Ladies and gentlemen, good afternoon. My name is Abby, and I will be your conference operator today. I would like to welcome everyone to the SkyWater Technology Third Quarter 2022 Financial Results Conference Call. Today's conference is being recorded. [Operator Instructions] Thank you. And I will turn the conference over to Claire McAdams, Investor Relations for SkyWater. Ms. McAdams, you may begin your conference.

Thank you, operator. Good afternoon, and welcome to SkyWater's third quarter fiscal 2022 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 also have 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 and our fiscal 2021 10-K filed on March 10. 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 on our earnings release as well as in our Q3 earnings presentation, both of which are available on our Investor Relations website. And with that, I'll turn the call over to Tom.

Thank you, Claire, and good afternoon to everyone on the call. Today, we are pleased to report record quarterly revenue of over $52 million, which reflects 10% sequential growth from Q2 and approximately 50% growth over Q3 of last year. Our ATS business was a primary driver of our growth in Q3 with sales up 18% sequentially and 57% year-over-year, reflecting the continued momentum we are gaining with multiple key customers in 2022. Wafer Services sales were similar to Q2 and up 36% year-over-year. With quarterly revenues now exceeding the $50 million level, our gross margin performance in Q3 demonstrates that we are delivering significant flow through to margins and profitability on the incremental revenue we've achieved since Q1. As we've been communicating all year, with ATS being the driver of our incremental revenue growth, our revenue flow-through to gross margin is well above 50%. In fact, we significantly exceeded our gross margin forecast for the quarter, as Steve will detail in his prepared remarks. We also have been communicating each quarter this year that the improved pricing terms with our legacy wafer services customer raised our quarterly revenue baseline from which to grow, and we have been delivering on sequential quarterly improvements in revenue despite the weakening macro environment. With our strong performance in Q3 and current outlook for Q4, we expect we will achieve or exceed our long-term revenue growth target of 25% this year. We are very pleased with the progress made in Q3, achieving sequential improvement in our revenue pipeline, increasing fab efficiency and output and significantly improving gross margin. A highlight of Q3 was not only did we turn the corner to generate positive adjusted EBITDA, but it was a very healthy $3.8 million equal to 7% of revenue. With this level of performance against…

Thank you, Tom. Total revenue for the third quarter of 2022 was $52.3 million, which was up 10% from Q2 and up 49% from the third quarter of last year. Advanced Technology Services, or ATS, revenue drove the majority of the growth and was $35.2 million, up 18% from Q2 and up 57% from Q3 of last year. Wafer Services revenue was $17.2 million, down slightly from Q2 and up 36% from Q3 of last year. The increased revenue levels in both ATS and Wafer Services continue to support our revenue growth targets for 2022. The higher level of legacy wafer services business is providing a higher base from which to grow, and we started several new products and designs with our 7 Wafer Services customers. We also continue to expand our current ATS programs, leading to increased ATS revenues in the quarter. Importantly, these incremental and more profitable customer programs are resulting in a significant flow through to gross profit. GAAP gross profit increased significantly in Q3 to $8.3 million or 15.8% of revenues. This reflects a total cost of revenue decline to $44 million in Q3, which benefited from a onetime cost reversal of $800,000. This reversal was for an estimated expense we had been recording through 2022 related to insurance on our employee benefit program, which was refunded in Q3 and which positively impacted gross margin by 140 basis points. On a non-GAAP basis, which adjusts for the impact of episodic tool sales, equity-based compensation and for a start-up costs, gross margin improved to 16.8%, significantly higher than our expectations even after subtracting the nonrecurring reversal benefit of 140 basis points. On an ongoing basis, you should look at our Q3 non-GAAP gross margin performance as improving to 15.4%. Last quarter, we indicated that our gross margins…

Thank you, Steve. Our upcoming investor activities include the Craig-Hallum Alpha Select Conference next week, the New York City Summit on December 13 and the Needham Growth Conference in January. Please visit the Investor Relations section of our website for other upcoming presentations. Operator, please open the line for questions.

[Operator Instructions] And we will take our first question from Raji Gill with Needham & Company. Your line is open.

Yes. Thank you. And congratulations on great results and positive momentum across all the metrics. That's great to see. So Steve, just a question on the cost structure breakout and that's really helpful to understand. So my first question is really on the unabsorbed fixed costs for some of the long-term investments that you outlined, whether it's for Minnesota or for Florida and the Rad-Hard facility. What time frame do you think that those fixed costs will be offset either by the current volume of revenue that you see now and then kind of the new revenue that you're anticipating from the Florida facilities is going to be basically absorbed in sometime in the first half of 2023? I'm just curious how those fixed costs ultimately will get absorbed and you could really see even more leverage in the gross margin model?

Yes. Sounds good. And thanks for the question. I'll adjust it in two ways. I'll talk about the amount related to the RH90 program, and I'll have Tom talk a little bit more about how that will be absorbed as the SkyWater Florida operations go and heterogeneous integration. So the way that we look at it, we look at the depreciation that we're incurring right now related to the RH90 program, we look at that as not being absorbed right now. While there is some development work that's currently taking place, we separate that from the manufacturing cost when we put the depreciation as a manufacturing cost. We see that being absorbed starting in 2025 as we talk about getting RH90 programs into production at that point in time. That's when you can expect to see - and we believe that those costs will start to be absorbed. When it goes to productization and manufacturing in 2025 on RH90. I'll let Tom talk about SkyWater Florida and heterogeneous integration.

Yes Raj, the Florida team continues to execute well on multiple fronts, three of them really creating enabling technology around interposers, fan-out and hybrid bonding. All those are still very much in an ATS mode. The team is also preparing to go into production. As we talked one of our biohealth customers continues to move towards their production ramp, which we believe will happen sometime over the next 12 to 18 months. That, of course, will be a driver of some of that absorption. The other is as the fab begins to exercise more of the ATS engine, you'll see some of that cost be absorbed just because there'll be more activity going on, which, of course, generates more revenue. As we always talk, we use the currency of activities to define how our business is running, and we're continuing to see increased activities in the Florida operation, which, again, will help us absorb some of the fixed costs as we prepare to go into more volume production, primarily in the 2024 time frame.

I appreciate that. And for my follow-up. Thanks for the details on the CHIPS Act. Wondering how we should think about CapEx in relationship to the CHIPS Act? You're getting grants to expand the Florida facility. I think you mentioned the $36 million grant. You're getting funding, I believe, from the Minnesota fab to help expand there. And then obviously, you have a longer-term build-out with Indiana. So you have funding coming from the government to help expand these facilities, which ultimately are going to generate volume and revenue for you at which the CapEx is being helped by the U.S. government. So just curious, how should we think about the CHIPS Act relative to kind of your internal kind of CapEx projects? Thank you.

Yes. So first on the Florida Build Back Better Regional Challenge, that is not at all tied to the CHIPS Act. So that has been awarded. That is in flight. That's $36 million of government investment. We also complement that with $9 million of our own investment. So that's a cost share model. We expect that to materialize over the next 24 to 30 months depending upon, again, when tools arrive, when projects get initiated. As far as the Minnesota facility, that would be the one that would go after initial CHIPS funding the most aggressively because it is an existing facility, we would look at adding capacity. But all that has to be defined and has to be awarded. We don't expect any of the awards to start until sometime mid next year. The Department of Commerce is saying February is when some metals will be due. So you can look at Florida, taking immediate advantage of the Build Back Better grant, but that's independent of CHIPS. And then Minnesota and then even further out with Purdue is all going to be gated on when the CHIPS proposals are being submitted, being approved and begin to move into execution. As I've also said, there's four elements to CHIPS. There's the building of fabs, which is $39 billion. There's $2 billion tied to Commons. The Commons program has been launched by the Department of Defense. We are actively involved with that. This is to create innovation centers around the fab - lab to fab concept. And then there's $11 billion for R&D and innovation. This is the National Semiconductor Technology center concept, which $5 billion is tied to advanced packaging and heterogeneous integration. So I believe we're well positioned for both of those. And then the last is the investment tax credit, which is 25% for all equipment procured starting in the next fiscal year, which began in October, so that could be an immediate benefit for SkyWater as well.

Thank you.

And we will take our next question from Krish Sankar with Cowen. Your line is open.

Hi, thanks for taking the question. This is Steven calling on behalf of Krish. First off, congratulations on the strong results and also the strong execution in the quarter. The first question I wanted to ask about either Tom or Steve is related to the RH90 program. So again, I understand that you guys are embarking on this Phase 2 $100 million program with the DoD now which trouble getting a few details here. First just going back to the Phase 1 portion, has the funding for that for Phase 1 have been completed now? Or is there still another quarter or two of funding from that desk still making its way through the P&L? And also related to Phase 2, as it progresses over the next two years, I think you mentioned until production revenues, should we think about that $100 million for Phase 2 being spread decently over the next eight quarters? Or is there a certain ramp profile to that spending?

Yes. So I'll start, and Steve can add additional color. Yes, the original program was $170 million total award for the development phase. All of that has been consumed except for around $33 million. We announced a $27 million option, what we call the option grant for that first award. This is tied to two programs we've announced. One is Google for $15 million. That's the open source initiative and then another $12 million for IP development. This is with our partners. So Google is one partner, Trusted Semi Solutions and Case are the other partners. And this is all around creating the design ecosystem for the RH90 platform. In the case of Google, it's a derivative of that Rad-Hard platform. And then as far as the $99 million, this was for the second phase. So first phase was development. Second phase is productization and qualification. There's a base program amount and then there's a series of options, again, much like the first award, the way to model that, I'll let Steve provide more detail, but I wouldn't say it would be something you just linearize over the next two years. It's going to have ebbs and flows. We were able to execute it very quickly once the award was received because a lot of that work was already in progress because we've been doing the development for multiple years now. So the movement into productization is really about getting to a frozen process of which then you go through extensive qualification and continued work towards yield entitlements so that when we begin to exit '24 and going to '25, we can begin to actually start producing product on this platform. And that would be going away from ATS derived dollars to Wafer Services dollars. Steve, anything to add on the lumpiness in terms of the RH90 funding?

Yes. Just the real world doesn't work that easy. We can just think I didn't evenly divide it over the next eight quarters. There's going to be a component of tool purchases that come through, and some of that $99 million will go to tool purchases. We'll also be using some subcontractors just like we did in Phase 1 of the program. So at certain times and quarters where we're getting two different phases, there could be other parties that are engaged in moving faster, which could increase our revenue and cost for that quarter. But it is going to be over the course of the next, what we'll call, two years in a quarter, all the way up into production in 2025. And a portion of that, like I mentioned, we'll be using subcontractors and tool vendors with that $99 million of funding as well.

Great. Thank you so much for that color. My second question is related to OpEx. So Steve, I think so much for the guidance for the current quarter. Just kind of wondering, in terms of your current staffing levels, would you say that you're currently, I guess, appropriately sized, given all of the revenue opportunities that you have for ATS and Wafer Services? Or is more head count would be needed given the current growth outlook going into next year?

Yes. We still believe that there is opportunity for significant growth going forward in 2023. We've talked about some of the challenges that we've had, but also the positive results in overcoming those challenges. Like we mentioned, from an operator standpoint in our manufacturing facility, last quarter, we were able to achieve close to our targeted headcount for those operators. But we also talked about some of the challenges with ongoing maintenance technicians in our facility. So we still do have open requisitions for maintenance techs within organization, and I expect that to continue over the course of 2023. Given our strong ATS pipeline, we will be recruiting and looking to hire additional engineers into our organization. Again, those are typically revenue-generating engineers. So they typically have a really nice return on investment. It will just be more so be a competition for talent and how quickly we can hire those engineers over the course of 2023 and to keep growing our business and not only growing our business but to move faster with our current programs that we have.

Yes. And I would just say that the attrition has stabilized, we're below our levels pre-IPO. And that's really important because now as we hire people, we're getting them trained, they're wanting to stay at SkyWater and our ability to get to what we call employee effectiveness is the cycle time is getting much shorter because we've also been investing in how we do training, making more effective and allowing people to move through that process at a faster pace than previously. So overall, we're feeling really good about where we're at with the headcount situation.

Okay. Thanks Tom. Thanks Steve. Congrats again.

We will take our next question from Harsh Kumar with Piper Sandler. Your line is open.

Hi guys. Let me add my congratulations as well on this increased momentum here recently. Guys, I had a quick question. You guys talked about increased momentum with customers. We're seeing some of that in the numbers. Could you talk about nongovernment activity here? How your sort of commercial customers are responding to what's going on at the fab? And are they also increasing the activity along with the government? And then I had a follow-up.

Yes, great question and good to hear your voice, Harsh. The way I would put it is the government is just APs. We have multiple development programs. Again, we've talked about over 50 active ATS engagements. And a large percentage of them actually are nongovernment. We have the biohealth space we've talked about, the connectivity space, also the high-performance computing space. There's a lot of energy around and having been in the industry as long as I have, you see these ups and downs. And one of the things that always happens is when you go into these contractions, companies that want to get new products to market hit the accelerator. And that way, they're positioned for the next upswing. And that's exactly what we're seeing. The other is - and Steve has talked about this before, is each of these ATS programs tend to start out at a relatively small spend rate and then they ramp as you get into the kind of two years and beyond time frame. And that's exactly what we're seeing is multiple programs ramping in parallel. That's why we continue to hire more engineers that allows us to accelerate those programs. And then as I've also talked about, we've I've been working very hard as a company to integrate our ATS and wafer services business so that they run seamlessly inside the fab. And the level of activities that we can generate for ATS doesn't really affect our overall wafer output, but it significantly drives our revenue and profitability. And that's really what we've been focused on is making those programs move faster.

That was a great update. As a follow-up, the world is changing. There's CHIPS Act money coming, this increased geopolitical tension as a result. I guess, foundries in the U.S. are seeing a lot of attention and affection from the government. So this, along with what's going on in the commercial activity, if I was to just ask you how comfortable are you with the 25% growth for 2023 as well? Do you feel that with all that's going on, you're in a relatively stable position from here on as you kind of sound like you're kind of footing here?

Yes. So we're cautiously optimistic with the business as we're running right now, but we're also cognizant of the fact that we're in an inflationary environment. There's a lot of unpredictability. You just outlined geopolitically with the economy. And so we're going to continue to execute the business at the pace we've been executing. We believe we have a lot of committed customers that want to continue to grow with us. That's both our historical customer Infineon and some of our new volume customers as well as all of our ATS partners. And obviously, we're not going to provide specific targets at this point, but I will say that we're optimistic about where we sit as a company and most importantly, our ability to really fine-tune this model that we're creating with this blended R&D, volume manufacturing capability. And I think it's going to put us in a very nice position as the decade unfolds and a lot of the chips dollars begin to become realized. But it's important to note that for the next couple of years, we aren't expecting any chips dollars. Our plan of attack is to execute the business we have. But I think when you look at CHIPS that just derisk the long term because there is a commitment within our country now to do more. And I think our model is uniquely positioned to take advantage of that.

Very well guys. Thank you. And congratulations again.

And we will take our next question from Mark Lipacis with Jefferies. Your line is open.

Hi, great. Thanks for taking my questions. Steve, maybe for you. Could you describe the accounting treatment that you would anticipate applying for - in the event that you receive grants or funding or investment tax credits? Does this all go against CapEx and then you have assets put on your balance sheet at a lower level and your depreciation is lower. Is that the right way to think about it? Or is there different treatments for different relief that you get to the CHIPS Act? Thank you.

Mark, good question. I would say it's pretty open-ended right now. Really the only clarity that we would have would be anything that we would do, what I'll call, somewhat separate from ships on the 25% tax credit. That one is a little bit more tangible on how that goes. From there, though, it depends on how the monies flow and what other partnerships we have on really financing whatever growth would come through CHIPS, whether we're talking about doing something to our current location in Minnesota or Florida or something different with a larger scale like we have planned for Indiana. So I would say, at this point in time, it's really hard to say specifically how that accounting would flow and the timing of when that would occur, given that we're still trying to understand how the money flows, what partners we would use and what the construct of those contracts would truly look like at this point.

Fair enough. Thank you. That's all I had.

Thanks Mark.

And there are no further questions at this time. Ladies and gentlemen, this concludes today's conference call, and we thank you for your participation. You may now disconnect.