SkyWater Technology, Inc. (NASDAQ:SKYT) Q1 2023 Earnings Call Transcript May 8, 2023

SkyWater Technology, Inc. beats earnings expectations. Reported EPS is $-0.06, expectations were $-0.13.

Operator: Good afternoon, ladies and gentlemen. Welcome to the SkyWater Technology First Quarter 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode and please be advised that this call is being recorded. After the speakers’ prepared remarks, there will be a question-and-answer session. [Operator Instructions] And at this time, I’ll turn things over to Ms. Claire McAdams, Investor Relations for SkyWater. Ms. McAdams, please go ahead.

Claire McAdams: Thank you, operator. Good afternoon and welcome to SkyWater’s first quarter fiscal 2023 conference call. With me on the call today from SkyWater are Thomas Sonderman, President and Chief Executive Officer; and Steve Manko, Chief Financial Officer. I’d like to remind you that our call is being webcast live on Skywater’s Investor Relations website at ir.skywatertechnology.com. The webcast will be available for replay shortly after the call concludes. On our IR website, we have also posted an investor slide presentation to accompany today’s call. During the call, any statements made about our future financial results and business are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially.

For a discussion of these risks and uncertainties, please refer to our filings with the Securities and Exchange Commission, including our earnings release filed on Form 8-K today our fiscal 2022 10-K filed on March 15th of last year and subsequent 10-Q filings. All forward-looking statements are made as of today and we assume no obligation to update any such statements. During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our earnings release as well as in our Q1 earnings presentation, both of which are available on our Investor Relations website. With that, I’ll turn the call over to Tom.

Thomas Sonderman: Thank you, Claire, and good afternoon to everyone on the call. We are pleased to report a strong start to 2023 as we set another record for quarterly revenues at $66.1 million. Q1 revenues exceeded our expectations going into the quarter, growing 2% from the previous record set in Q4 and representing 37% growth over the same period last year. The strong revenue growth in Q1 exceeded our forecast chiefly due to increased demand urgency on multiple existing defense programs. We continue to demonstrate our ability to execute. In the previously completed quarter, we were awarded extensions and expansions of several existing contract awards. As a result, we have entered 2023 with an increased program scope on multiple defense initiatives.

This accelerated demand as well as our strong execution in the quarter also provides us with greater clarity for the year and increased confidence that we can approach our long-term annual revenue growth objective of 25% in 2023, notwithstanding, the overall macro concerns and softening semiconductor demand environment. Our gross margin performance in Q1 also demonstrated especially strong flow-through on our incremental revenue growth as we continue to deliver quarterly gross margin improvements well-ahead of schedule. As Steve will detail later, our quarterly revenue and gross margin performance in 2023 will depend on a number of factors, most notably on our mix of ATS programs, customers and tool derived revenues. And it’s important to recognize SkyWater’s unique positioning in the semiconductor ecosystem.

Our company is growing through this period of challenging macro environment conditions due to our diversified portfolio, which includes a strong A&D component. This should allow us to deliver year-over-year increases in our gross margin and EBITDA performance, again, driven by top-line revenue growth approaching 25%. Reflecting on the highlights from last quarter’s earnings call, 2022 was a year of improved operational and financial execution. This allowed us to demonstrate important progress towards achieving the strong revenue growth and operational leverage objectives communicated since our IPO a little over two years ago. A vital component of the strong revenue growth achieved last year was US government’s increased commitment to SkyWater with a strategic rad-hard investments.

The increased momentum achieved last year on this and other strategic government initiatives set the stage for 2023’s revenue growth and helped drive another record revenue quarter in Q1. During the first quarter, we obtained scope increases on several of these key defense programs indicating an increased sense of urgency and desire to accelerate the delivery of key development milestones. Our customers made these new commitments, specifically because of our ability to execute. Furthermore, we believe our successful partnership with the DoD uniquely positions us to be a major beneficiary of CHIPS funding. SkyWater’s growth story remains consistent with our outlook as we entered the year however, with greater clarity and an increased level of confidence in our ability to achieve our targeted financial objectives.

We have all witnessed incremental softness in many segments of the semiconductor industry this year. In SkyWater’s case, these headwinds have been offset by the growing scale and scope in many of the key programs we have with our partners in the A&D and commercial space. We continue to expect modest growth in wafer services this year, which we anticipate will come from continued focus on improved productivity, additional ATS customers transitioning to production later this year and ongoing improvements in pricing as we take advantage of our unique capabilities in the market. We continue to believe our ATS growth story this year will be relatively decoupled from macro weakness in the semiconductor industry. Our DoD and US government programs are established funding is secured and as mentioned, the scope and scale of these programs has only increased year-to-date.

On rad-hard, we continue to make progress on the productization and qualification of SkyWater’s 90-nanometer rad-hard platform to prepare for the planned production ramp in 2025. In the commercial space, customer R&D investments continue through this period of overall industry tightening. We see this as a unique opportunity to review which customers are best-positioned to succeed in the long-run, allowing us to prioritize these specific programs accordingly. One example of this is our recently announced program expansion with our partner, PsiQuantum. This program demonstrates the value that our Technology as a Service model brings to the industry’s rapidly evolving ecosystem. PsiQuantum is pursuing the bold vision to deliver a commercially viable, air corrected general-purpose quantum computer that scales beyond one million qubits using silicon photonics.

Technologies incorporating Quantum Computing and Photonics are the building blocks for the future of artificial intelligence, our AI-enabled systems. PsiQuantum’s pursuit of their goals has and continues to demand innovation across a range of materials with unique process integrations to achieve the novel architectures, which enable their scalable technology. SkyWater is supporting this state-of-the-art and rapid pace program in our 200-millimeter facility in Minnesota as we mature the technology and position PsiQuantum for their ultimate production ramp. The enablement of this critical emerging technology will support advances in various industries, such as climate, energy, healthcare, finance, transportation and government. So while we do observe some early-stage customers facing higher standards for raising capital, we also have observed that the strongest and best positioned customers are experiencing a surge in support, as they redoubled their efforts to accelerate the time to market for their solutions.

This is an important proof point that the demand for innovation never rests. Our task model continues to attract innovators with long-tail applications addressing large TAM opportunities. Today, we can stay with confidence that our visibility and customer demand pipeline has never been stronger. Of course, strong demand and expanding opportunities for growth requires ever-increasing efficiency gains, which we are driving aggressively through our automation and modernization efforts. This includes the installation of a variety of new software and metrology capabilities that we are bringing online in 2023 to accelerate improvements in the productivity and yields of our two fabs. The result of these and other operational excellence efforts gives us strong confidence in our ability to extract more margin from the business as we expect to continue to generate positive EBITDA and further strengthen the balance sheet.

Looking forward, SkyWater continues to remain confident in our ability to secure chips funding to expand the capabilities at our existing sites in Minnesota and Florida, while transforming the industry with our unique partnership with Purdue in the State of Indiana. We believe that the momentum we will build in 2023, including the expected efficiency gains we are now institutionalizing in our fabs will position us for another strong year in 2024, as we continue to grow revenue and expand our gross margin profile. While we expect the revenue growth in 2023 will be largely driven by strategic government programs, we believe 2024 will be a year when our growth will be more balanced between A&D and commercial customers. As previously mentioned, many of our partners are accelerating their R&D efforts to ensure proper product positioning and readiness in their targeted markets.

SkyWater’s unique TaaS model allows for an efficient transition from development to buying, manufacturing, a critical capability to maximize the potential of new product launches on highly differentiated platforms. Challenges in the current macro environment are providing clarity for both us and our partners, as we work synergistically to ensure we are ready when the market is ready. As for expectations for gross margin performance next year, we anticipate higher revenue levels will lead to increased absorption of our fixed costs from our RadHard and Florida fab investments and more favorable contributions from our Wafer Services business, due to improved pricing and mix. Therefore, we anticipate gross margin acceleration to continue positioning SkyWater into the high 20s to low 30s gross margin level, as we exit 2024.

Further, just as communicated last quarter, we believe 2025 will be the year when all the components of our business model fully come together. By that time, we expect SkyWater to be firmly established as the country’s leading next-wave pure-play foundry, providing both highly differentiated front-end wafer fabrication solutions and the most advanced semiconductor integration and packaging technologies. And we expect to be nearing our target gross margin objective of 40%. In summary, we believe the uniqueness of our business model and a strong customer pipeline positions SkyWater for several years of consistent growth. This belief is independent of the macro weakness currently facing the semiconductor industry. Also, to be clear, we do not require chips funding to achieve our long-term model, but we do intend to aggressively pursue it since we believe it could be an accelerant to our growth as the decade unfolds.

For 2023 specifically, we have multiple DoD programs ramping with increased scale and scope and the funds are committed. We believe this derisks our revenue growth objectives during this otherwise soft year for semis. We also plan to continue to execute on high priority commercial ATS programs where the end markets are clear, customer funding to secure and the transition to volume production remains on schedule. Our efforts to scale existing A&D and commercial programs are expected to deliver continued growth for our company in 2024. We also expect to have several tailwinds driving improvement in our gross margin profile for multiple years, as described earlier, but 2025 expected to be the first year when we can see our target long-term financial model coming to fruition.

And finally, as we look beyond 2025 to the second half of the decade, we remain confident that the strategic investments being made to onshoring critical semiconductor device manufacturing in part due to the CHIPS Act will ignite accelerated growth in our company as we aggressively drive towards our long-term revenue objective to be a $1 billion pure-play semiconductor foundry within this decade. I want to close by conveying the strong confidence all of us at SkyWater have and our ability to execute successfully towards our long-term growth and profitability objectives. Our amazing employees have now delivered consistent execution for several quarters. We intend to continue to build your confidence in our ability to execute on our future growth and profitability objectives as well.

I will now turn the call over to Steve for more information on SkyWater’s financial and operational performance in the first quarter as well as further details on our outlook. Steve?

Steve Manko : Thank you, Tom. Total revenue for the first quarter of 2023 was a record $66.1 million, which was 2% higher than Q4’s record and up 37% from the first quarter of last year. Wafer services revenue was $17.8 million, up 3% from Q4 and 17% lower than the first quarter of last year. As a reminder, the revised contract with our large historical customer closed in Q1 of last year and the improved revenue recognition terms resulted in a pool of over $8 million of wafer services revenues that quarter. Record Q1 ATS revenue of $48.3 million was slightly higher than the previous record set in Q4 and was up 82% compared to Q1 of last year. Q1 ATS revenue exceeded our expectations due to the acceleration of customer demand on certain aerospace and defense programs, which effectively pulled in a portion of the revenue expected later in the year and we believe the expanded scope of certain of these programs also bolsters our confidence in the revenue growth forecast for the full year.

The team was able to quickly capture this revenue upside and with cost of revenues remaining fairly consistent with the prior quarter, the resulting non-GAAP gross margin of 25.8%, also was well above our expectations. As we entered 2023, our expectations was that our gross margins through this year would be in the range of 15% to 20% on a non-GAAP basis, which was the range of our normalized gross margin performance in the second half of last year. The pool of customer demand that we achieved in the first quarter did enable us to deliver better gross margin performance than we would typically model at these — volumes. For example, our gross margin flow through above the $45 million revenue breakeven threshold was approximately 80%, which was well above our stated objective of 50% plus.

We were able to achieve such high flow-through because the increase in cost of revenue was less than our forecast. Our non-GAAP cost of revenues was expected to increase closer to the $50 million to $51 million level by Q1, but the actual increase in costs was lower due to our revenue growth coming from higher-margin ATS programs. As a reminder, when comparing our Q1 gross margin to the previous quarter, our Q4 gross margin of 26.2%, had included a $4.7 million program completion revenue benefit with no associated costs, which lifted in prior quarter margins by approximately 600 basis points. As we look ahead, while our performance in Q1 gives us increased confidence in being able to deliver 2023 gross margins at the upper-end of our previous expectations.

We do expect components of tool and pass-through revenue to kick in that will not carry the same level as these high-margin pull-ins of ATS revenue we saw in the first quarter. Our expectation for the forthcoming quarters is that revenue mix will continue to vary, which will result in varying gross profit contributions quarter-to-quarter. This, combined with a similar to slightly lower revenue expectation for Q2, as a result of the Q1 pull-in, brings us to raise the new gross margin baseline for 2023 to the high-teens-to-low 20% level, up from the 15% to 20% expectation discussed last quarter. Moving now to operating expenses, on a GAAP basis, operating expenses of $17.6 million were up about 15% from Q4. On a non-GAAP basis, which excludes equity-based compensation, operating expenses were $16.2 million, compared to $14.1 million in Q4.

The majority of the quarter-over-quarter increase was in SG&A, which came in above expectations, due to the adoption of an accounting pronouncement that requires us to estimate our bad debt allowance on a prospective basis. Given the strong revenue and gross margin performance, adjusted EBITDA of $8.1 million represented 12.3% of revenues, as a reminder, last quarter’s record $10.3 million of adjusted EBITDA included $4.7 million of pure profit in the quarter from the revenue recognition event. Interest expense was $2.5 million in the quarter, and with no tax benefit to GAAP net loss was $0.10 per share and the non-GAAP net loss was $0.06 per share. Now I’ll turn to the balance sheet. We ended the quarter with $13.8 million in cash and cash equivalents, which declined from year-end, as expected, given our plan to use working capital to pay down our revolver.

Total debt outstanding declined to $96.1 million and included $56.1 million on our revolver, $36.6 million for our variable interest entity and $3.4 million from tool financing, excluding unamortized debt issuance costs. Since August, we have put into place additional funding alternatives, as we continue our plans for growth. This includes our $250 million universal shelf registration filing from which we completed $3 million of at-the-market equity proceeds during Q1. We believe these funding alternatives provide us with increased financial flexibility and liquidity that will help fund our expected growth and the new larger debt facility announced last quarter is a reflection of our success over the past year as we have turned EBITDA positive and strengthened our credit profile.

As you update your SkyWater models, the following is some additional color for various components of our P&L for the year ahead. Quarterly research and development expenses are anticipated in the $2.3 million to $2.5 million range, excluding the stock-based compensation. Quarterly SG&A expenses are expected to be approximately $11 million to $11.5 million, excluding stock-based compensation. We anticipate stock-based compensation to range from approximately $1.9 million to $2.4 million per quarter. We expect similar depreciation profile for full year 2023 as we reported for 2022 which was $28 million total. Within this amount, $6 million was related to the RadHard program and approximately $15 million was associated with acquisition purchase accounting.

As a reminder, the $15 million of acquisition-related depreciation on an annual basis will phase out after Q1 of 2024, and we expect depreciation expense to go down by about half. Total accounts of revenue investments in Florida were $3.1 million in Q1, and we expect these will range between $3.2 million to $3.6 million per quarter through the remainder of 2023. We expect neutral to no benefit from our tax assets in 2023. With that, I’ll turn the call back to Claire. Claire McAdams Thank you, Steve. Our upcoming investor activities include the Craig-Hallum Annual Conference in Minneapolis on May 31, the Cowen Tech Conference in New York on June 1, The Stifel Cross Sector Conference in Boston on June 6 and the CEO Summit in San Francisco on July 12.

Please visit the Investor Relations section of our website for other upcoming presentations. And as always, please feel free to reach out to me directly to a range of call or meeting. Operator, please open the line for questions.

Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from the line of Krish Sankar with TD Cowen. Your line is open.

Operator: Your next question comes from the line of Raji Gill with Needham & Company. Your line is open.

Operator: Your next question comes from the line of Natalia Winkler with Jefferies. Your line is open.

Operator: Your next question comes from the line of Richard Shannon with Craig Hallum. Your line is open.

Operator: This concludes today’s question-and-answer session as well as our conference call. Thank you for attending. You may now disconnect.