Nick: So this begs the question, Kasey, it sounds like 2024 is going to be another, let's call it transition year. When are customers going to begin buying actual wafers? When will they actually utilize Skywaters manufacturing processes? Kasey: So let's talk about that, does this newfound profitability change our minds with our investment in ACMR Research? We do not currently have a position, we've been sitting on the sidelines for this one, but are we ready to put a little money on the table, put a little skin in the game? Nick: That's the big ticket question for this one. Kasey: Hey, everyone.
Welcome back to Chip Stock Investor. We have a great week coming up with lots of new content, but we're going to start the week off with a couple of small cap companies that we've received a lot of questions about. Skywater Technology and ACM Research. These two small caps have definitely gained momentum in the past few months.
So we're going to discuss whether or not these stocks are a buy. Nick: Yeah. And maybe we should start the episode with the usual rant on small caps. small can be very weird. And these two in particular are some of the weirdest you'll find in the semiconductor industry.
We'll talk about why that is. But, folks, seriously, please, if you have not heard this rant before, commit this to memory, small cap stock does not automatically equal big stock price gains. On the contrary, more often than not, what it actually means is you're probably going to underperform the market overall at best over the longterm. The law statistics do not work in your favor here. So if you want to buy these two small stocks that we're about to talk about, it should be part of a well rounded basket of small cap stock bets. That's why we own at least a couple dozen of small cap names at any given time, because, yes, they can go on a hot run at times, but they will be followed by long stretches of underperformance to the market overall.
Also for the record, we have our own definition of what constitutes a small cap stock. We talk about that over on our new Discord channel quite often. So check that out, if you'd like some discussion on how to invest in small cap companies. Okay.
End of rant Kasey. Kasey: All right, let's talk about our first company Skywater Technology. This company falls into the wafer fab and packaging portion of the semiconductor industry flow chart. But this company is not a Taiwan Semiconductor Manufacturing or a Global Foundries. We've described Skywater Technology in the past as a startup for startups.
This is still the story, despite the progress on growth, as well as a layoff of 10 percent of employees to curb spending. In fact, the last time that we covered this stock late last summer, shares were trading for about 1. 1 to 1. 2 times trailing 12 month sales. We've actually been invested in this company in the past in a roundabout way.
Skywaters Fab in Minnesota used to be part of Cypress Semiconductor, which spun out the assets that have since become Skywater or SKYT to private investors via Oxbow Industries, before Cypress itself was acquired by Germany's Infineon. Now Infineon is still ultimately the main customer for Skywater that pays for wafer manufacturing. Because many of the IDMs utilize a hybrid strategy these days of in house wafer fab and some outsourced fabrication. You may recall that the CFO, CEO duo from Cypress Semiconductor is now at On Semi. Nick: Yes.
Just a little bit of history. And again, of course, if you've been following along with us, you know that we have a small position in Skywater today. We were buyers last year and nibbled again after that last update, as we said, we would, late summer and into the early autumn months. And that said, let's talk about the Q4, 2023 update, initial outlook on 2024. There are some important changes taking place over at Skywater. So the company is a fab, a semiconductor fab.
But it has this unique model where it cuts these research and development deals with its customers, forming a co development tech platform that it calls ATS or Advanced Technology Services. Basically how it works, customers invest in both the manufacturing tools and the semiconductor manufacturing process itself, along with SkyWater. And then once complete, the goal for Skywater is it moves those ATS customers on to become wafer customers where those customers ultimately hire Skywater to manufacture the silicon wafers and then buys them, packages them up into some sort of computing or electronic system and then sells those to ultimate end customers. Skywater can ultimately use some of this tech that's co developed under ATS, for its own use later on with other prospective customers. So that's the general business breakdown and why Kasey, you said, we call this a startup fab for startup tech companies. Kasey: We'll briefly go through the most recent quarter's financials for SkyWater Technology.
Revenue of $79. 2 million in Q4, up 11 percent from Q3 and up 22 percent year over year. Record ATS revenue of $67. 1 million. up 17 percent quarter over quarter and 40 percent year over year. And this ATS revenue includes $9.
9 million of tool sales compared to $3. 2 million in Q3 and very little last year. Nick: So in digging through the new annual report and the earnings call from Q4, you can definitely get the sense that 2023 is going to again, be a bit of a wash as SkyWater continues to rebuild its business after the spinoff from Cypress. And also again, Infineon, the major customer sun setting some older products and then Skywater replacing those sunsetted products with some new development under that ATS program. The business mix in the past was about two thirds ATS, one third actual wafer services, but a few things happened in 2023 that bumped that mix up to about 80%, 20 percent. ATS, 80 percent, wafer services, 20%.
So a lot of customers, especially the Department of Defense contract, which has hired Skywater for this radiation hardened or rad hard, 90 nanometer wafer manufacturing process. Customers like that, and others in the aerospace and defense sector, ramping up its co development, the ATS spending with Skywater. So this is not exactly what you want to see, right? ATS is a fantastic pipeline of potential business. In the years to come. It's again, what fuels the startup fab for technology startups. However, wafer manufacturing is where the company will really make some more serious money over time.
And so you see that split dropping to 80, 20 ATS to wafer services in this past year, indicating that yes, there's lots of investment, but Skywater not manufacturing actual wafers. And it looks like that trend is going to continue into 2024 Kasey, in spite of the Minnesota fab getting an application for Chips Act funding, and Skywater announcing that $190 million, new five year department of defense contract for the new facility in the chip packaging facility in Florida. So this begs the question, Kasey, it sounds like 2024 is going to be another, let's call it transition year. When are customers going to begin buying actual wafers? When will they actually utilize Skywaters manufacturing processes? That's the big ticket question for this one.
Kasey: Yes, absolutely. We've talked about this in recent videos, On Semi, Microchip and other companies, there's a soft end market demand in industrial applications. And so that ATS growth is still expected to have some offset by declining wafer services for Skywater. You can see this in one of the comments made by CEO, Mr. Sonderman, he says that the ATS business, they expect continued growth, but they do expect that sequential growth in ATS services to be offset by a further decline in wafer services revenues, which they expect to be down about 25 percent from Q4. And then he goes on to say that he anticipates their wafer services revenues will be down at least 50 percent in 2024 compared to 2023 levels.
And again, tool sales and especially eventual wafer sales made with those tools is the real long term growth driver for a company like Skywater Nick: Yeah, it's been a great run the last five, six months. Our ultimate cost basis on this is now under 6 per share. As you already mentioned, this thing looked really, really cheap late last summer, and so we added to our position to get our cost basis under six bucks. We'll take it.
It's been a fantastic run. There are definite merits to this operating model for certain. That is what still has us interested in this company. One more quote here to emphasize this from the CFO, Steve Manko. About 80 percent of Skywater's capital expenditures or CapEx that's spending on property and manufacturing equipment, primarily manufacturing equipment.
80 percent of that CapEx in 2024 is expected to be funded by the customers. And so Skywater's actual capital needs are very, very low compared with your typical semiconductor wafer manufacturer. This is an interesting business model. However, the actual wafer manufacturing business is going to be down again in 2024 so we're not adding to our position again at this point, despite the recent momentum in the stock popping all the way up to 12 bucks, we've had a nice double in price from where we bought last, but I think we're on pause with this one for the time being. Kasey: Yeah, absolutely.
If we see the stock dip back below the $8 to $9 range, we'd consider nibbling again. But until then, we'll hold. Nick: And the reason why, again, we have a basket of small cap stocks because they will go on these occasional runs like this, and it can be highly unpredictable when they do, but then oftentimes these runs higher will be followed by some long, brutal stretches of underperformance to the market.
We have other small cap names we're considering. We're happy with what this one is doing for now, but we see no imminent need to add to the position while we wait for those industrial end markets to solidify again, perhaps the summer, maybe sometime during the later half of 2024. Stay tuned on this one. Kasey: Quick break from Chip Stock Investor Kasey and I wanted to talk to you about Main Street data. MainStreetData is a data visualization and charting platform that helps investors analyze companies in the stock market.
Because the stock market is so complex, it can be very difficult to make informed investment decisions without the right tools. MainStreetData gives you the tools and information you need to make better investment decisions. MainStreetData offers a variety of benefits including data visualization, charting tools, and company earnings calls transcripts, which are an easy way to reference up to date comments from management of your favorite stocks. You can sign up for MainStreetData today and get a special discount through our link below in the description. Let's now talk about ACM Research. ACM Research falls into the wafer fab equipment part of the semiconductor industry flowchart.
One of the most critical choke points controlled by the Fab 5. And it's imperative for chip manufacturing. And why we personally prefer this space versus fabrication businesses themselves.
ACMR shares have skyrocketed up over 80 percent so far in 2024. And that's fueled primarily by China's very ambitious chip making plans. We still think this is a massively misunderstood business, although we have started noticing some analysts asking questions about some of the things that we've talked about here on Chip Stock Investor regarding some of ACMR's business model. Nick: Yeah, that's right, this equipment space typically a part of the industry we prefer over the fabs. Although we just said we own Skywater Technology. Said that we would be taking a wait and see approach to ACMR and we're still doing that.
We do not own ACMR. We're not interested in chasing the stock price. If that means we lose out on gains, whatever. That's fine.
That's just not our style. We're making money in other places. But let's talk about this business model, Kasey, because this is, I think, really important to understand before anybody dips their toe in on this one. This is a weird one. Okay.
Folks, you need to get in the habit of reading annual reports, before you make a long term investment. If you're trading, whatever, that's a different story, but here's the background. You probably know, China is ramping up production of its own semiconductor manufacturing capabilities, especially to meet needs for their fast growing electric vehicle market, as well as other just general purpose consumption. Most of these types of chips, used especially in EVs and automotive applications are known as mature node manufacturing chips. These are not the most advanced, leading edge manufacturing techniques used in AI chips, designed by NVIDIA, or maybe not even Apple's most advanced chips for their iPhones and the MacBooks. Rather these mature chips are used in well established industries, and that's just fine for these particular end use applications.
And ACMR is a key facilitator of that. Kasey: ACMR especially sells equipment for cleaning and prepping the silicon wafers, which is the foundation of every chip with China's chip makers on a buying spree. ACM's revenue has soared and their profits are quickly hitting profitable scale. This slide provided by ACM Research shows that most of the revenue is tied to the cleaning and prep equipment for those silicon wafers, the discs that you see pictured here by people in bunny suits holding. There are dozens of steps in the manufacturing process that manipulate and change the surfaces of these discs.
But between those dozens of steps, especially after lithography and etch, but before deposition, there's a cleaning and preparation phase. And most of ACM's research is designed for that, providing a very thorough, but gentle cleaning and prep process. One specific product from ACM Research called the Tahoe, was 72 percent of all revenue last year.
Nick: Yeah, that's right. Important tidbit, that was briefly mentioned on the Q4 earnings call. This is not just a niche part of the semiconductor manufacturing equipment space, that makes ACMR, a specialist. It's one piece of equipment in particular, which is fine. You can get some fantastic growth from companies that have extreme focus, but again, you got to mind the risk with these things when there's product concentration, and as we're about to talk about here, there's particular risk with geographic concentration with their sales as well. At any rate, you can see they are expanding into other tools as well.
So besides cleaning, you can see track equipment often used in tandem with the photolithography equipment. It just helps with the general flow of this process because oftentimes photo lithography is not done in just one single exposure step. There's oftentimes multi patterning or just different types of exposure going on, on, on the surface of these wafers. So you'll have deposition where material is laid down, photo lithography that sort of, you could say prints the patterns on the surface of the wafer and then etch where that excess material is removed to reveal those patterns. And then the process starts over again with more deposition.
Between each of those steps, you have the cleaning process, so very important. In addition to that, you have this PECVD, plasma enhanced chemical vapor deposition. It's a specific type of deposition, the laying down of some sort of chemical that reacts with the light from photolithography, also a very delicate process.
Specifically this plasma enhanced CVD is a type of lower energy consumption CVD process. And oftentimes advanced packaging, like again, that Skywater Technology facility, in Florida, that just got the new department of defense award, use some of these steps as well. Not necessarily for, again, advanced leading AI chips, but maybe just more mature chips used in things like automotive and industrial applications.
Okay. That out of the way, let's talk about some of the weirdness with ACMR's business model. Kasey: This is weird. And we've talked about this every time we've talked about ACM Research.
Well over 90 percent approaching 100 percent of their revenue is still coming from China. And so the logical question that you might ask yourself is how does a company based in Silicon Valley in California, USA, sell all of that equipment to China, especially under current restrictions? Surely you would think that is a massive risk, both from regulators in China, as well as regulators here in the United States. But if you do some digging into the company's annual reports, you'll find that, there is a segment that actually operates as a not wholly owned, but majority owned subsidiary of ACMR. That subsidiary is called ACM Shanghai and ACM Shanghai actually had an IPO in 2021.
And the purpose of that was to help reduce some of the complexity of a California based company doing most of its sales in China. . That's how they were able to skirt some of this by operating through that subsidiary. So ACMR, the holding company that's traded in the United States owns over 82 percent of this company, ACM Shanghai. And so there are some minority shareholders in China for the subsidiary business operating in China that handles most of the revenue for this company. Have I lost anyone yet? Nick: Well, not much has changed from the 2022 annual report. You've got the slide here from the 2023 annual report, that's fresh out at the end of February.
And you can see right on page three of the annual report, they don't even bury it. You just have to open up the 10 K and get a few pages and to see the complexity of this operating structure. Yes, it's a US business, but most of the business is happening in China, which is totally fine. We're not saying that makes this bad, but it is a veritable risk.
You cannot skirt this at this point. ACMR is operating on the front lines of the trade war between the U S and China. And so it's fantastic that the stock is up another 80 percent plus to kick off 2024 building on it's already massively successful 2023, but you can't skirt this risk when you have a company operating on the front lines of a hot debate and a hot economic conflict between the U S and China. There's an elevated risk that this could become a casualty on the front lines of the trade war between these two countries. So this is not any political statement whatsoever, this is just an investing reality that you have to face, if you're looking at becoming a long term shareholder in a company like ACMR. Elevated geopolitical risk and not future, potential future geopolitical risk like with Taiwan Semi, where you have to worry about, what if there's an invasion of Taiwan.
This is a current risk right now that ACM Research has been trying to navigate for the last few years. Kasey: Yeah. Ultimately ACM Research has done a very good job at making some exceptional growth, with its primarily Chinese fab customers, exceptional growth. So let's talk about that, does this newfound profitability change our minds with our investment in ACMR Research? We do not currently have a position, we've been sitting on the sidelines for this one, but are we ready to put a little money on the table, put a little skin in the game? Nick: Well, I think this is another complication with the business that we've addressed, in all of our past videos that it needs to be addressed again, nothing has changed. So oftentimes investors, take issue with a business that is operating at a GAAP net loss, but generates lots of free cashflow. With a company like ACMR, it's actually flipped.
The company reports GAAP net income, but has been reporting negative free cashflow. Again, that's just the nature of this particular business. So as of this recording ACMR stock trades for about 31 times trailing 12 month GAAP earnings per share. It's not cheap anymore, like it was in our past updates on a GAAP basis, but maybe it's not super expensive either. However, the downfall of this business is remember those spending capital expenditures on property and equipment, CapEx, like we just mentioned with Skywater Technology, with their tool purchases this year that 80 percent of their customers are going to foot the bill for. ACMR has to foot those bills themselves.
Right now they are ramping up their operations, they have new facilities that they're building and getting ready to open in China to address all of the orders they're getting for these cleaning equipment and some of their other deposition equipment, and as they spend that money on CapEx, that's what has free cashflow deep in the red. That's the difference between GAAP net income, which depreciates CapEx over time versus the negative free cashflow, which expenses those things immediately at the time that the cash leaves the company's account. Kasey: Those two metrics are converging. So it's something that we'll just have to keep an eye on and see what happens in the future.
And you may recall that in past updates, we have mentioned that it was a record year for manufacturing chip equipment in China for ACMR, but a possible slowdown was going to be on the table in 2024. And that is not what happened at all. It actually, the opposite has ended up happening at least for this specific equipment. So we're sufficiently interested in ACMR to continue keeping it on our watch list. And we know that many of our viewers are also keenly interested in this company. So we'll continue to follow it.
As we mentioned before, it's still not a company that we're going to add to our portfolio at this time, but We will keep an eye on it and see what happens. We'll keep you updated as well. That's a wrap for these two small cap companies, ACM Research and Skywater Technology.
We have much more coming your way later this week. So make sure you have hit the subscribe button if you have not already. And just a reminder, we released a cybersecurity industry video earlier last week. And that video takes a look at how to invest in the cybersecurity industry, how these companies operate, what types of products they offer and how they ultimately make money, which in turn shows you as an investor, why or why not, you may add these companies to your portfolio.
You can check that out here in the video link or in the description and make sure if you have not seen it yet, check out our manual over on our Ko Fi page. And of course, if you are a member of the channel here on YouTube or over on Ko Fi, either of those memberships will get you access to our Discord channel, where we discuss all things, semiconductors and stocks in general, as well as publish our show notes and those manuals for a one low price of $5 a month. So check that out and we will see you again here at Chip Stock Investor.
2024-03-11