Good afternoon and welcome to Nanometrics Fourth 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. Please note that this conference call is being recorded today, February 5th, 2019. At this time, I would like to turn the call over to your host, Claire McAdams. Please go ahead.

Thank you, Tiffany and good afternoon everyone. Welcome to the Nanometrics fourth quarter 2018 financial results conference call. Speaking on today's call are Dr. Pierre Lesaicherre, President and Chief Executive Officer; and Greg Swyt, VP of Finance and our Principal Financial Officer. Shortly, Pierre will provide a recap of the quarter and year 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 the benefits that Nanometrics expect, it will realize from its acquisition of 4D Technology Corporation. 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 2017. 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.

Thank you, Claire and good afternoon everyone. Our fourth quarter results were at the upper end of our forecast due to a modest amount of customer pull-ins during the quarter. Incremental revenues from the partial quarter of 4D Technology's operations also added approximately $2 million in revenue. Total revenues of $77 million were similar to both the prior quarter and the same period last year. Within this total, however, we feel meaningful shift away from memory towards foundry, IDM, and other devices. Memory declined to 69% of product revenues for the quarter, while all non-memory segments increased more than 50% quarter-over-quarter to comprise the remaining 31% of product revenues. Our gross margin was within our guidance range, but at the lower end of our forecast for the quarter. OpEx was at the high end of the range due to the partial quarter of 4D operations. Operating margin of 16.8% exceeded the midpoint of our guidance range for the quarter. Earnings also exceeded our guidance range, due primarily to the impact of the true-up in tax expense in Q4 in order to reflect a lower overall rate for the year of around 17%. This adjustment had a net benefit of approximately $0.11 per share versus Q4 guidance and 4D Technology was accretive ahead of schedule in its first partial quarter at around $0.01 per share for a total earnings of $0.53 per share in the fourth quarter. For the full year, we reported $324.5 million in revenue, up 25% over 2017, the highest growth rate achieved in the process control market, well outpacing the growth of the overall wave of fab equipment industry. Our outperformance was driven by strong growth in memory spending, where we saw an increase in product sales of well over 60% year-over-year, reflecting our strong customer positions…

Thanks Pierre. Before I begin my prepared remarks, I'd like to remind you that our schedule which 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 Investors 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 surge and transition costs, as well as certain discrete tax and other items. Starting with the summary of our fourth quarter results, fourth quarter revenues were $77 million, a decrease of 2% from the fourth quarter of 2017 and an increase of 1% from the prior quarter. Product revenues were $63.8 million, flat from the third quarter and a decrease of 6% year-over-year. Service revenues achieved another record at $13.2 million, an increase of 4% from the third quarter and up 24% from the year ago period. Included in the fourth quarter revenue was $2.1 million for 4D technology. By end market, product sales to the NAND segment continued to be the largest contributor at 44% of product revenue. DRAM sales were 25% of product revenues and foundry, IDM and other markets comprised 31% of product revenues. Our 10% customers in the fourth quarter included SK Hynix, Toshiba, and Intel. Our Q4 gross margin of 55.7% decreased 130 basis points from the third quarter and was at the low end of our gross margin range. Product gross margins decreased 180 basis points from the third quarter to 58.1%. The decrease in product margins is associated with product and customer mix as well as one-time charges related to our year end physical inventory and slighter higher -- and slightly…

Thank you. [Operator Instructions] And our first question comes from Tom Diffely with D.A. Davidson. Please proceed.

Yes, good afternoon. First question is on the memory side. You last -- you talked about last year, the memory market for year grew 60%. So, what do you think would parse it up between what you think were share gains versus just the market growth?

So, we had -- well there were -- both contributions were there. We had the two wins that we mentioned, the win in China with the 3D-NAND manufacturer and then the DRAM win that we had in Korea. But even if we take these two wins out of our numbers and we run that exercise, we would still have outperformed WFE in 2018. So, we -- the contribution was from our normal business and the addition of these two wins.

Okay. And then when you look at all the cross trends that has happened over the last few months in the industry, what has happened to the utilization rates of the tools in the field and what impact if any that might have on services over the next few quarters?

So, we have seen only one customer doing some idling of tools. All of the other tools are being utilized today and we have the expected revenue from the service, except maybe for that one customer.

Okay, great. And then on the margin side--

Go ahead.

Just to say if you look at the margins, then I think come down. Is that strictly just because of overall revenue or it was something in the mix or other thing that can touch the margins as well?

It's primarily due to customer and product mix and there is a small element of underutilization. But the biggest impact is really customer and product mix. And as our mix and our product -- as our customer and product mix evolve over the year, we expect the gross margins to go back normal in the second half.

Okay. And then finally, when you look at any of these starting to roll out in production this year, what is the impact on the OCD over time from EUV?

So, we are not directly related to EUV. Most of the metrology that is associated with lithography is served by ASML or KLA. So we don't have the strong correlation with EUV. So this is relatively neutral to us.

Okay. I thought maybe it would create some extra features that you can measure in the future. Thank you very much. I appreciate the time today.

Thanks.

Thank you. And our next question comes from Patrick Ho with Stifel. Please proceed.

Thank you very much. Pierre, maybe first off on the foundry logic spending that you're seeing in the first half of the year. You talked about advanced nodes such as 10 nanometers or below. Two-part question. First, can you discuss right now, the sustainability of those spending trends that you'll see in the first half of the year, whether they can remain strong through all of 2019? And secondly, given I think what you've said in the past about capital intensity trends for OCD metrology, particularly at these smaller, smaller nodes with new features, more FinFET. How do you look at capital intensity transfer OCD metrology in that marketplace, I guess today as well as when the industry goes to their new features such as NanoWires?

Okay. So, for the first question, we are benefiting in the first half strongly from the increased spending in foundry and logic. And when we look at the whole year, we're actually -- in foundry and logic, we're second half weighted. So, we expect that contribution from foundry and logic to grow from first half to the second half. And then on the -- the other question, we see increasing OCD intensity at each node and that's particularly true for DRAM and for logic. In NAND, the situation is a little bit different because the main evolution, as you know, from generation to generation is the addition of layer in the capacitor structure and there what we see is an increasing challenge to measure critical dimensions in a very high aspect ratio channel. And for that, we believe there's going to be an increasing need for advanced metrology to be able to measure these increasingly complex high aspect ratio structures.

Great, that's helpful. And as my follow-up question, you talked about the growth in your services business in 2019, which isn't a surprise given the growth of your installed base over the last few years. Does this segment potentially create incremental investment opportunities or the necessary growth that requires in services that are not factored into your outlook for 2019? Basically, do -- are there going to be pressures in the costs of goods and OpEx side as you grow this services business?

Maybe I'll ask Greg to answer that.

So, Patrick, this is Greg. So, the answer to that is, as we mentioned, the service margins are reflecting in our current outlook, our run rate. There will be improvements in utilization as we move through the second half of the year. It isn't requiring us to do any incremental investments in OpEx. And although, there may be new product offerings, there is very limited investment that we need to do to bring those to market in the service business.

Yes, I just wanted to add one thing around service. Today, obviously, with the revenue coming a little bit down, we have a lot of service personnel around the world. And our choice has been, at this point in time, waiting to see how the later quarters develop, not to reduce our headcount and service because it takes quite some time to hire these people and train them and we want to be ready from when -- for when the business comes back. So, as Greg mentioned, slight underutilization in Q1, but we are holding onto the headcount because training and having the headcount is really important for us as we expect a -- the business to go back up.

Right. And a final question for me, just as a follow-up to that. A lot of your customers, obviously as you mentioned, are underutilized a bit right now. But one of the things that they relied upon over the years for many equipment vendors is upgrades and enhanced capabilities to their existing tool base. How do you see that type of business, especially in this kind of market environment, as part of your 2019 growth strategy?

So, it is an important part of our strategy. We want to increase the upgrades business. It's also a business that typically has a higher margin than the normal service business. So, we want to increase that. We have seen, over the years, conversion from our Atlas II to our Atlas II plus or some other upgrades that we've done in terms of the lamp brightness or the stage or the computer or the operating system. So, we have seen these upgrades. They've been coming on and off and what we're trying to do now is develop a more consistent business that keeps growing our service and upgrades business. So, it's definitely an opportunity for 2019 and beyond.

Great. Thank you very much.

Thank you. And our next question comes from Weston Twigg with KeyBanc. Please proceed.

Hi, thanks for taking my questions. I have two of them. First, from the demand side, it sounds like you're painting the picture that this is the trough, whether it's Q1 or Q2. But I'm just wondering, given the density of bigger visibility, is there any other risk that maybe you could highlight or that you would highlight related to either another downtick for member customers or potentially a little softer ramp in logic or foundry on lower demand, just curious about your thoughts on that.

Well, the -- we've had a good relationship with our customers and what our history in the last year has been is once the orders are placed, the customers tend to abide by their order and take delivery of the equipment. And typically, we have a visibility of how we'd sail the -- three to six months. So, we are pretty confident about our Q1 and Q2 orders and the fact that they will turn into sales. And the proof point was last year, even the things started softening a little bit in terms of the demand in the NAND and DRAM market, our customers still took delivery of the tools that they had ordered. So while there's still a possibility that there is some push out from 1 quarter to another, we expect this will have a relatively low impact to our overall sales, and we're relatively confident with our Q1 to Q2 forecast.

Okay, that's very helpful. And the other question I have is around new products. You said you're going to launching the new product this year, but I'm not sure exactly I understood. Are these evolutionary products related to OCD or other existing products? Or are these some of the brand new products you have been talking about for a while? And what would be the potential impact at 2019 revenue?

So, what I said is that we've had a lot of interest from customers to further advance the current set of products. As you know, the flagship and automated metrology is the Atlas and then the flagship and the integrated metrology impulse. And we've been asked by customers to prioritize enhancement of these products ahead of some of the new products we were working on. And we decided to do that also because we can get faster returns on the R&D investments by doing that. So, these are the product launches that we're going to have this year that I talked about.

Very helpful, so that's embedded in the -- into full 2019 outlook then?

Yes.

All right. Thank you.

Thank you. [Operator Instructions] Our next question comes from Mark Miller with The Benchmark Company. Please proceed.

Thank you for the question. I'm just wondering, are you expecting to see significant contributions from Chinese domestic NAND manufacturers? Or is that also going to slow in the first half of the year?

So, we are seeing somewhat of a slowdown in China and I'll talk about China in general, but if we look at the specifics between China domestic and China foreign companies, we see a slowdown in both. I think the slowdown in DRAM and NAND is well documented. So that would be the impact that we see at Intel, Dalian or Hynix in Wuxi or Sansui in Qian, but we also see a lower demand from the domestic China customers. And our 3D-NAND customer, the -- most of the demand is weighted towards the second half of the year. But overall, we see China domestic being longer this year than it was last year.

Are you still expecting to add third DRAM customer this year?

We are still working on it, and hopefully, we have some good news at a later stage, but we are working on it.

Inventories were up slightly in the December quarter, is that just 4D's contribution? Do you expect those to trend down in the current quarter?

Yes, Mark, this is Greg. That -- the majority of the increase is related to the 4D. As I said, we had a little less than $4 million of inventory that we brought on related to 4D. On debt of that, we did see some improvements quarter-over-quarter.

Thank you.

Thank you. And at this time, I'm showing no further questions in queue. I'd like to turn the call back over to Dr. Lesaicherre for closing remarks.

Thank you. So, thank you for joining our call today. Together with the leadership team and all our employees, we remain steadfast in addressing the challenges and opportunities in front of us and profitably growing our business to create incremental shareholder value. I would also like to take this opportunity to thank our employees for their amazing efforts growing the company by 25% this past year. I look forward to updating you on our next earnings call scheduled for late April. And that concludes our call today. So long.

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