Thank you for standing by. My name is Greg, and I will be your conference operator today. At this time, I would like to welcome everyone to the SkyWater Technology Q1 2024 Financial Results Conference Call [Operator Instructions] I would now like to turn the call over to Claire McAdams, Investor Relations for SkyWater. Claire, please go ahead.

Thank you, operator. Good afternoon, and welcome to SkyWater's first quarter 2024 conference call. With me on the call today from SkyWater are Thomas Sonderman, 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 posted an investor slide presentation to accompany today's call as well as a financial supplement which summarizes our quarterly and annual financial results for the last 3 years, including all non-GAAP adjustments and comparisons to our GAAP results, as well as the impact of tool sales on our gross margins. 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 2023 Form 10-K. 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, our financial supplement and in our Q1 earnings presentation, all 3 of which are posted 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. I'm pleased to report another record quarter for SkyWater with revenue up $80 million. ATS development revenue exceeded our expectations to reach a new record of $61 million, up 7% from Q4 and up 28% compared to Q1 of 2023. This growth was driven by continued strength in our aerospace and defense, quantum computing and biomedical programs. Wafer Services revenue was $10 million, a bit higher than expected, while tool revenue was lower than forecast due to some transitory delays in equipment deliveries. Given the record results and revenue upside in ATS, the resulting mix of revenue was indicative of strong gross margin and adjusted EBITDA momentum. However, as Steve will detail in his prepared remarks, we recorded a multimillion dollar charge to cost of revenue that reflects the anticipated additional costs required for us to complete certain development milestones for a significant A&D program, and this impacted our expected progress towards profitability in Q1. We believe our CapEx light and high operating leverage business model will lead to strongly profitable results in the years to come. And today, I will focus my prepared remarks on the drivers for the anticipated strong customer demand and earnings leverage ahead. This quarter marks the 3-year anniversary of our IPO. During that time, we have firmly established the key aspects of our unique value proposition within the global semiconductor industry. Through leveraging existing chip manufacturing infrastructure and introducing new materials and processes, we are able to enhance the capabilities of traditional IC flows. While innovations in semiconductor advanced nodes are fundamentally enabled from shrinking geometries, in mainstream fabs such as ours, innovation comes from new ways of integrating new materials, new types of devices and new additive process flows to provide new…

Thank you, Tom. First quarter revenue reached another record for us at $79.6 million, up 1% from Q4 and up 20% from the first quarter of 2023. Record ATS development revenue of $61.2 million exceeded our forecast for the quarter as a result of accelerated development time lines as well as our internal initiatives to prioritize high-growth ATS programs. We had forecast ATS development to be similar to Q4, but with strong demand and operational execution, actual results demonstrated sequential growth of 7% and year-over-year growth of 28%. As expected, Wafer Services revenue declined meaningfully from our prior run rate but still came a bit higher than forecast at $10 million. Tool revenue was $8.5 million, lower than expected due to certain delays in equipment deliveries. Our non-GAAP gross margin for the quarter was 16.9% compared to a forecast in the low 19% range due to an additional accrual recorded in cost of revenue. We recorded a roughly $8 million charge in Q1 to reflect the anticipated additional cost for us to complete certain development milestones for a significant A&D program. Outside this accrual for expected future development cost, our gross margin for Q1 would have surpassed our prior expectations chiefly as a result of the more favorable mix of business in the quarter. Tool revenue in the quarter impacted non-GAAP gross margin by 170 basis points. As a reminder, you can find the impact of tool revenue on gross margin each quarter in the financial supplement posted to our IR website. Non-GAAP operating expenses were $13.6 million, which was below the forecast primarily due to lower variable compensation, along with a shift in timing of certain other SG&A costs to subsequent quarters. We reduced the variable comp accrual during Q1 to reflect the softer market conditions, primarily affecting our…

[Operator Instructions] It looks like our first question comes from the line of Quinn Bolton with Needham & Company.

Nic Doyle on for Quinn Bolton. First, can you just expand on the $8 million A&D accrual? Are there additional accruals needed for the project? Do other additional rad-hard projects you're looking at come with similar structures? I mean, it just seems like this is the main driver for the margin miss. You had a bunch of tailwinds, like you talked about in your comments.

Yes, I'll start, and Steve can elaborate on how we accounted for the essentially additional engineering work that's going to be required to get one of our strategic A&D programs to the level of performance that's required by our customers. As is typical, when you're doing R&D and creating products in parallel, it's an iterative process. And as the technology matured, we got to the point where we decided it was going to take a little bit more engineering effort to get the program completed. And that resulted in the additional charge. Steve, you can elaborate on how we accounted for that.

Sure. Under the accounting rules, when you're dealing with a contract with the government, certain of those rules require us to record an accrual in the period we identify additional costs needed for that program. This is one such case where that accounting principle had to be applied to this contract. So that was our best estimate as of right now what the additional costs needed for the program are. So that accrual was put on our balance sheet and that expense was recognized completely in this quarter. So essentially what happens, as opposed to recognizing that expense, let's say, over the next 3 to 4 quarters in the P&L, it all comes through under government accounting in the quarter when it's recognized.

Okay. It makes sense that it kind of got pulled in. Second question, just the shape of the tool revenue over the next couple of years. You mentioned this 3-year pipeline at $200 million would be higher than our estimates. I mean, you gave some commentary around that $70 million for this year. So just how you're thinking about that tool revenue coming in? Would it make sense for '25 to be lower and then we step back up in '26? Any thoughts on timing, maybe risk of further pushouts.

Yes. So I mean, I think we gave kind of a broad view of what we think it will be over the next 3 years. You can do the math. $70 million will be about close to the average over that 3-year period. I think that's a good way to model it. Each quarter, tools are arriving per plan, sometimes they're coming sooner, sometimes later than planned. And so we think for modeling purposes the $70 million is probably a good rate over the next 3 years.

I just like to ask a follow-up there to the pushout. I mean, what's driving that push out? Is that a demand issue or really just the supply chain, things taking longer than expected?

Yes, supply chain. It's literally -- we get commitments from customers on when tools will arrive, and sometimes they meet those commitments, sometimes they slip a little bit. And that's literally what happened this past quarter.

And that's why we provide the guidance that we do. I mean if you look at it, really, we had one slight pushout in this quarter. However, at the same time, we were also saying with the clarity we have, we expect more tools to come in over the course of 2024. So I think that's why we gave the overall pipeline of what we think the tool revenue is for the next 3 years. There can be slight timing delays. We don't see anything systemically in the supply chain at this point in time. But tool deliveries can come right at quarter end and slip by a week or so, could have an impact on the quarter. And that's why we give a general guide on what the pipeline really looks like. So again, we had one tool slightly miss coming into this quarter, but we also have visibility that more tools are likely to come in, in 2024 than what we otherwise said in the last quarter earnings call.

And our next question comes from the line of Krish Sankar with TD Cowen.

I had a few of them. Steve, I'm just kind of curious. Clearly, the revenue is improving nicely, but the gross margin is lagging. I understand the onetime cost. Kind of curious how to think about overall gross margin for this year relative to last year? And if I remember right, you have spoken about in the past a long-term gross margin target of 40% exiting 2025. Is that still realistic? And then I have a few other questions.

Yes, sure. So on the gross margin standpoint, I mean, really, it was the $8 million, but you're also getting a little bit more tool costs flowing through as well. So that was really the impact of where we were for the first quarter. Otherwise, it was pretty much in line with where we thought our costs would be, and really would see that incremental growth taking place. Now going forward, we gave a range where we thought the gross margins would be for second quarter, which is approximately 16% to 19%. And given what we talked about on the revenue side, that we'll still have good top line revenue growth over the course of 2024. With what we're seeing right now, that revenue mix changes. And our expectation is that revenue mix for the rest of the year would be very similar to what we talked about and have expectations for the second quarter of this year.

So is it fair to assume gross margin this year will be down versus last year because of the tool revenue?

Yes. So if you look at the margin, the margin likely would be slightly down. Again, what you have to look at is the impact basis points, of what we said 300 to 500 basis point impact of tools coming in. So if you're looking at the margin, it's more important way to look at what the gross profit line is for the company because the margin will be impacted significantly by the amount of tool revenue coming in this year.

And clearly, the lower run rate of Wafer Services with our legacy Infineon platform is going to contribute to gross margin dilution as well.

Got it. And then 2 other quick questions. One is, can you just tell us what your utilization rate is in your Minnesota front-end fab and Orlando back-end fab?

Yes. So again, we don't quote utilization at SkyWater, but we have talked about in the past our target utilization. We tend to want to run it at a target utilization to drive our ATS business. We're running at the minimum levels of utilization for Wafer Services. That's obviously tied to the macro environment we're in. And as we've talked before, we're using this as an opportunity to accelerate our ATS programs. And that is really the focus of the company right now as we kind of deal with the macro reality that the whole semiconductor sector is working its way through.

Got it. And then one final question, Thomas, Steve. How much of your front-end customers are using the Florida back-end fab?

Yes. So -- and you asked about utilization in Florida. That fab is still an ATS centric fab. There is no volume products down there. So there is really no utilization to quote. But as far as customers using the facility, we have multiple A&D customers as well as commercial customers that are doing development in the fab. And as we announced in January, we were awarded a $120 million program through the DoD to stand up a fan-out wafer packaging technology. That was kicked off, again, in January, and that program will ramp throughout the year. We were excited to have AMD applaud our efforts in moving that type of capability back here to the U.S. So we expect to see a lot more coming from Florida as this year unfolds because of the technology that we're putting in the fab. But nothing from a volume perspective at this point.

[Operator Instructions] And our next question comes from Robert Aguanno with Piper Sandler.

Just a quick strategic one first. Can you maybe walk through your longer-term outlook for Wafer Services, obviously, with the business taking a hit? And I understand the macro side of things. And I'm not asking for numbers, but maybe just kind of the long-term strategy and how you're thinking about kind of the relative scale of the business? And any sort of qualitative things that might impact the business going forward maybe in a positive way?

Yes. Good question. And we've talked in the past about the J curve effect as we have customers convert from ATS to Wafer Services. So this year, we are excited to announce Nautilus Bio last quarter, Lumotive this quarter. We expect another announcement coming soon about these conversions. But they are not going to immediately replace our legacy volumes that we obviously get from Infineon and a few other customers. Our plan all along has been to use our ATS business to seed our fab here in Minnesota with new technologies on new platforms and new products that will have a long, long life cycle ahead of them. And that is working per plan. Obviously, along the way, we are dealing with a macro environment where there's semiconductor weakness certainly as it relates to some of the legacy programs. And so while we are hopeful that at some point that business will come back in some form, our focus is really on seeding our fabs with these future technologies. The rate at which they'll come back, again, is somewhat out of our control. It's up to our customers to get the products in the market, get the traction. Our goal is to make sure that we can scale when they're ready to scale. And that is definitely what we're doing. Obviously, in the A&D space, we have programs also moving through the funnel, preparing to go into production. Those will be very viable products, not necessarily high volume. But we see -- as you get through '24 into '25 and certainly in the second half of the decade, you're going to start seeing a much more robust Wafer Services business with much better margins, and that will really carry the business forward as we continue to grow and scale SkyWater.

Great color there. And just one on margins, just to kind of expand on an earlier question. Is there a way maybe to quantify the mix shift around the Wafer Services versus ATS and tool revenue? Basically, just asking for something to -- maybe put some more context around maybe the decline that you guys are seeing year-over-year?

Yes. I believe we forecasted out what we expect the revenue to be. So I think that was in the prepared remarks on the upper 50s for ATS revenue for the second quarter, approximately $20 million for the tool revenue, and a range of, I believe, it was...

$4 million to $5 million.

$4 million to $5 million for Wafer Services. So you can see that there's a significant change in the mix of the revenue compared to the Q1.

Any color around margins there?

So tool margins are relatively, I'd say, similar to Wafer Services margin.

Yes, we -- you can see that the -- we basically say that the margins are somewhere between 5% to 10% on the tool depending on the tool that's being sold. But tools are of all different revenue sizes. So really, the margin would be -- if you look back at our supplemental information, you can see where we break out tool revenue and tool cost over the past couple of years. So you can see the whole goal of what we do on the tool side is not necessarily to generate gross profit, even though we do get a slight gross profit, but it's really to limit our depreciation expense and the need to raise capital for those tools.

And with that, I will now turn the call back over to Thomas Sonderman for closing remarks. Thomas?

Thank you, operator. I want to close by reinforcing the confidence that all of us at SkyWater have in our ability to achieve long-term growth and profitability. We will keep working to build your confidence in us. We will be attending the Craig-Hallum and Cowen conferences this month, and you can contact Claire for further follow-up. We look forward to speaking with you again in August during our Q2 webcast. With that, I will conclude today's call.

And ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect.