Shares of small U.S.-based chip manufacturing start-up SkyWater Technologies (SKYT -0.79%) initially tanked over 30% following its Q1 2024 earnings update. Shares have rebounded a bit since then but are still down nearly 30% pre-earnings and down nearly 20% so far in 2024.
It seems that stock market movers and shakers were surprised by a temporary dip in SkyWater's trajectory toward reaching profitability. To be clear, SkyWater remains a high-risk and only potentially high-reward stock. But are investors missing the forest for the trees -- or in this instance, missing the chip fab for the wafers?
A unique business model creates potential -- and risk
I explained a couple of months ago that SkyWater has a unique business model. Just as it was in 2023, 77% of Q1 2024 revenue was ATS -- or SkyWater's "Advanced Technology Service." ATS is a joint development and investment business with a SkyWater customer, where both SkyWater and the customer spend on semiconductor manufacturing processes and chipmaking tools to solve the customer's specific needs.
This makes SkyWater a type of start-up chip fab (meaning a facility that makes silicon wafers and chips cut from those wafers) servicing other start-ups. A standing development program with the Department of Defense (DoD) makes up the bulk of revenue, but there's a long tail of private start-ups and researchers tapping SkyWater for help -- especially in quantum computing, artificial intelligence (AI), and healthcare technology.
ATS revenue increased 28% year over year in Q1, which lifted the total revenue reported by 20% to $79.6 million.
The problem, though, is that ATS isn't a profitable source of revenue and was never designed to be. SkyWater's ATS program is meant to be a feeder for its "Wafer Services" segment. This is when a co-development program moves out of ATS, and SkyWater starts manufacturing and selling the resulting researched wafer technology to the customer. Wafer Services revenue was $10 million in Q1, a bit ahead of expectations, but down 44% year over year.
As management explained a few years ago, this is a transition year for SkyWater. Much of the semiconductor manufacturing industry is in the midst of a cyclical slump, and ATS development is ramping up for a final push before converting into more Wafer Services in 2025 and beyond.
Additionally, there was an extra $8 million ATS charge related to a customer project that needed a bit more engineering. That also impacted SkyWater's margins and will help the company move toward achieving profitability for the balance of 2024.
Data by YCharts.
Measure twice, buy once?
This type of volatility from one quarter to the next is exactly why I've been preaching caution with SkyWater stock. Periods of quick share-price run-ups can give a false signal that some significant development is happening at the business when in reality, it's just normal small-cap stock-price volatility. Volatility moves down and up.
I own a small position and have no intention of placing a big bet on SkyWater -- even if the long-term potential seems promising.
This is still a start-up, and it's going to take time for the company to move enough of its ATS customers over to Wafer Services to have a more robust impact on profitability. In the meantime, expect more extreme volatility in this small-cap stock throughout 2024.
That said, I'm still happy to hold the shares of SkyWater Technology that I already own. I have no plans to add any more shares just yet but might later this year if more near-sighted pessimism drags the share price down further, assuming nothing materially has changed with the growth story. For bigger investments in semiconductors, there are lots of other great picks that make more sense for new money right now.
