SkyWater Technology, a Minnesota-based pure-play semiconductor foundry, just released their Q1 2024 earnings transcript, and while the headlines focused on record revenues and the continued strength of their Aerospace & Defense (A&D) segment, there's a hidden signal buried within the text that could point to a much larger, more explosive growth story.

It's not the robust growth in their Advanced Technology Services (ATS) division, which saw a 28% year-over-year jump. Nor is it the landmark $70 million in expected customer-funded CapEx for 2024, a testament to the unique value proposition SkyWater offers. It's something more subtle, something that speaks to a fundamental shift in SkyWater's strategy and a potential inflection point in their commercial business.

The signal is this: SkyWater is aggressively phasing out their legacy Wafer Services business, specifically their standard CMOS production, even as demand in those markets remains sluggish. The company expects a 60% decline in this segment for 2024. On the surface, this seems like a risky move, surrendering a stable, albeit lower-margin, revenue stream in the face of a broader industry downturn.

But here's where things get interesting. This isn't simply a cost-cutting measure in response to market conditions. It's a deliberate, strategic shift to prioritize their ATS business and the transition of those development programs into a new generation of high-margin, high-growth Wafer Services products.

This hypothesis is supported by several key points in the transcript. First, CEO Thomas Sonderman emphasizes the strength of their ATS pipeline, with multiple customers poised to transition to Wafer Services in 2024. He specifically highlights Lumotive, a company producing revolutionary optical beam steering chips, as a recent example, hinting at another biomedical customer conversion in the coming weeks.

Second, despite the decline in legacy Wafer Services, SkyWater maintains a positive outlook for overall revenue growth in 2024, driven by the expansion of ATS and record tool sales. This suggests a high degree of confidence in the revenue potential of the new products emerging from their ATS pipeline.

Third, and perhaps most telling, CFO Steve Manko states that a gross margin 'in the mid- to low 20s could be something that could generate some positive non-GAAP EPS for us over the course of 2024.' This implies a significant increase in gross margin contribution from their non-tool revenue streams, which can only come from the new Wafer Services products.

If this hypothesis is correct, it means SkyWater is not simply riding the wave of increased domestic A&D spending, but building a foundation for a much larger, more sustainable commercial business. They're leveraging their unique technology development model, customer-funded CapEx strategy, and lean operating structure to create a new class of high-value semiconductor products.

Projected Financial Impact of SkyWater's Strategic Shift

To illustrate the potential impact, let's consider a scenario where SkyWater replaces their declining legacy Wafer Services revenue with new products at a 30% gross margin, a conservative estimate given the highly differentiated nature of these technologies. Assuming a 15% growth in ATS development revenue and $70 million in tool sales, this would result in total revenue of roughly $330 million for 2024, with non-tool revenue contributing approximately $260 million.

At a 30% gross margin, this translates to a non-tool gross profit of $78 million, significantly higher than the $42 million generated in 2023. Factoring in estimated operating expenses of $65 million, SkyWater could potentially achieve $13 million in non-GAAP operating income, a remarkable turnaround from the -$12.8 million in 2023.

Revenue Breakdown (Q1 2024 vs. Q4 2023)

This is just one possible scenario, and the actual outcome will depend on factors such as the ramp rate of the new Wafer Services products and the overall market environment. However, the key takeaway is this: SkyWater is making a bold bet on their future by aggressively pivoting away from legacy products and towards a new generation of high-margin, high-growth commercial technologies. If successful, this strategic shift could unlock significant value for investors, pushing SkyWater beyond their current niche as a trusted A&D supplier and into the forefront of innovation in a rapidly evolving semiconductor landscape.

"Fun Fact: SkyWater Technology's headquarters is located in Bloomington, Minnesota, a city known for its thriving technology sector and its proximity to the Mall of America, one of the largest shopping malls in the world."