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Executives

Claire McAdams – IR

Timothy Stultz – President and CEO

Ronald Kisling – CFO

Analysts

Shawn Yuan – RBC Capital Markets

Tom Diffely – D.A. Davidson

Nanometrics Incorporated (NANO) Q1 2013 Earnings Call April 30, 2013 4:30 PM ET

Operator

Good afternoon and welcome to the Nanometrics’ First Quarter 2013 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. Please note that this conference call is being recorded today, April 30, 2013. At this time I would like to turn the call over to you host, Claire McAdams. Please go ahead.

Claire McAdams

Thank you and good afternoon, everyone. Welcome to the Nanometrics first quarter 2013 financial results conference call. On today’s call are Dr. Timothy Stultz, President and Chief Executive Officer; and Ronald Kisling, Chief Financial Officer. Shortly, Tim will provide a recap of the first quarter and our perspective looking forward. Then Ron 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, operating expenses, margins, profitability, and earnings per share; customer concentration and mix, tax rates and technology and product development and adoption. 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 its levels of industry spending, the adoption and competitiveness of our products, industry adoption of new technology and manufacturing processes, customer demands, shifts and timing of orders or product shipments, changes in product mix, our ability to successfully identify complete and integrate acquisitions to realize operating efficiencies and to achieve reduced tax rates and the additional risk factors and cautionary statements set forth in the Company’s Form 10-K on file for fiscal year 2012 as well as other periodic reports filed with SEC from time to time. Nanometrics disclaims any obligation to update information contained in any forward-looking statement.

I will now turn over the call to Tim Stultz. Tim?

Timothy Stultz

Thank you, Claire, and good afternoon, everyone. We appreciate you taking the time to join us on our call today. For the first quarter of 2013, we delivered financial results pretty much at the level we expected. Revenues came in at the lower end of our guidance range due to delayed revenue recognition on two systems already installed at our new pure-play foundry customer. Gross margin, however, was better than expected due to product mix and increased operational efficiency in our core service business.

Operating expenses were lower than forecast due to more efficient R&D spending and a shift in the timing of expenses for new programs resulting in operating performance for the quarter than was slightly better than planned. Ron will address these items in more detail during his prepared remarks.

The real story behind the quarter, however, is the progress we made against our key initiatives to improve and grow our business through continued strengthening of our position within key accounts, new customer applications and end-market engagements, an increase share in our served and emerging markets.

During our last earnings call, we shared with you our commitment to continue to invest in R&D and applications despite the softness in first half spending by our largest customers. We do so because history has shown that it is during downturns when customers evaluate new tools, make selections for the next generation devices, and importantly, when market share gains can be achieved.

Though it’s still early in this cycle, I am pleased to report that our investment and competitive strategy are already yielding results. Notably, last quarter, our Atlas platform in combination with our proprietary NanoDiffract OCD software was selected as the tool of record for first generation 3D memory devices by a major Asian memory manufacturer. This is a key win following a head-to-head evaluation demonstrating success in our primary objective to continue to strengthen our OCD leadership position within our top customers.

During the quarter, we also made further gains in expanding our business in the pure-play foundry market. In Q1, our UniFire was selected for advanced front-end-of-line stress and [bull] metrology for post [CMP and MEL] for high volume manufacturing up to 20 nanometer node. This win not only increased our penetration into the foundry market but just as importantly represents an expansion of the UniFire served market into front-end-of-line process control.

On the emerging markets front, we received our first order for our 450 millimeter UniFire on our Lynx platform. This closely follows the successful launch in shipment of our 450 millimeter Atlas tools late last year. This order further reinforces the growing opportunity for the UniFire for front-end-of-line applications in addition to its already established role in advanced packaging. It also highlights the growing appeal for the Lynx platform and for instance our ability to capitalize on the 450 millimeter inflection point.

And finally, last quarter, we had follow on shipments of our SPARK module for EUV radical inspection, this also to our leader foundry customer. So the EUV market has a ways to go before we expect to see high volume production of devices coming from it. The infrastructural requirements to support the ramp of this technology are already being addressed and our products are beginning to play an important role in supporting this.

So summing up our progress against our key initiatives just since the beginning of the year, we have successfully built upon a key customer position in OCD and set the stage to benefit from increased spending on 3D memory devices. We expanded our served market by developing additional front-end-of-line process control applications for our UniFire platform and we strengthened our business within the foundry sector.

Turning now to our business outlook, we continue to see strengthening in revenues for the second quarter with further growth through the second half of the year. Specifically, as it pertains to our second half, we currently see the majority of incremental improvement being driven by investments in logic and foundry by our largest customers. Whereas the DRAM market has been showing signs of improvement and announcements have been made about significant investments planned for 3D memory capacity, most of the current and near-term memory spending is targeted on technology versus capacity needs.

So while we see growth in our business throughout the rest of the year, we need to see investments in memory capacity really kick in before our quarterly revenues can approach and exceed 2011 year levels.

Today, we believe meaningful memory capacity investments will not begin before the end of this year. These forecast investments combined with planned incremental spending in advanced logic sets the stage for our potentially very strong 2014.

With that, our guidance for the second quarter is as follows, revenues ranging from $30 million to $34 million up to 22% to 39% over the last quarter. Non-GAAP gross margin is up 42% to 45%. Non-GAAP operating expenses between $21 million and $22 million and non-GAAP loss per share of between 15% and 26%. As a final note on our outlook for the rest of the year, with the growth and revenues forecast near term and into 2014, we fully expect to return to profitability in the second half.

And now, I will turn the call over Ron to discuss our financial result and guidance in more detail. Ron?

Ronald Kisling

Thank you, Tim, and good afternoon. 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 is available in the investor section of our website.

As Tim discussed the expected pause in spending by our three largest customers had a significant impact on our Q1 results. First quarter revenues were $24.6 million, down 19% from Q4. Product revenues declined 41% to $13.1 million compared to $22.1 million in the prior quarter driven primarily by declines in sales for automated tools which declined 65% from Q4 levels to comprise 21% of our total revenues.

The decline in sales of our automated tools was partially offset by an increase in Materials Characterization revenue which was up 29% over the prior quarter to comprise 23% of revenues. The increase in Materials Characterization revenues which generally had been weak due to a lack of LED capacity expansion which is driven by a small number of relatively high ASP tools to silicon wafer manufacturers; sales to this market are historically very lumpy and therefore we do not expect to sustain this higher levels of Materials Characterization revenue through 2013.

Integrated Tool revenue was down 21% from the prior quarter and comprised 9% of the total revenue. Overall trend and our sales by end markets followed the reduction in purchase by our largest customers with into logic, foundry, and memory all declining from Q4 levels. Sales into the logic end-market comprised 23% of product revenue. Sales into the foundry end-market comprised 17% of product revenue. And sales into the memory end-market remained at historically very low levels comprising 17% of total product revenues. As I noted earlier, the purchase of a few relatively high ASP products by silicon wafer manufacturers drew the 57% increase in sales into the LED, silicon wafer, and discrete end market which comprise 43% of product revenues.

Strong upgrade revenues drove an increase in total service revenues of 40% to $11.5 million from $8.2 million in the prior quarter as a key customer upgraded the number of their existing tools. By customer, only revenues from Intel comprised greater than 10% of total revenues and were 29%.

Turning to our other P&L metrics, my prepared remarks regarding the income statement will refer to non-GAAP information which excludes the impact of amortization of acquired intangible assets unless I identify the measure as GAAP based.

Our Q1 gross margin improved to 45.4% from 41.6% in Q4 and came in above our guidance range primarily due to product mix which resulted in higher than forecast tool margins as well as stronger core service margin. At these lower sales volumes, product gross margin was 39.1% compared to 42.7% in the fourth quarter. Service gross margin was 52.5%, up from 38.6% in Q4, primarily due to a much higher mix of upgrade revenue in the first quarter compared to Q4. And we expect Q1 to represent the largest quarter of upgrade revenues in 2013.

Operating expenses increased $1.6 million from Q4 to $19.9 million, approximately 400,000 under the low end of our guidance due in part to a slower ramp of spending and new initiatives. Of the $1.6 million increase over the prior quarter, approximately two-thirds of this increase was in R&D and application spending, the latter of which is included in the [inaudible] expense.

Our GAAP tax benefit for the first quarter was $4.2 million representing an effective tax rate of 42.8%. Included in the Q1 tax rate is the one-time benefit of the 2012 R&D tax credit which was reinstated in Q1 2013 retroactive to the beginning of 2012.

Our net loss for the first quarter was $5 million or $0.22 per share compared to a loss of $3.1 million or $0.13 per share in the prior quarter.

At March 30th, our cash and investments declined to $95.3 million or $4.13 per share and reflects the operating loss as well as the repurchase of $5 million of our common stock, approximately 300,000 shares at an average price of $15 per share.

Our DSO was 72 days, up from 64 in the prior quarter due in part to lower sales to our largest customers who typically pay more quickly than other customers.

Inventory was $45.1 million at the end of the first quarter as we increased the placement of the evaluation tools to customers and took advantage of certain discounts on key components from suppliers.

Our tangible book value was $185 million or $8 per share and we ended the quarter with a head count of 524 employees, a net decrease of 12 employees from the prior quarter.

Commenting on our guidance for Q2, the revenue increase over Q1 is primarily driven by a modest improvement in memory spending levels with some additional gains from foundry spending. Sales of our Materials Characterization tools are expected to decrease as sales into the silicon wafer market are expected to decline significantly in Q2 from the high levels we saw in the first quarter.

The slight decrease in our expected gross margin is primarily due to a meaningful decrease in expected upgrade revenue which will more than offset the favorable impact of improved product margins from the increased revenue.

The increase in operating expenses of $1.1 to $2.1 million in Q2 reflects the continuation of our investment in key initiatives and achieving the remainder of our planned increase in R&D and applications. We expect our operating expenses to remain relatively flat at these resulting levels for the remainder of 2013. And for 2013 as a whole, we expect our effective tax rate to be in the 36% to 38% range.

And with that, I’ll turn the call over for questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And our first question is from Mahesh Sanganeria of RBC Capital Markets. Your line is open. Please go ahead.

Shawn Yuan – RBC Capital Markets

Shawn Yuan sitting for Mahesh. Thank you for taking my questions. So, in your prepared remarks, you mentioned that there is a reduction in the largest customer. Going forward, do you expect their spending at the same level or will ramp up in second half.

Timothy Stultz

Thanks for [inaudible] that call. I didn’t catch your name. You’re speaking for Mahesh.

Shawn Yuan – RBC Capital Markets

Yes, this is Shawn Yuan.

Timothy Stultz

Oh, Shawn Yuan, thank you. Yes, we do expect a pick up from our largest customer in the second half and particularly going into 2014. So we’ve got a pretty positive and optimistic outlook once the investments in memory start to kick in.

Shawn Yuan – RBC Capital Markets

Great. And then, in the past two quarters, you have 10% customer in the foundry [inaudible] and you also mentioned that you have expand the foundry market this quarter to – but there is no 10% of customer this quarter. So how should we think about the foundry customers going forward?

Timothy Stultz

That’s a good question. The way we think about it is that we’re making incremental and penetration into those accounts. Most of these are in the technology sector, they’re new positions for us. And so it’s really a timing and also when they start to fan that out into high-volume manufacturing when we’d expect to see them to come across as the 10% or a greater customer in the future.

Shawn Yuan – RBC Capital Markets

Great. Thanks.

Operator

Thank you. Our next question in queue is from Tom Diffely of D.A. Davidson. Your line is open.

Tom Diffely – D.A. Davidson

Good afternoon. I wanted to dwell a little bit more on the memory business I guess and looking at the – let’s start with the DRAM market. When the DRAM market moves from the 4x to the 3x and the 2x node, maybe you could describe a little bit about how your OCD tools become more important and we move down and potentially, is there a bigger market as we move down those as well.

Timothy Stultz

Yeah, and it’s a good question, Tom, and part of it is what kind of investment are going to be necessary to support the end demand for DRAM. The technology itself is going to require some tools, maybe some technology conversions. The questions is can you satisfy the incremental demand with shrinks as opposed to having any meaningful new capacity. Right now it looks like some technology buys fab conversions and shrinks might address the end demand. And so it’s ongoing and an incremental business for us but I don’t see it being as large as it has been historically.

Tom Diffely – D.A. Davidson

Okay. And so it’s just actually just reuse of your tools going to the next node with a little bit extra added?

Timothy Stultz

Well, I think there will be some reuse. I also think that there’s upgrades and there’s probably some incremental tools. But it’s not going to be the same as putting in a significant new capacity in Greenfield fabs.

Tom Diffely – D.A. Davidson

Okay. Is your expectation that the mobile DRAM market sufficient to drive that Greenfield activity next year then?

Timothy Stultz

I don’t know. We would hope so. I mean, DRAM has been notoriously low for the last year with the most of it being – most of the memory spending being in the VNAND and the NAND area. But I think we’ll just have to see how that one plays out and whether or not there is going to be sufficient demand to drive the need for incremental capacity.

Tom Diffely – D.A. Davidson

Okay. And then maybe, talk a bit on the NAND side when the industry or if the industry moves to the 3D NAND structure what that does to the demand for your tools.

Timothy Stultz

Yeah, actually, I would say that it’s when. It’s not an if. They VNAND is a technology that is definitely got legs. We won – first slot for us in the 3D memory. I think that you’re going to see a slight increase in the OCD tool used for that technology because it’s a little more complicated advice than in traditional plainer NANDs. And they’re also – the fab investments that are planned are for some very large fab. So, the one that’s in China is going to be up to 200,000 wafer starts per month which is a pretty significant Greenfield opportunity.

Tom Diffely – D.A. Davidson

Okay. And then, Ron, looking at the margin structure, with the guided margins, is that simply a function of just overhead absorption or are there still some issues we’re working through on the product margin side?

Ronald Kisling

It’s principally an issue of absorption. The issues that we talked about last year particularly around the new product releases have been resolved with agreements with our suppliers. And so, as we get to the second half of the year with the expected increase in revenues, we should see our gross margins back up to around 50%.

Tom Diffely – D.A. Davidson

Okay. And then I didn’t quite catch the comments you made on the OpEx side. Did you say that they were going back up again in the second quarter?

Ronald Kisling

Yes. So, in the second quarter, sequentially over Q1, we expect to see an increase of about $1.1 million to $2.1 million increase; that puts us back in the similar range as to what we guided for Q1.

Tom Diffely – D.A. Davidson

Okay. So that’s more of a normalized level then.

Ronald Kisling

Correct.

Tom Diffely – D.A. Davidson

Okay. All right. Thank you.

Timothy Stultz

Thanks, Tom.

Operator

Thank you. (Operator instructions) And I’m showing no further questions on queue. I’d like to turn it back to Timothy Stultz for any further remarks.

Timothy Stultz

Well, thank you, and thank you once again for participating in our call. I close thanking the employees and business partners of Nano whose steadfast commitment to excellence and execution are second to none in the industry and we look forward to reporting on the results of our operational and financial results for the second quarter of 2013 this coming July.

Operator

Thank you. And again, thank you, ladies and gentlemen, for joining today’s conference. You may now disconnect and have a great day.

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