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Nanometrics Inc. (NASDAQ:NANO)

14th Annual Pacific Crest Global Leadership Technology Forum Conference

August 13, 2012 3:00 PM ET

Executives

Ron Kisling – CFO

Unidentified Company Representative

All right. Let’s go ahead and get started. So, we have with us today, Ron Kisling, the CFO of Nanometrics to talk about the company.

Nanometrics has been gaining significant share over the couple of years but growth has stalled a little bit this year, with the spending slowdown at Intel, Samsung and Hynix for Nano’s concentrated. The biggest controversies around the company are right now, one, whether Nano will fully recover from a margin hit taken when the customers are pushed for a rapid ramp of new tool this year. Number two, whether Nanometrics will win more foundry business. Number three, whether Nano becomes a takeout target.

So, we’ll have Ron open up with sort of the overview of the company and then we’ll jump right into Q&A. Ron?

Ron Kisling

Good afternoon, thanks for coming. First up, just real highlight, we’ll be talking a little bit about some forward-looking statements and predictions that we believe that we believe to be accurate, that are guaranteed.

So, talking about our unique strategy, technology changes today are driving an increasing demand in the industry for OCD, which is creating secular growth in our core markets. In addition to that, we’ve expanded our market – assured market through R&D investments as well as strategic acquisitions and I’ll talk a little bit about those and how those are driving our growth. And then lastly, market share gains through competitive wins, particularly with our two largest customers. They are also supplemented by targeted wins at other customers.

Just a quick overview of Nanometrics. We offer a complete suite of non-destructive optical technologies that we use in our products such as our Atlas product, which is our flagship OCD tool. The UniFire which is a product we acquired from Zygo in 2009 which is focused on the advanced Wafer Scale packaging market. And Spark which we acquired from Nanda in November of 2011.

We share multiple markets and the main value proposition of our process control tools is to increase yields, accelerate the ramp of new technologies and overall reduce manufacturing costs, which is becoming increasingly more important as the value in capsulated and wafers continues to increase.

There is, a number of drivers that are creating specific growth opportunities for Nanometrics. One is, as the chips become smaller, the strings and node sizes become smaller, more process steps are added. And as you add more process steps, there is a number of Mac-in labels increase substantially and this shows the increase from 130 to the 1X nodes, 100% more process steps and 200% increase in sampling and dye sampling.

The other driver is that OCD is replacing conditional metrologies in the fab space, increasing to almost half the market. And the thing that’s really driving the displacement by OCD is the appearance of 3D device structures such as Intel’s Intercept, vertical memory devices such as Samsung’s, DNAND.

And then lastly, the 3D packaging market or the advanced wafer-scale packaging in terms of micro bump, through-silicon via, their UniFire tool, is directly focused on our another opportunity for significant growth for Nano.

Just real quickly, OCD has become a disruptive force because OCD is the only technology that provides a 3D visibility across all the layers of device, in a very fast online methodology that’s non-destructive.

This chart shows a number of OCD measurements or recipes that are in production with our customers using our systems. And what I’d like to point out is this is separated by node, and you can see the rapid growth over time in the number of recipes in production as the 2X node. And the 2X node is really where OCD started to gain traction and a deep presence in the fab. We’re also starting to see an increase in growth in recipes for the 1X node in the fab. And then, later this month, we’ll be shipping our first 450 tool to the industry.

In November, we acquired Spark from Nanda Technologies, which is a new approach to inspection. Conditional macro inspection tools, scan across the wafer with a very small view of collection, making them very slow creating a trade-off we need to make between what sort of speed do you want versus what’s the level of sensitivity that you want in this brightfield only.

The Nanda tool approaches it completely differently by basic illuminating and capturing the entire wafer in one shot, much quicker, you get the high-sensitivity, high throughput. And it’s both brightfield and darkfield. And where this does, it really bridges the gap between the micro-inspection which is slow but extremely high resolution. The existing macro which is very fast, but limited resolution to what’s a dance macro, which retains the speed and throughput that all macro tools have today but with significantly better sensitivity in the market.

And it’s precisely this advance macro space that in our nine months of OEM has allowed us to see in deep conversations with our customers, new applications where this Spark tool can be used, such as backside inspection which is particularly important with the emergence of EUV, where particles can be a fatal issue in terms of imaging on the wafers, CD mapping which is very complementary to our existing OCD.

And lastly, advanced packaging, where the Spark tool works particularly well in certain elements of the advanced packaging. And we have a tool that’s undergoing qualifications in that particular space right now.

So, looking at the UniFire tools, I said, this was a product we acquired in 2009 from Zygo, focused on the advanced wafer-scale packaging. The product really is focused on micro bumps and through-silicon via in terms of being able to provide high level measurement of these components. We have tools that all of the major components, all of the major semi-conductor companies, including one in high-volume manufacturing.

And the interesting thing is, this is an example of all the process steps in the advanced wafer-scale packaging integration. The UniFire as I said is particularly good at the TSV formation (inaudible) and backside inspection.

I’ll turn briefly to customers and talk about our recent financial performance before opening it up for questions.

Our top three customers, Samsung, Intel and SK Hynix are significant spenders in the industry. And 2012 comprised just about 50% of total CapEx spend. We believe that their robust spending provides a great opportunity for Nano. And as we penetrate other customers, it provides additional opportunities for growth. This chart shows the breakdown of our quarterly revenues going back to 2009 by products and services.

Turning now to our automated system sales for the first half of 2012 were at record levels, exceeding those in the first half of 2011. This was offset somewhat by slowing investments and integrated metrology which is largely capacity driven by and a significant drop in our materials characterization business which is our sell of tools into the high brightness LED. Solar and our silicon markets with revenues that are three year low.

Lastly, our service revenues in the first half were record high driven by strong upgrade business as well as strong core service business on our expanding customer base.

Looking at Q3 guidance, we guided 40% to 45% in view of the positive we’re seeing in our largest customers. Our customers, Samsung and Intel, if you look at their 2012 CapEx spending, were slightly weighted in terms of spending 60% to 65% of their annual budget in the first half, and so we’re seeing the affect of that. Our product margins are expected to increase and improve quarter over quarter based on the efforts we have around our Atlas 2, despite the lower revenues.

Looking at our financial model, when we acquired Nanda back in November, we committed to an investment a quarterly investment in the macro inspection market that we indicated will take us through into 2013 before we began to see significant revenues in the second half of 2013. With that additional investment, our long-term model starts to achieve the margins that we’re targeting, when those revenues become significant and that we believe that to be around $80 million levels, and we’re starting to see successful margins from UniFire and Spark. That gets us to where we’ll see gross margins in the 55% plus range and operating margins of 25% or better.

Lastly, just talking a little bit about our balance sheet. Our strategies around deploying capital of focus on investing in R&D and new products and acquiring companies and technologies as to expand our markets.

And lastly on stock repurchases, our objective with stock repurchases is to offset the effect of employee stock programs. And in Q2 we repurchased $5 million worth of stock.

With that I’d just like to summarize that our focus is on gaining market share amongst our key customers, entering new markets such as the advanced wafer-scale packaging and macro inspection market and leveraging the secular growth that’s inherent in the OCD market and the spaces that we participate in.

And with that, I’ll open it up for questions.

Question-and-Answer Session

Unidentified Company Representative

Great, great. Thanks for the overview. I do have a few questions and then I’d like to open it up to the audience a few minutes as well. The first one, Ron, just wondering if you can explain what the margin problems you had this year are – as your rent down was two. And how can investors feel comfortable that you won’t see the same kind of margin issue as UniFire or Spark products would have?

Ron Kisling

Yeah, okay. So, just to recap the issue, in Q4, 2011 we shipped a new version of our flagship product called the Atlas 2. We shipped one product out to Samsung for their evaluation. And our typical process is we ship it to allow to our customer, they evaluate it for about six months and come back with a list of things they would like to see us improve and then we ship them our improved product and they evaluate that.

Six weeks after we sent them the products, Samsung called us up and said, we liked the product so well, we’re canceling all the orders of your current product and we’ll only accept Atlas 2s. And at that point, we hadn’t even moved it from engineering in terms of building the product. We did lots of discussions, we talked pricing with them, we were able to increase the price. But in order to meet the production demand, which called for double-digit tools in Q1, roughly six weeks away from when they let us know this, we embarked on a strong effort to get the materials we needed to meet their deliveries. We met all the deliveries but the cost of retrieving that were higher. And so, we had an adverse impact to our gross margin because we didn’t have the long-term supply agreements in place, and we had to do some very quick buys to meet the demand.

Over the last couple of quarters we have been putting those agreements in place, and we have made progress each quarter in terms of improving the Atlas 2 margins. And by the end of the year, we expect Atlas 2 margins to be on par with our standalone tools which are some of our stronger margin products.

With respect to new products, I think there is, two things to say. One, in the case of UniFire, we’ve been selling that for a number of years. And so, it is fully integrated into our supply chain as well as into our manufacturing process. And there have been a number of Spark tools built and we fully transitioned that into our process.

One of our learnings though was when we launch a tool for evaluations, we’re also putting in place the discussions and arrangements with vendors, in the event the customer has decided to like the product so much, they want to buy a dozen.

Unidentified Company Representative

Okay, good. So, in other words, this product was so successful it caught you a little bit?

Ron Kisling

Yeah, I mean, we’ve never had a customer take a product after six weeks in the semi-conductor space and say we want to replace all the tools we’ve been using for the last couple of years with your new product. And by the way, we want double digits of those in the next quarter. And so, in – by Q2, almost 50% of the units and over 50% of the Atlas revenue was the new version.

Unidentified Company Representative

And does that Atlas revenue have a chance, does the gross margin profile I should say, have changed to actually see the corporate average as you get new pricing worked out?

Ron Kisling

I think what we have done at this point is as I said we believe we can bring it on par with the existing tools. There certainly is a little more headroom in terms of revenue because we increased the price. But we’re very confident that we will bring it in line with our other standalone tools which are some of our top gross margin tools.

Unidentified Company Representative

Okay. On the foundry side, I know last year, investors and the analysts were hoping for more foundry traction. Can you give us an idea of what are some of the hurdles you have to – to winning more foundry business? And when do you think we might see some more progress?

Ron Kisling

Yeah. So, I think I clarified, whenever I get this foundry question, I sort of view it as TSMC question because in reality we have a strong foundry presence, with the foundry business at Samsung. But we have been challenged by entering TSMC, it was one of the last companies that we went to, to try to participate in, as the company sort of restarted it’s penetration in this market back in 2007, 2008.

And typically what we found is that most of the companies only bring open up to the evaluation of other tools when the current tools don’t work. We’ve been involved in a number of evaluations at TSMC. We have sold them our UniFire tool. Couple of months ago, we won the integrated HES business, HES industry. And we’re continuing to participate in evaluations. But the opportunity is to win a significant slot depending on couple of things, which is one, having the right product, which we believe we do and two, the foundry deciding that the current tools don’t meet their needs and that they need to evaluate additional tools.

And so, they’re really only going to do an open evaluation once the existing tools, which are largely using TSMC understand the loan basis, don’t meet their needs and they need to evaluate it.

We believe that we have continued to increase our penetration. We’re continuing to build our relationship there so then, when that opportunity comes where they have to take advantage of it and demonstrate our complete success in winning in the OCD market against KLA.

Unidentified Company Representative

Okay, that makes sense. And there is probably some of the things I’m actually getting some traction on foundries. But I’m wondering if you could help us understand, when you think about Nanometrics over the next five years or so, how do you see Nanometrics stacking up against other process control companies in this space in terms of growing revenue or taking market share?

Ron Kisling

So, I think that, one of the things that’s been a strong focus is one, to be able to develop leading products that can compete against other products. And we understand what it really takes to win in the market and to develop products that meet customer expectations. We demonstrated that with the wins of our Atlas product at Intel, at Samsung, at Toshiba, at Hynix. And we’ve demonstrated that with our most recent product the Atlas 2 which was widely and very quickly accepted.

In addition, we’ve had a very good focus on trying to expand our server market so that as we go forward over those five years, we continue to demonstrate the growth. As we continue to get deeper and deeper penetration in OCD at companies like Intel and Samsung, the opportunity for significant growth there just based on that single product footprint, becomes more and more limited.

And so, we’re very focused on expanding our server market particularly with the Zygo Acquisition in 2009, which revenue was increased on that product every year for the last two years. And it’s expected to increase this year. And then with our recent introduction of the Acquisition of Nanda, with the advanced inspection tool, the Spark tool, all of which we believe who can drive significant revenues and continue to expand our presence in the market and build on the relationships that we’ve established with the top semi-conductor manufacturers.

Unidentified Company Representative

Okay, so, can you just take a minute and go through each of these three growth platforms. For OCD, can you give us an idea on how the OCD platform differs…? (Inaudible).

Ron Kisling

It played a very critical role. And that you’re given the structure and then you have to create a model of what that structure is going to look like when you shine the light and measure the reflections of retractions. So, we’ve got to create that modeling in the software. Then you actually get the actual data, you have to map it against it. And then, show the differences in a way where the users can actually understand where the difference is and what did they mean, how can I understand it better and use it in a user friendly way.

And back in 2008, the company began a rewrite of its software. And believe we’ve demonstrated that our software makes it easier to model provides much more fidelity to the structures and provides better meaningful data that user to interpret which really gives us our competitive edge against KLA.

Having said that, they are a very strong competitor as is NOVA but so are we. And so, while they are continuing to innovate, we’re continuing to innovate and do everything we can to make sure that we continue to maintain that lead that we believe we have in the OCD space.

Unidentified Company Representative

So it was really innovative new software. Does it feel like maybe that innovation really demonstrated its strength a year or two ago and I think matters are starting to catch up in terms of maybe trying to emulate this?

Ron Kisling

No, I think, well, I do think that, certainly I think KLA recognizes. I think they were late to rewrite their software. But they recognized that that is the differentiator because that’s the direction they’re going. But I believe that we have a head-start and we’re continuing to innovate. And I think we’ve got some of the best scientists in the industry. And I believe that the success of our most recent tool and the tick-up of some of our software upgrades demonstrate that we can continue to innovate, and advance our software well beyond where the competitors are. So, we started with a benefit and we’re going to continue to exploit that head-start.

Unidentified Company Representative

Okay, good. On this flat platform, I would say, kind of stole the show at your Analyst Event. It’s a really compelling new platform. Can you give us an update on what kind of traction you’re seeing with customers now? And I was just wondering, do you still expect revenue to ramp in late 2013 or is slightly declining?

Ron Kisling

Yeah. So, I guess, I’ll answer the last one first. I mean, we’re seeing really good traction. So, we’re still comfortable that we will see significant revenues in the second half until 2013. We’re seeing a lot of interest in the product and we have evaluation news of number of customers. And as I said, we’re seeing a lot of interest in applications beyond what we initially focused on when we acquired the company, particularly around a dance wafer-scale packaging, which is very complimentary and now allows us to have a solution across all the key process steps in advanced wafer-scale packaging. And also, applications that extend into new technologies such as the EUD era that we’re very excited about.

Unidentified Company Representative

Okay. So, still looking at second half 2013?

Ron Kisling

Still looking at second half 2013.

Unidentified Company Representative

For UniFire, that one has been ramping for a while, of course, gaining traction for a while. So, I’m just wondering, if you look into 2013, how much revenue could you actually – could UniFire contribute. And how do you defend on the advanced packaging space, where you’re beginning to get traction in the front end and the back as well?

Ron Kisling

So, primarily, so we do have some applications in the front, still primarily traction driven by the back into the fab in the advanced packaging. And so, it does largely depend in terms of this ramp on the take-up and that’s wafer-scale packaging. So, we believe that we are – we’ve seen growth in every year and we expect to continue to see that. But we haven’t quantified specifically what we expect to see. And I think some of that depends on just how quickly the market moves to advanced wafer-scale packaging TSDs. We’re seeing expanded use but how quickly that ramps. I think is still to be determined. Yeah.

Unidentified Analyst

(Inaudible).

Ron Kisling

Yeah. I think the good news is that it’s now at such a level at the most recent quarter that there isn’t much lower fort to go. So, if it drops further it creates much less of a headwind. We’re continuing to look at that market and try to understand other value added places, particularly in the high brightness LED, where our existing technology can play. But I do believe that that market is going to be depressed for a while.

Although we have a lot of confidence that that market will expand as production volumes are able to increase as high volume manufacturing, high volume automated manufacturing really comes to high brightness LED. We still think it’s a big opportunity. But I think it’s out a little bit of ways. And so, I think that’s going to create headwind for this year. We structure new comparisons year-over-year, it’s going to be less of a headwind. And in some point in the future, hopefully it will become a tailwind. But I’m not willing to predict that yet. Yes, any other questions?

Unidentified Analyst

(Inaudible).

Ron Kisling

So, we have a strong presence here at Samsung foundry. The other one is global foundry, is an opportunity I think we see a larger opportunity in terms of total spend as well as current activity at TSMC. But we also see an opportunity and have engaged with global foundry and a number of evaluations with a number of tools in the past. And those are probably the two biggest ones. Any other questions in the audience?

Unidentified Company Representative

Okay, I have one question. I’m wondering how large Nano can get organically with your existing product lines. And can you give us an idea of what you think, how large you think an equipment company needs to be now to remain competitive in this space given all the industry consolidation, what’s happening in the pending moves that you want to be up though?

Ron Kisling

So, I think with the current product portfolio, including the most recent Acquisition of Nanda, which gave us access to, close to $300 million market size. We believe that we can get to $400 million, $500 million pretty easily with the current portfolio without additional technology. So, we think that’s within reach with once we get a full traction on the new product.

I think in terms of size, a lot depends on the space that you’re in. Nano today at our current size is able to provide a very high level of service to our global customers, some of the largest semi-conductor companies. We’re able to make the investment in the new technologies. We’re shipping our 450 tool later this month. So, with new technologies we can develop that, we can continue to innovate in our market.

So, I think we were comfortable that our size allows us to deliver the level of service that our customers need. But we are focused on growth because that’s how we really create value.

Unidentified Company Representative

So, if you can grow to $400 million, $500 million annually, I think your long-term model showed $80 million a quarter is it right?

Ron Kisling

Yeah.

Unidentified Company Representative

So, what’s the delta of creating a long-term model and your full organic growth opportunity?

Ron Kisling

So, the delta, I mean, what we’ve built really was given the incremental investments that we’re making in wafer-scale packaging and macro inspection that we’ve committed to the P&L is, that’s the revenue size we need to get to what really our target mark starts in the near term.

And so, we believe that there is a lot more opportunities in that. But we don’t have to be at $125 million a quarter to achieve those margins. So that is really the indication that a pre-requisite to be able to fund the investments in those products, it’s probably around the $80 million level, to get to those margins. But we can grow well beyond that.

Unidentified Company Representative

Okay. I’m seeing it’s time I’m going to see one more in.

Ron Kisling

Okay.

Unidentified Company Representative

Is Nanometrics an acquisition target?

Ron Kisling

You’d have to ask the buyers. My philosophy very strongly is what do with the company as you focus on growing value of the company, scaling the business and focusing on building a successful standalone company. And if you do that well, and build shareholder value, you’re going to block some opportunities. And those maybe an acquisition, it may be within the – as a standalone, it’s an acquirer. But I think if we focus on that, the best opportunities are going to come and you’re going to maximize shareholder value. And it can come in a lot of different ways.

Unidentified Company Representative

Okay. So, if not its target right away then, how about an enquire.

Ron Kisling

I think we’re continuing as part of our strategies to look at opportunity for other companies that expand our surf market and to opportunities that are growth driven, that have a unique technology that really is disrupted to the industry so, that we actually can take a product into an existing market and actually gain market share fairly quickly. So, our goal is, we don’t want to be in the market unless we can be number one or number two.

Unidentified Company Representative

Okay. I think that about does it on time. Thanks a lot Ron.

Ron Kisling

Thanks.

Operator

Presentation has now finished. Please check back shortly for the archive.

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