifically will be low 50s in the second half and high 40s in the first half..

Okay.

Also just curious in terms of that second half incremental pick up on, is it sort of – you see sort of like 3Q building, 4Q building off of that? Or do you see more like a higher slop kind of pick up or kind of bias one quarter or the other, 3Q versus 4Q?.

So, with our current visibility we expect Q4 to be the strongest revenue quarter of the year, Now, this being said, in order to achieve the 25% to 30% growth in the second half we obviously would need to see strong sequential growth starting in Q3..

Sure, sure. One more question just about that and I have one more follow-up. In terms of the foundry spending, logic spending, you obviously think Taiwan, you think U.S. In the terms of the improving strength you’re seeing in second half visibility, is it a broader customer set may be inclusive of the reasons like Korea, China.

Any color you could give would be great?.

Well, it’s across the board. I mean, it definitely U.S. and Taiwan, but it's just across the board because memory as you know is very distributed. But if your question was specifically on logic foundry and others it is mainly driven by the U.S. and Taiwan..

Okay, okay. Maybe just one last thing just in terms of the gross margin permutations Q1 versus Q2. How much of that would you attribute maybe just having new product like Atlas III+ and potentially having more immature margins kind of an the initial get go before you hit stride there.

Is that kind of a large attribution in terms with happened in Q1 and Q2?.

No, that's not. What happened is, we had some grades that were planned at the end of Q1, that did not happened. That shifted in to Q2. And the mix were really a customer and products related. So, not specifically related to the shipments or adoption of the Atlas III+..

Okay. That’s it. Very helpful. Thank you..

Thank you..

Thank you. [Operator Instructions] Our next question comes from Tom Diffely from D.A. Davidson. Your line is now open..

Yes. Good afternoon.

So just following up on the last question, in cycle cycles passed when a new product came out, a lot of times there was a bit a margin head but as soon as like the Atlas III was already fully design for manufacturer building all that, so the margins are inline with the expectations and in line with the predecessor?.

Yes. You’re talking about the Atlas III+ I believe..

Correct, yes..

Yes. So the Atlas III+, yes, the margins are in line with our expectations in our model and this is why now with the adoption of the Atlas III+. This year we expect to get back to the financial model in terms of gross margins..

Okay, great.

I think looking at the increase in demand that you’ve seen on the foundry logic side, is it skewed more to foundry or logic?.

Well, what I would like to say first is that its – our strength in foundry logic is, first, most important I think that the most advanced technology knows for each customers. We don’t like to comment specifically about one customer or the other and with very limited number of customers in logic and in foundry we prefer not to distinguish that.

But if we look at the Atlas III+ we mentioned the adoption in the foundry logic market which is an important part of this year’s growth story..

Okay. I guess what I was getting at is, I guess I worry a little bit that both foundry and logic are very strong right now and will be for a few more quarters.

But what gives you comfort that there won't be a pause in that strong spending before memory comes back in earnest some time in 2020?.

Its the visibility that we have already for Q3 and the relationship we’ve had with customers over the years that -- in particular this customers in foundry and logic they tend to be very reliable with their forecast and their sales plan – their plan to us, so ourselves plan.

So we’re very confident that this is going to happen given the visibility that we have right now..

Okay, great. And then given that the memory is a little soft right now.

Does that impacted at all your timing of unique product that you're working on? Or is there R&D spending or delivery times?.

No, it hasn't. As I said we have continued to invest in R&D for new products. We had put a little bit more emphasis [ph] in the last few quarters on releasing the Atlas III+ and enhancing the current line of product, but that has – the current spending in memory hasn’t impacted our ability to conduct R&D and continue developing new technology..

Okay.

And then just finally, when you look at some of the other markets, the material characterization, is that more for technology capabilities or is that capacity driven demand?.

It is more about technology actually. Its – we have a few new products coming out there as well and it's adoption for Advanced Technology..

Okay. Thank you for your time..

As well as the activity at 4D you know the continued growth in 4D..

Yes. Okay. Thank you for your time..

Thank you..

Thank you, [Operator Instructions]. I'm showing no further questions. I’d now like to turn the call back to Dr. Lesaicherre for further remark..

Well, thank you for joining our call today. Together with the leadership team and all our employees, we’ll remain steadfast in addressing the challenges and opportunities in front of us and profitably growing our business to create incremental shareholder value. I look forward to updating you on our next earnings call scheduled for late July.

And this concludes our call for today..

Ladies and gentlemen thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day..