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Operator
Good day. Thank you for standing by and welcome to Skywater Technologies' second quarter fiscal year 2021 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press the star 1 on your telephone. Please be advised that today's conference is being recorded. In addition, if you require any further assistance, please press the star 0. Thank you. I would now like to hand the conference over to your speaker today, Ms. Heather Davis. Ma'am, please go ahead.
Heather Davis
Good morning, and welcome to Skywater's second quarter fiscal 2021 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. 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 8K yesterday and a prospectus filed April 22, 2021. 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, which is available on our investor relations website. Unless noted, all comparables referenced today are versus the prior year or second quarter of fiscal 2020. With that, let me turn the call over to Tom.
Thomas Sonderman
Thank you, Heather, and good morning to everyone on the call. Today, I'll briefly cover last quarter's financial results and then have a broader review of our exciting growth strategy. I'll also start providing a deeper dive into a specific area of our business to further your knowledge of Skywater's disruptive capabilities. This quarter, I'll focus on Skywater, Florida and our new advanced packaging path. Steve will then go into further details on our financials. In the second quarter, net sales grew 34% to $41.2 million compared to last year, driven by solid increases in both advanced technology services and wafer services. Gross margin was 4.4%, net loss attributable to shareholders was $7 million, and adjusted EBITDA was negative $800,000. Skywater made solid progress executing on multiple fronts during the quarter, but also experienced some revenue recognition delays. This included U.S. government funding tied to existing programs that we expect to occur, but the timing remains difficult to forecast. We also experienced a delay in the recognition of the majority of the revenue for wafers produced and put in inventory for a temperature monitoring wearable for early COVID-19 detection due to the market dynamics tied to the rapid introduction of new vaccines. These wafers are now being repurposed for an alternative health-related wearable application. Lastly, an ATS program that generated significant revenue for the company in 2020 and was forecasted for 2021 is being restructured with the customer. We expect it to resume in 2022. I am very pleased with Skywater's year-over-year top-line performance and remain confident in our long-term revenue growth target of approximately 25% for 2021 and beyond. Our vision at Skywater is to improve the world by revolutionizing technology realization because we're impatient waiting for the promise of tomorrow, so we're focused on making it happen faster today. Our industry-transforming technology-as-a-service, our task business model, allows us to co-create next-generation technologies with our customers, accelerating their time to market with the confidence of automotive quality manufacturing and extensive IP protection. As the market potential continues to expand for artificial intelligence, quantum computing, power management, and various sensing technologies, we expect to see a corresponding growth in demand for our unique task offering. During the quarter, we began the transition of multiple ATS customers to volume wafer manufacturing, a key attribute of the task business model. This achievement has literally been years in the making because of the multi-year characteristics of microelectronics R&D and is a testament to the long-term intimate relationships we have established with our customers. While we expect these transitions will drive significant long-term shareholder value, they do create a J-curve effect in the near term. We also continue to see strong pipeline growth in ATS and Wafer Services as multiple companies engage with us on new program scopings and shuttle runs. Skywater continues to make substantial progress on RH-90, our radiation-hardened technology, to address the U.S. government's needs for extreme environment microelectronics, which are necessary for satellite and mission-critical defense systems. We recently announced the launch of our first multi-project wafer shuttle using the RH-90 platform with our existing aluminum interconnect technology. We anticipate future RH-90 shuttles will leverage copper interconnects to deliver further enhancements in speed and performance for the mixed-in-road devices enabled by this leading-edge RadHard technology. We also announced our strategic partnership with CASE to support the development of the design ecosystem necessary to enable market access to our RR90 technology platform. Through this engagement, we will work together to achieve key design enablement milestones that support the productization and qualification of radiation-hardened applications. We are very excited to be working with an industry leader like CASE as they bring their extensive experience in rad-hard ASIC product realization to Skywater's RH-90 platform. Skywater also continues to execute against our RH-90 technology qualification milestones as we prepare for rad-hard testing. We expect investments in our Rad Heart program to be a long-term growth driver for our skywater, but they are a near-term drag on gross margins as we continue to develop and qualify this critically important technology platform for our nation. In the second quarter, we continue to win new ATS business in the biomedical space. Customers are seeking to co-develop MEMS-based microfluidic protein sequencing and genome technologies with Skywater. This area of the business is anticipated to be a strong performer over the next several years as demand for rapid diagnostics and other disease screening technologies proliferate across the healthcare industry. During the quarter, Skywater aggressively ramped our Minnesota FAF to support the growing IOT and automotive segments of the business. In addition, we made significant progress transitioning multiple ATS programs into wafer services, including our differentiated silicon-based power management platform, which will begin to ramp in the second half of the year. Skywater expanded its entry into the high-growth advanced packaging space in February as the operators of the Center for Neovation in Kissimmee, Florida. This fab was built by Osceola County and the University of Central Florida in 2018. After the COVID-19 related business slowdown in 2020 and funding priority changes at UCF, Osceola County searched for a new operator, ultimately selecting Skywater after a highly competitive bid process. This created a great opportunity for our company to expand our reach across the semiconductor value chain by offering customers a comprehensive, domestically sourced, advanced packaging platform. Today, advanced packaging is done primarily overseas. Our FAB is one of the few dedicated advanced packaging facilities in the United States and is anticipated to be part of our nation's solution to create a secure domestic supply chain. We also plan to move existing advanced packaging programs from Minnesota to our Florida FAB. I am also excited to announce that two current customers are expanding their engagements with us with new programs at Skywater Florida, including our long-term technology partner, Rockley Photonics. Skywater's capabilities will enable both 2.5D and 3D heterogeneous integration architectures, enabling customer improvements and component density, which reduces die size while improving product performance. It is our intent to bring the most advanced capabilities in the industry to our Florida fab. In addition, there is currently open cleanroom space in Florida, allowing us to aggressively expand as we co-create new advanced packaging solutions with our customers. We expect this offering to be a key differentiator for Skywater. In the second quarter of this year, we focused on restarting the Center for Neovation facility, qualifying the existing tools in the FAB, and hiring key talent with proven advanced packaging expertise. An operations director with deep foundry experience is now in place, and we continue to build out the FAB operations organization. Our Florida team is now executing on the three existing programs held with multiple DOD contractors. By leveraging our existing business infrastructure, including sales, marketing, and finance, we have been able to efficiently expand further into the advanced packaging space. The cost incurred in the first half of the year have put pressure on our gross margins as we started up and began to ramp our advanced packaging facility, but we expect these investments will translate into another high-margin revenue stream for our company over the long term. Skywater has a long history of successfully executing public-private partnerships. We remain highly confident about the long-term potential for these types of engagements to further increase the production capabilities of microelectronics in our country. We applaud the Senate's passage of the U.S. Innovation and Competition Act. Skyworker recently hosted Senator Klobuchar and Representative Phillips at our Minnesota FAB to discuss solutions to resolve supply chain constraints and improve long-term domestic semiconductor output. In addition, we've spoken with multiple U.S. government officials about how best to increase the capabilities of U.S.-owned and operated foundries that are focused on enabling the required innovation and production of microelectronic technologies for the automotive, industrial, defense, and medical device markets. Much remains to be decided as to how and when the U.S. government will implement its plans to co-invest with private sector companies to improve our nation's domestic R&D and manufacturing capabilities. But we strongly believe that the passage of the USICA is an important first step toward regaining U.S. leadership in microelectronics production. In addition to our interactions with Washington, Skywater continues to engage with multiple state governments, including Minnesota, Florida, and Indiana, to discuss co-investment models, an important component to secure the future of public-private partnerships that are being discussed in our nation's capital. And finally, last week we announced that our Board of Directors approved $56 million in strategic capital investments to expand capacity at our Minnesota fab and to accelerate our entry into the high-growth 200-millimeter gallium nitride market. It is our belief that the fastest way to address the current global chip shortage is to rapidly increase the capacity at existing fabs with qualified manufacturing processes. This is especially true in the automotive sector, where new product qualifications can take multiple years. The majority of our $56 million of investment will be targeted towards the purchase of new equipment, allowing us to quickly repurpose existing cleaning room space from wafer-level testing to expanded wafer production. This investment and our ongoing efficiency improvements are expected to increase the overall output of our Minnesota fat by at least 40%, further accelerating our revenue growth and gross margin expansion as we exit 2022. A portion of the $56 million in strategic investment is also targeted towards expediting Skywater's entry into the 200-million-year GAN market. As the White House's 100-day supply chain review noted, there is a significant need for a U.S. foundry to offer technology services for GAN. GaN is a promising emerging technology for electric vehicles, 5G, and consumer electronics, among others. Its unique properties enable higher charging efficiencies, smaller die sizes, and lighter weights for many applications. Your development estimates that the GaN power device market alone is expected to grow at a compounded annual growth rate of 70% through 2026, reaching $1.1 billion. I firmly believe Skywater is the right boundary to offer domestically sourced GAN-based technology development and scale manufacturing, leveraging our technology-as-a-service model. Fast-tracking our entry into the GAN market is anticipated to further enhance our position in the aerospace and defense, computation, industrial, and automotive markets, creating another disruptive technology platform that Skywater can use to rapidly grow over the long term. These strategic investments to swiftly increase the production output in our Minnesota fab and hasten our entry in the GAM market are expected to enable Skywater to continue to deliver substantial top-line growth and gross margin expansion well into the future. It is important to note that our capital commitments are in addition to the previously announced $170 million of funding from the U.S. Department of Defense to establish our RADHAR platform and the $133 million of facilities and tools from Osceola County that we are leveraging to expand our advanced packaging offerings. In summary, we are winning new business, aggressively ramping our Minnesota and Florida fabs, securing key supply arrangements with collaborative partners like Rocklea Photonics, and building our rad-hard and advanced packaging capabilities while investing strategically to drive industry-leading, long-term profitable growth for our company. I couldn't be more excited about Skywater's future as America's foundry. I will now turn the call over to Steve for further information on our financial performance in our recently completed quarter. Steve?
Steve
Thank you, Tom. Skywater accomplished much in the second quarter, including our initial public offering. This achievement is a great testament to our team members, customers, and partners as we co-create the next generation of technology through our technology as a service model. We continue to execute our strategy during the second quarter and grew our net sales. Net sales for the second quarter were $41.2 million, an increase of 34% versus second quarter of 2020. Advanced technology service grew 35% to $26.9 million, and waiver services increased 31% to $14.3 million. ATS growth was driven by continued program expansion with existing customers and new program additions. ATS sales in the second quarter contains 2.3 million of customer-funded tools compared to zero in the second quarter of last year. Q2 ATS sales of 26.9 million compares to 38.1 million in Q1 this year. Excluding $2.3 million and $15.4 million of customer-funded tool revenue in their respective quarters, the ATS business delivered 8% sequential growth. As anticipated, wafer services increased from 2020 levels, driven primarily by strong demand from the IoT and automotive sectors. Cost of sales were $39.4 million and increased by 56% year-over-year. Gross profit was $1.8 million, decreasing from $5.5 million in Q2 last year. Gross margin of 4.4% declined versus the prior year of 17.8%. Non-GAAP gross profit was $3 million compared to $5.6 million in Q2 last year. Non-GAAP gross margin was 7.2% and 18.1% respectively. Both GAAP and non-GAAP gross profit and margin declined due to increased cost of goods. Cost of sales increases were driven by labor increases as we ramp our Minnesota and Florida facilities. The labor market for skilled manufacturing remains tight as the country restarts the economy post-pandemic, and we've increased our average starting wage in our fabs to attract the best talent in the market. Cost of sales also increased from additional waiver services output and investments we are making for the long-term growth of the company to build out our RadHard and advanced packaging capabilities. These investments are expected to be a drag on our margins in 2021. In the second quarter, depreciation related to RadHard was $1.8 million and there was $1.6 million of startup and operating costs for Florida in cost of sales. R&D in the second quarter was $3.3 million, an increase of $2.5 million as we added executive leadership, engineers, and expanded design enablement capabilities to accelerate and support the development of our platforms. SG&A was $15.4 million compared to $6.9 million in the second quarter last year. The increase was driven primarily by public company costs and equity-based compensation. including non-cash costs of $4.5 million for equity-based compensation and non-recurring costs, which includes $1.5 million of corporate conversion and IPO costs, approximately $400,000 of management transition expense, and approximately $200,000 of Skywater Florida startup costs, SG&A was $8.8 million in the second quarter. Adjusted EBITDA was a loss of $800,000 declining from a positive $2.5 million last year, reflecting the decrease in gross profit flow through this quarter. Cash used in operations in Q2 was $22.4 million. We spent $7.7 million in CapEx this quarter on FAB improvements aimed at increases in capacity and efficiency. We ended the quarter with $64.6 million in cash and cash equivalents, which includes proceeds from our initial public offering in April 2021. Total debt outstanding was $66.4 million as of July 4, 2021, and we had $28.9 million available on our $65 million revolver. Total inventory at the end of Q2 was $29.2 million compared to $27.2 million at the end of fiscal year 2020. As you are developing your skywater models, the following is some additional color for our expected operating costs. Research and development expenses are anticipated in the $2.5 to $3 million range per quarter. SG&A expenses are expected in the $8 to $9 million range per quarter, excluding equity-based compensation. And we anticipate equity-based compensation in the $13 to $14 million range for the full 2021 fiscal year. I am pleased with our year-to-date top-line growth and remain confident in our ability to deliver long-term annual revenue growth of approximately 25%. Given the nature of our business, funding sources, and current scale, we will have quarter-to-quarter fluctuations in net sales. As Tom detailed, Skywater has many opportunities to deliver long-term sustained growth, and I remain confident that the company can execute on these opportunities. With that, I'll turn the call back to Heather and welcome your questions on Skywater.
Heather Davis
Thank you, Steve. Skywater will be presenting at the Jefferies Semiconductor IT Hardware and Communications Infrastructure Summit on August 31st, 2021. Please visit the investor relations section of our website for other upcoming presentations. Operator, please open the line for questions.
Operator
As a reminder, if you would like to ask a question, simply press the star, then the number one on your telephone keypad. And please note to limit your questions to one primary and one follow-up. If you have additional questions, you may re-enter the queue by again pressing star one on your telephone keypad. Your first question comes from the line of Bradley Gill of Needham & Company. Your line is open.
Raji
Yes, thank you, and I appreciate the additional insight on the OPEX going forward. Steve and Tom, I'm wondering if you could give me a sense of the gross margin trajectory as we progress throughout the year. So the margins drop to about 7.2% on a non-GAAP basis. This is due, as you mentioned, to labor increases in your investments in Red Heart and the AP in Florida. Wondering how to think about the margins on a go-forward basis. When do we think those investments will start to kind of pay off? And how do we think about a longer-term margin target?
Steve
Yeah, good morning, Raji. This is Steve, and thank you for your question. Gross margin is a metric that we focus on. We have a long-term plan to get to a gross margin of roughly 40% to 45%, and that's what we're targeting. What we'll see first is revenue growth will lead the way, and then gross margin expansion will follow. As we look at how we're going to build our gross margins from where they are today to our long-term model, there are various phases of doing that. I would say over the course of the next 12 to 24 months, the items that we focus on first are, number one, having scale, increasing scale, and keeping our FAB highly utilized. The second would be transitioning to a higher, richer wafer services mix from average sales prices. And you'll see that with some of the MEMS technology that we're looking to bring into production in the next 12 to 24 months. And then also growing our advanced technology services business. Through that, we believe we can grow ATS not only with our current customers and programs, but also growing ATS through advanced packaging in Florida. Those would be the near-term elements that we're looking at and targeting to grow our gross margin, and we hope that that would expand to our long-term rate of 40% to 45%. Okay, thanks.
Raji
In terms of the 25% growth rate that you talked about in 2021, and beyond, I'm wondering if you could give us a little more color on some of the growth drivers within that. So, for example, how do we think about existing customers ramping versus new customer additions? How are we thinking about wafer versus ATS growth? And then as we look beyond 2021, Now, how are we thinking about the Florida facility as part of that overall growth rate? How much revenue are we building in for Florida? Is that part of the 25% or is that an addition too?
Thomas Sonderman
Thank you. Yeah, thanks. Good morning, Raju. This is Tom. Yeah, great question. I think the way to lay it out is what I just discussed in my opening remarks. There's really multiple drivers for growth in the company pipeline. Obviously, the immediate is the transition of uh ats customers into wafer services that again will not only drive growth on the top line but also in gross margins as we get a richer mix inside the fab we're also making great progress on our rad hard technology of course we're building capability today over the next couple years these capabilities will be turned into products that will be manufacturing again as a sole source provider And then we have our expansion that we talked about. We believe with both the expansion here in Minnesota, the 40% increase in capacity, coupled with our Florida FAB, that we can double our output collectively Over the next 18 to 24 months, this, of course, will drive, again, both top and bottom line growth. And then, of course, related to AP specifically, you know, we inherited the facility back in February. We spent the last quarter getting the fab started up. really preparing to run the existing programs, which are now being executed. And at the same time, we're beginning to expand our relationships, as I mentioned, with Rockley. One other customer we're not mentioning yet, but there's multiple others within our existing customer base that we're continuing to engage with in terms of how to leverage Florida. And then, of course, we have a strong pipeline for both ATS and tied to AP and other platforms that we have. And then we're also getting a lot of design wins from not only the traditional kind of NPW-driven, download the PDK, put your IP on our platform, and then launch those products into the market, kind of the traditional foundry model, that continues to go well. But we're also getting a lot of traction with our Google-sponsored open source initiative. We have a shuttle going through the FAB now. That will be coming out later this quarter. And then we already have the next shuttle prepared. And this is driving an expansion in our reach to a whole new set of customers that we believe ought to be a long-term driver for us.
Operator
Your next question comes from the line of Mark that passes up Jet Free. Your line is open.
Mark
Hi. Great. Thanks for taking my question. First question on the – I appreciate you're not going to give guidance for the next quarter, but, you know, I guess, Tom, when you expressed – confidence in the 25% growth for this year. I think that's going to assume second half is above the first half. So should we think about this in a linear trajectory? Is it a hockey stick, kind of more back-end loaded? Is there any color that you can give us on
Thomas Sonderman
you know the you know the uh the linearity of the of the growth that you're that you're looking at for this year yeah i'll start and then steve can add additional color now obviously you know we've uh we've projected you know with the 25 uh long-term growth model that is uh you know going to apply to this year as well i would say it's it's not linear but it's uh essentially I'm hearing some background noise. The basic way to think of it is I would just say consistent growth compared to last year, and then the ability to, you know, continue to execute on programs that are already secured. So think of it as POs already within Skywater that we're executing against. We're obviously continuing to go after new business, and we believe that there's good opportunities. The market is obviously very robust. But at this point in time, as Steve alluded to, we have a lumpy business. We're going through the transitions of ATS to wafer services. That creates a J-curve effect that we're learning how to model. We believe that 25% is a consistent number as far as
Mark
Great. And then a follow-up, if I may, and I apologize for the background noise here. You talked about qualifying, you know, making progress, qualifying the Rad Hard. You talked about, again, you talked about some new customers in Florida. Can you kind of give us a sense of when you think that revenues from those efforts start to hit your top line?
Thomas Sonderman
Yeah, great question again, Mark. The way to think of it is that, and this is the unique part with our technology as a service model, is that we will begin to initiate ATS revenue in Florida this year. That is going on as we speak. As we get into next year, those programs will grow. Eventually, they'll move out of R&D into scaled manufacturing. So think of as far as it relates to Florida, primarily ATS-driven. Next year, as we go into 2023, that will transition away for services. We also have a lot of clean room capacity that we expect to leverage jointly with our customers using our FAB light, I mean capacity light model through co-investment. The ability to get rad hard online is making, again, really good traction. We're qualifying the technology today. So everything we've done has basically been expanding the FAB, bringing in tools, getting them qualified, standing up the process. We're now working with Case and another company called Trusted Semi to create the design ecosystem. We have our first shuttle going through the fab as we speak. This has got multiple customers on it already through our early access program. As those customers begin to validate their IP on our technology. We'll begin starting next year to start getting into what I would call the design cycle as well as the qualification cycle. This is what we refer to as rad-hard testing. And then as 22 unfolds and we get into 23, you'll really begin to start seeing the rad-hard revenue ramp up. So from my perspective, all these exciting new programs that we have been working on for multiple years are beginning to come to fruition. And then I'll also mention the BioMed space. We're seeing great traction with our MEMS-based technology. to serve many different types of solutions in the biomedical market that we believe we can get not only through ATS but into wafer services within the next 12 to 18 months. So we feel very confident about everything we put in place and, of course, the backdrop of CHIPS funding, the commitment from our nation to really begin to invest in semiconductor technologies also gives us a lot of confidence, especially as we position ourselves as America's boundary.
Operator
Your next question comes from the line of Harsh Kumar of Piper Sandler. Your line is open.
Harsh Kumar
Yeah. Hey, guys. I had a handful of questions. I want to go back to, I think, the first question on the, or the question before this on the 25% growth rate. I just want to make sure that that business, the 25% organic growth rate assumes basically organic business, and you're not assuming either any government subsidy or you don't need a whole lot of new orders. In other words, should I assume that this is a business that's in the bag that's already peeled? And then as that business hits and you start to grow sort of meaningfully in the back half of this year, how should we think about gross margins progression for this year?
Thomas Sonderman
Yeah, so I'll start and then Steve can amplify on the gross margins. Yeah, so the way you outlined it is a good way to think about it. We have secured the business for the projection, you know, the 25% that we're talking about. And, of course, we're continuing to win new business. The assumption of the 25% does not include anything tied to CHIPS funding, the delay in government. Funding is for all existing programs. These are not at all tied to, again, assumptions based on new initiatives that are going through Congress. The idea of executing on the business that we booked is the focus for the growth rate we're talking about. Of course, we believe there is upside to that. But again, the timing for when these deals occur, there's a lumpiness to ATS in terms of how we monetize R&D, how the R&D programs get configured that make it a little difficult to kind of get the traditional quarter-to-quarter projections. But we believe the business is beating stronger, will continue to be a major driver in our industry for the types of technologies we're bringing to market, and, again, are very confident with the 25% number we've talked about. Steve, you can talk about the first one. Thank you.
Steve
Yeah, I can amplify really quickly. Like we talked about previously, revenue will come first, and then we can see gross margin expansion. I outlined what our near-term strategy is to expand those gross margins. Keep in mind the indicator will be the revenue growth that you would see. while also realizing, as we talked about, that we still have a drag on gross margin as we're making investments in 2021 in the RadHard technology and the advanced packaging platform that will be a drag on gross margin for 2021 until we start generating significant revenues from both of those businesses.
Harsh Kumar
Understood. And for my follow-up, Tom, maybe it's a multi-part question, but I wanted to um understand some of the services the aps work that got pushed out into 2022 i just wanted to understand your confidence level on on that business coming back maybe you could give us like to the extent that you can share some logistics around how that process will work and you know when when that business might hit and maybe some clarity around is it one customer is it multiple customers was it a technology that kind of went sour for you or got pushed out just just any color and then to a similar way on the temperature sensing wafers should i assume that the basic function still remains the same for temperature sensing and that the customer will be able to pick this up without meaningful modifications and just deploy it in some other application. So the business hasn't really gone away like you're saying, and it's relatively not any different for you to do this, but just push it out to a different application later.
Thomas Sonderman
Yeah, great question. I'll kind of go in reverse. So regarding the temperature sensor, basically what it is is a differential temperature monitoring structure that we created in partnership with our design entities. And it's a wearable device that is essentially being moved from early COVID detection to Things like chemotherapy patients looking, again, to sensitive temperature variations that could be indicative of reactions when cancer patients are basically being treated with those type of chemicals. So the idea of the wafers, they've been fabricated. They're in inventory. It will be software and packaging design that will potentially change to accommodate the new kind of trajectory for the end customers. But, yeah, there's really nothing we have to do to ultimately recognize the revenue. We just need to define a new target application, again, because of, the rapid, and it's good news for all of us, the rapid introduction of the COVID-19 vaccine. Related to the ATS program that we referenced, it was a single program. The customer was extremely pleased with our performance, was meeting and exceeding expectations and milestones. And what we wanted to do, because again, this is how technology works, is we began to look at the next phase of development We felt it was important to really go to more of a multi-year trajectory versus an annual renewal for this type of program because of the type of, you know, technology that we were developing. The customer also wanted to reconfigure it along those lines, and so we're, you know, confident that the program will start and continue. 2022 and we're literally working through the details as we speak in terms of what it will look like again the the timing is is hard to project so we're talking 2022 for the start date but I certainly I'm very confident and not only how the customer views what we're doing but the criticality of the technology and that it will continue to be an important program for Skywater
Operator
Your next question comes from the line of Chris Sankara, Cohen and Company. Your line is open.
Chris Sankara
Hi, thank you for taking my question. I have two of them. First one, Tom or Steve, I'm kind of curious on those margins. Clearly, you know, 7.2% gross margin Q2, I understand the argument you made about, you know, increasing the loading in Minnesota and then increased labor costs. It seems like some of those things like labor costs increases are probably not transitory. So I'm kind of curious, Is the path to a 40% gross margin really realistic? And what kind of timeframe are we talking about? And along the same path, what is the gross margin for the tool phase? I'm going to have a follow-up.
Steve
Yeah, hi, this is Steve. I'll take that question. Again, the timeline that we're looking at is about a five-year horizon to get to our target of 40% to 45%. Keep in mind, right, a lot of the steps to get there would be increased scale and increased growth. We are investing for the future with more personnel and more cost coming into our organization just to build out that core foundation for the growth that we expect to be coming in 2022 and beyond. In addition to those technology investments that we continue to make, in the rad hard technology and the advanced packaging technology. So we're investing in building for the future. Revenue will come first, and we believe gross margin expansion will follow.
Chris Sankara
Just, you know, the second part of our first question, Steve, what is the gross margin for tool revenues? I'm going to have a follow-up. So you said what was the tool revenues?
Steve
What is the gross margin for tools? Yeah, there is margin on the tool revenue. The revenue comes through ATS. So the reason that we talk about that is there is margin on that tool revenue. However, it's not at the similar margin that we see from the other services that we offer in ATS. So while there is margin on the tool sales, it is not at the equivalent level as other services that we offer in ATS.
Operator
And we have a follow-up question coming from the line of . Your line is open.
Raji
Thanks for the follow-up. Just on the $56 million of strategic capital investment to expand capacity at the Minnesota FAB, what is the expected payback period of that $56 million? In other words, what's the timeframe of when that capacity will kind of turn into production and into revenue?
Thomas Sonderman
Yeah, I'll start and see if you can add additional color. You know, the expectation that we're talking about is 40%, you know, increase in capacity. We will be obviously ordering tools over, you know, the near term. That's the first phase of this. And then the timeline for when it ultimately turns into increased capacity way for output is going to be obviously materialized, I would say, as we exit next year and go into 2023. The other thing to point out is that the $56 million isn't just for the capacity increase in Minnesota. A portion of that is also tied to our GAN investment, which will, again, be another technology platform We're obviously very focused on the power management space. We're bringing our silicon-based power management platform, which has got some differentiated transistor architectures to the market in the second half. And then our long-term strategy has always been to move into the GAN space because we believe that is the future of power management. And so, again, a portion of the $56 million will be tied to standing up that capability. Steve, any further comments?
Raji
Okay. Yeah, it did. It did. Thank you. And just one more, if I can, just for a point of clarification. So, the tool revenue looks like it's on track. It generated about $17.8 million of revenue for Q1 and Q2 of this year. Last year, it was $8.4 million, according to your press releases. I'm wondering how we're thinking about the tool revenue for the rest of 2021, if there's any insight there. And when we're thinking about that business over the course of time, is this a business that you are opportunistically looking at, you know, to add as a service for your large customers? Or is this something that there's a concerted strategy to say, yeah, let's try to expand that part of the business to other customers. We have expertise in kind of procuring tools, qualifying tools. Let's expand that service to other customers, although it might be lumpy, but this is something that we want to offer. I'm trying to get a sense both financially, quantitatively, the lumpiness of the tool revenue, and then kind of qualitatively how you're thinking about it strategically. Thank you.
Steve
Yeah, sure, I'll take that question. And that's why we provided additional color for what the tool revenue was for each quarter going back to 2020, which was the first year when we really started generating any sort of tool revenue. So you can see the lumpiness as we articulated. We tried to stress that, especially in the Q1 earnings call from 2021, given the significant amount of the revenue that came through. We also mentioned at that time that through the first quarter and second quarter of 2021, that is when we anticipate the majority of the tool revenue for 2021 to come through from the aspect of the business really what we do is it's co-investment and co-development with our customers that's what we stress we see this as a co-investment with our customers our customers come to skywaters especially on the ats side because they don't have a fab and we do with that comes our expertise in having the relationships with the tool vendors, knowing how to procure that tooling, install it, qualify it, and then get that up and running for R&D and then later into production. So we're always looking at opportunities to co-invest with our customers, and this is one that will remain. It will be a lumpy part of the business, but we think it's a good indication of our customers being committed to long-term programs with Skywater.
Operator
And your next question comes from the line of Mark Lepas. This is Jeff Reese. Your line is open.
Mark
Hi. Thanks for taking my follow-up. So another question on the $56 million strategic investment. So I just want to make sure I'm clear on this. So is this going to show up in your CapEx line? And what are the cash flow implications of this? So I guess my question is, is this a co-invest? Are you co-investing with customers is this part of your capex light um kind of um you know um position or is this a one-off strategic investment where you see an opportunity to to add capacity so you're going to go for it and you're bearing the the the cash flow implications of that and and and if it's the latter can you help us understand how that ramps through the cash flow statement that 56 million dollars and then when do you start depreciating that and when does that hit your your income statement? Thank you.
Steve
Yeah, Mark, good question. I'd be happy to clarify that. So this would be an investment that Skywater would be making. This would not be tool revenue like we talked about previously on the previous question. I think it still does support our CapEx light model. If you go back to the facilities and tools that we obtained earlier this year from Skywater, Florida, The Department of Defense investment that we announced quite some time ago for the RadHard technology, as well as the tool revenue and the investments being made by our customers, I think this still does support a CapEx Lite model. However, this will accelerate and build a good baseline for growth in the organization, not only for wafer services, but also for additional ATS moves and ATS customers that we believe will move to wafer services. With that investment that we will be making or plan to make, we would really see this investment taking place over the course of four to six quarters on a quarterly basis. That will be dependent on tool availability and lead time, but it will be something that we will be looking to execute on in the near term. That will be quarterly investments made over the next four to six quarters.
Mark
And when do you start depreciating those assets? Do you have to qualify before you depreciate, or does that – does that start depreciating and hitting your gross margin as soon as it hits your PP&E?
Steve
Sure. Typically that's on a tool-by-tool basis, and typically the depreciation starts once the tool has been qualified in our manufacturing facility.
Mark
So can you give us a sense of, like, roughly how long does it take to qualify a tool once it gets bolted down in the factory?
Steve
Yeah, a ballpark estimate would be six to nine months. Great.
Harsh Kumar
Thank you.
Operator
Your follow-up question coming from the line of Harsh Kumar of Piper Sampler. Your line is open.
Harsh Kumar
Yeah. Hey, guys. Tom, I was curious if you could provide us some perspective on the government subsidy angle. U.S. government seems to want to give money to semiconductor companies. I think you guys are in a very good position to get it. I'm curious, when you have your conversations, What kind of commitments do you have to make in return? Is it tied to a number of jobs, certain number of jobs in a state, or what is involved in terms of getting some of that money, and how are you suited for that?
Thomas Sonderman
Yeah, again, another great question. Obviously, you know, Skywater is very involved with these conversations, not only with the White House directly, but with the Department of Congress, obviously Department of Defense. The Department of Commerce will be the one kind of facilitating the deployment of those dollars if Congress approves the CHIPS Act. So what we anticipate is there's going to be two angles for Skywater. One is it ties to not only the CHIPS Act but also the Endless Frontiers initiative. There will be R&D dollars flowing into various entities, R&D facilities that are creating new technologies. A lot of the focus isn't, you know, just replicating capabilities that are traditional kind of Moore's Law, you know, platforms, but really looking at differentiation, which is what Skywater is all about, you know, new emerging technologies. like carbon nanotubes, superconducting, et cetera. So we expect to be able to leverage R&D investment. We become the corridor as technologies leave incubation and come into technology validation, demonstration, and ultimately commercialization. The other piece will be adding capabilities. So one of the things that we're pushing is that to solve some of the immediate crisis with high chip demand, it's basically adding equipment to existing facilities. That's one of the things we're doing here in Minnesota. Automotive qualifications take multiple years. So the best way to really resolve some of this is by adding capacity. We're, of course, getting ahead of the game to enable that. But we expect there will be continued joint investment opportunities with the state governments as well as with the federal governments, which is why we're very focused on engaging states. as I mentioned in my remarks, with Minnesota, Florida, and Indiana. Indiana, of course, is where Navy Crane is. This is tied to our Rad Hard program. And we expect that combination of state and federal, plus Skywater's commitment to, as you alluded to, create jobs, create capability, and more important, create a corridor so that the IP that is invested in by Americans can stay in the United States. That is a unique capability that Skywater brings. We're a pure play contract manufacturer foundry, and we believe that we are in a very unique position to not only leverage the R&D dollars, but then ultimately the dollars associated with that in scale.
Harsh Kumar
Thank you, Don.
Operator
And your last question coming from the line of Chris Sunkar of Cohen & Company. Your line is open.
Chris Sankara
Thanks for taking my follow-up. Tom, just want to quickly touch base. You know, you said the 56 million cap tax, the vast majority is going to existing silicon infrastructure. How much is going for GAN and what time frame are you talking about? And it seems like that could translate into just a few hundred basis costs for GAN. Is that the right way to think about it?
Thomas Sonderman
yeah so i'll start and steve you can add a color the we're not breaking out how much is going for the capacity expansion versus gan but the the gan focus is really again to position skywater to be the the right option to for 200 millimeter GAN here in the United States. Everything on GAN today is at six inch. Certainly within products that are tied to the power market, which is our initial focus, but we see great opportunities with GAN and RF and other application sensors, et cetera. So our goal is to accelerate the adoption of GAN technology. It's always been part of our strategy uh to get into the power management market uh we believe differentiation will occur again as i alluded to with our silicon platform uh coming out later this year and then we're going to begin to do development on our gam-based technology it is clearly the future of power management in my opinion and i believe that you know the 100X switching speed improvement, the 40% more efficient power consumption are the attributes that will really drive this adoption. And, again, as I've mentioned, the White House specifically called out the need for a 200-millimeter GAN fab in the United States, and we certainly expect to take advantage of that. So we're accelerating our push into GAN, and that's why we're investing in it today.
Steve
Yeah, I would just highlight on that as we look to make investments in our facility, oftentimes we look at where bottlenecks occur in our typical process flows. A lot of our flows can be used for a lot of the services that we offer, both in-wait for services and ATFs. So with this investment, we can break through some of the bottlenecks that we would forecast with the growth that we expect. So it's very exciting to see this investment into our facility. On top of that, with the GAN investment, keep in mind with our business model that typically what's going to take place with the GAN, that revenue would come through from an ETS perspective first and then go into wait for services at a later point in time. So as we typically do with most of our technologies and platforms, we look at capabilities first, and that's what we're investing for, the GAN capability in the near term.
Chris Sankara
Thanks, Tom. Thanks, Stephen.
Operator
And we have reached the end of our Q&A session. I would like to turn it back to our CEO, Tom Sunderman, for the closing remarks.
Thomas Sonderman
I couldn't be more excited about Skywater's future as we continue to win new business, aggressively ramp our fab, secure key supply agreements, and bring new capabilities like RadHard and advanced packaging to market. I thank you for listening to our call today and look forward to talking to all of you again in the future.
Operator
Ladies and gentlemen, thank you for participating in today's conference.
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