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.

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.

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…

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%,…

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

Hi, guys. Thanks for taking my question. This is Stephen calling behalf of Krish. First question I had for Tom, regarding your commercial customers in the main markets. Just wanted to do that a little bit on industrial and sort of automotive market customers. I think previously, you said that was going fairly well based on some of your larger customer exposures. Just curious like in Q1, how did your investor and automotive customer exposure pair throughout the quarter? And any signs of additional slowing or order adjustments? And any color in that sense, that would be helpful.

Yeah. Hi, Stephen. The way I look at automotive and industrial is that they continue to be robust any weakness that we've seen on the consumer side has been more than made up on the automotive industrial. So it makes up about 20% of our overall revenue, and we continue to see robust healthy market in that space.

Okay. Great. And for my follow-up, I wanted to ask a little more about the, I guess, updated gross margin range for the rest of this year, the high-teens follow 20 range. Just curious, like, is that more a function of the higher cost coverage and the revenue levels in this year that will help you guys achieve that, or I guess, cost optimizations still a big portion of that -- and if so, is it more focused on adding more, as I mentioned earlier, metrology and inspection tools that might be helping cycle time potentially, or are there other types of investments and initiatives that you should think about for hitting the revised gross margins? Thank you.

Yeah, sure. This is Steve here. Good afternoon, and I'll take that question upfront. A lot of what you mentioned there are things that are in the works. All those are elements that Tom talked about in his prepared remarks, what I'll focus on, though, is really you saw from this quarter, it was really an optimal quarter. If you look at the growth we had, especially after you remove the $4.7 million of the pure profit pass-through that came through in the fourth quarter of last year, the ATS growth that we saw in the first quarter was above our expectations. And with the revenue mix like we had in the first quarter of this year was so much coming from ATS, that is why we can achieve the non-GAAP gross margin that we did this quarter. That was above our expectations as we communicated. Now that we've done that for a couple quarters in a row, that's why we were comfortable to increase the range from what we presented previously. What we have to be cautious of, though, is just like we've had to pull in on the high-profit ATS revenues, we also have to watch for some of the tool revenue that could potentially come through. We didn’t have a significant portion of that in the first quarter, whatever that revenue and that similar pass-through revenue comes through, it carries little to no margin with it. And that's really why we were comfortable upping the range for the year, but don't have the full expectation that we'd be at the same level of what we saw in the first quarter of this year.

Okay. But in terms of, I guess, metrology and inspection tools is that an important element of, I guess, a bad level cost improvements, and also so, I guess what's the thought on two delivery times for metrology detection?

Yes, that is an element. But again, I don't think there's anything that is a large driver. It's a bunch of little changes and a little -- in fact, small investments have a big impact at the end of the day. So like I said, Tom mentioned those because those are important drivers, but they don't carry the full weight of what's out there. Again, it's going to be the ATS revenue that really drives the good flow through, just like we saw in the first quarter. That's what we've been communicating, especially since the past year and that's what evidencing. Anything we can do though to get more efficient, we believe we'll have a good flow through as well, and we should see the benefits of that coming through the Wafer Services side, making Wafer Services more profitable than what they currently are today, and that's really where we're focusing on the optimization. But again, I can't stress enough that the ATS revenue will be the driver of flow-through and gross margin flow-through.

Okay. Got it. And congratulations on the strong results -- result.

Thank you.

Thanks.

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

Yes. Thanks and I echo my congratulations on really good results. Steve, just a question on the tool revenue. You mentioned that could create some volatility in the margins and the revenue because it's associated with no margins. Can you give us a sense in terms of the timing of that potential revenue? My understanding was that, that tool revenue related to the RadHard program was more of a 2024 story. So I just want to get ahead of it and try to get a sense of how much tool revenue we're expecting this year so we can kind of model it accordingly?

Yes, that's a good question. The way the tool revenue comes in, there's a little bit of uncertainty when it comes in. What I will say is we -- you saw in the release we had today that it wasn't a significant contributor in the first quarter, roughly around $500,000 with little margin coming through, tool revenue in 2022 was roughly around $1.5 million. What I would say is our expectation is that we will see higher tool revenue in 2023 than what we saw in 2022. It won't be -- my expectation is that it wouldn't be to the levels that we saw in 2021, but probably in the later half of this year, there will be some tool revenues and pass-through revenues coming through. When we get more clarity to that, we'll definitely try to give a better forecast of what our expectation would be on a quarterly basis of those revenues. But what we're seeing right now, there is an expectation that there should be some flow-through coming from that type of revenue in the second half of this year.

Okay. Understood. And in terms of the commentary about gross margins accelerating to high 20s, low 30s exiting 2024 and the reasons were higher revenue levels are leading to better absorption of fixed costs, particularly on these long-term projects like RadHard and Florida and pricing and mix also helping as well. I'm just curious, what revenue level are you kind of anticipating quarterly revenue level to get to that gross margin number? By that time, would have all the fixed costs been absorbed for those two programs and then it's just sort of straight immediate benefit and the variability then will be more about mix and pricing. Just curious on the -- how you substantiate that comment?

Yeah. I'm going to be careful to not give a revenue number because it's going to -- again, it's going to be very dependent on the mix, just like we saw this quarter, we would have modeled roughly mid-60s on the revenue level, we expect a different cost flow to come through to different gross profit. So I'm going to be careful not to give you a revenue number. What I'll say is I don't expect our fixed cost to be fully absorbed for the RadHard program until sometime in 2025, assuming at that point in time, it goes into production. It won't -- again, so production will be when that program will be fully absorbed on the fixed cost side. On the Florida costs, we said we had $3.1 million of costs come through with that. I do not expect those fixed costs to be fully absorbed over the course of 2024. Again, that would probably be more so at 2025 as we ramp and scale that business. Again, you have to remember that we had these pretty good gross profit margin in the first quarter while absorbing those start-up costs with both of those facilities. There's a bit of a clearer path to production in 2025 with the RadHard program. and we'll still be in the development phase for a number of our programs in the Florida facility. So that will take a little bit more time until those fixed costs are fully absorbed.

Got it. I just guess I'm just asking kind of what's giving you confidence then of that below 30% -- high 20s, low 30s, if there's a lot of uncertainty in terms of still around the revenue levels and the fixed costs are not fully going to be absorbed until 2025?

Yeah. I would separate those two things. The fixed cost being fully absorbed is separate from the clarity of visibility on the revenue. So the revenue visibility is what gives us confidence in those gross profit margins. So that's where we can make those statements, like Tom said earlier, on escaping the year at those margins, but that's a separate conversation and discussion from fully absorbing the fixed cost, which, again, would not be absorbed until the 2025 timeframe.

Okay. Understood. And just my last question. The really strong revenue numbers, some of that obviously was some pull-insurance, but then you also mentioned, Tom, that the A&D programs are also kind of expanding in scope. And so could you talk about that? Does that -- are you -- is the program -- the RadHard program expanding in dollar size greater than what you initially expected in the different phases? Because in the past, you kind of outlined that the phases and the different award programs, et cetera. Because it does seem like it's been driven by the commercial, but it's more on the DoD and aerospace and defense program. Can you just talk about that? Thank you.

Yes. So again, the RadHard program continues to be a healthy driver. That program did not expand beyond what we have talked about before. As we've mentioned, we have other programs that we do for the DoD, those did expand. And think of it as both expansion and then pull in due to an increased sense of urgency. So we were able to capture that upside when the customer said we want you to move faster. We were able to put more resources very quickly on that program. But essentially, think of it as being independent of the RadHard program, but still an important DoD initiative that we've been working on for multiple years. The program has expanded and been brought in, in terms of timeline, which is accelerating the deliverables.

And just remind me what your thoughts are for Q2 in terms of topline?

I think Steve said in his prepared remarks, slightly down from Q1 of this year, still in the 60s.

Got it. Thank you.

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

Hi, thank you for taking my questions. I had a couple here. So, my first one was just sort of an update on the kind of capacity split that we should think of. You mentioned the Florida, could you kindly provide some more color on the floor the ramp? And then how should we think about your current capacity kind of split between the Minnesota and the Florida facility?

Yes. So, clearly, most of the capacity that we have still exists here in Minnesota. That's where we ramp up our wafer services and ATS business and Florida, it's just ATS. These are all development programs, I would say, early stage development programs. We do have the long-standing IVAS program, which is through the DoD. This was the program that we inherited when we took over the facility. That's the most mature activity that we have. Again, we've announced previously that we hit a major milestone for that, continue to make good progress. And then we have several other programs, both in the commercial space and the A&D space that are also ramping up and beginning to be a contributor to our revenues. There is still a fair amount of costs that we're absorbing down there, as Steve talked about, but we feel really good about where we are with the three technologies. We've talked about our interposer technology from IMEC, our fan-out technology from DECA, and our Hybrid Bonding Technology from Audio, which is the Expedia -- old spintronic technology that we're also beginning to ramp up. So, all of those are moving per plan, and we'll continue to see those ATS programs ramp and then we do have a targeted customer that we're expecting to start moving into production down in Florida as well as this year unfolds.

That's very helpful Tom. And then I think Steve this one is probably kind of more focused on the model. So, you mentioned that the some of the start-up costs and depreciation specifically related to the previous acquisitions will be coming off at the end of 2024. I'm just curious if, from your standpoint, do you expect any additional depreciation layering in somewhere in the future coming from the Purdue program -- from the potential Purdue of capacity?

Yes. Clearly, if there would be something with Purdue, that would add to the depreciation expense potentially. Also, we are making some periodic acquisitions to machinery and equipment as time goes on. That's why we're pretty clear about stating the amount that would fall off. There's going to be always increases to the capital to increasing the baseline, but again, focusing on that significant portion that's been on seven-year depreciation that all of a sudden falls off over the Q1 of 2024. I want to make sure people clearly understand when that would be taking place. But again, you have to net at against some of the additional acquisitions on the M&E side that we'd be making between that time and now.

Thank you very much.

Thank you.

Thanks.

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

Great. Thanks guys for taking my questions. Tom, I guess, I want to clear something up here. Maybe I got my signals across this one, when you're talking about trends in the commercial space. Your press release was indicating some weakness. And then I think one of the questions that you responded to, said there was some strength here. So I guess I wanted to understand that. And maybe if you can define what you mean by commercial customers, is that the only within the Wafer Services bucket? Are you also talking about commercial customers within ATS as well?

Yeah, no. When we talk about commercial customers, we're talking about both, Wafer Services and ATS. Obviously, we have a lot of customers in the ATS bucket that are going after the commercial space. When we talk about Wafer Services, today that's predominantly Infineon, and that's where we continue to see a robust demand signal from the SA and other programs that we make for Infineon and a handful of others that are targeting that space, we continue to see robust demand. And so while we saw a modest decline in overall Wafer Services, the increase we're seeing in industrial automotive is more than offsetting some of the weakness we've seen in the consumer side, which is, I think, what's driving a lot of the weakness in the overall semiconductor market.

Okay. Fair enough. That is helpful, Tom. Thank for that. Maybe just following up on the topic of CHIPS Act here. You sound like you're confident and still applying for those funds here, there's been somewhat negative news flow about this over the last couple of months. I suspect is impacting your stock to a degree. And I guess, I want to get your sense of the regulations and requirements of that money. Are they becoming more onerous or uninteresting to you in any way, or do you still just view this as a high priority funding mechanism for you?

No. We, obviously, think differently than maybe others, we still see the CHIPS act as being an accelerant to SkyWater's growth. We have a three-stage strategy. Obviously, in Minnesota, looking at modernization, automation, very excited about what's happening in the state of Minnesota. They put $500 million into the state supplemental budget for chips matching funds that is hopefully going to get signed into law very soon. So we feel really good about what's happening in the state of Minnesota. Obviously, Florida, there's multiple entities that have come together, leveraging our existing partnership with BRIDG in Osceola County. As I've mentioned before, we were the recipient of the only award for a semiconductor company and to build back better regional challenge. We continue to execute that program well with the Department of Commerce. And then, of course, what we're doing in Purdue -- with Purdue in the state of Indiana continues to set the example for how universities and industry can come together in partnership with state governments to really transform not only how you do innovation, how you do secure manufacturing, but how you build a workforce of the future. So we feel really strong on all three of those elements. But as we've said, we do not require chips funding to hit our long-term model. But we believe all the things that we've been doing in the last couple of years preparing for this are coming to fruition. And frankly, some of the constraints that others get concerned about, we do not see it as an issue for us at all.

Okay. I appreciate all that detail, Tom. That is all for me.

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