AEHR reported a 20% cut at the midpoint to full year revenue guidance from $100M to $75M to $85M, — a near-perfect mirror of ON Semi’s 20% cut in its SiC revenue forecast from $1B to $800M.

We thought the impact could have been $16M given ON is 80% of AEHR’s revenue. Interesting enough, AEHR stated in the call the miss not from ON but rather from “other customer forecasts.”

We were cautiously optimistic that ON would not become a readthrough for AEHR, yet what has materialized is that the EV market is weaker than expected, and ON is one of many that will either report this or already has reported this. Therefore, it is irrelevant if ON created the miss as weakness in the EV market resulted in a similar miss.

This was the part in the Q&A where it was distinguished the miss did not only come from ON Semi or even primarily from ON Semi:

“Jed Dorsheimer

[…]it sounds like there was a material change in the last 30 days in terms of demand and visibility to your business. Is that correct? And I just asked that because your largest customer did flag something last quarter, but I want to separate what happened in the past versus what's occurred in the last 30 days. Thanks.

Gayn Erickson

All right. Well, one thing I'm going to start giving people heads up on is, I'm trying to be more thoughtful about giving insight into our customers, to be fair. But I'm going to specifically answer what I think you're implying. Right after our largest customer talked about their change in their forecast, we not only did not hear a negative impact to us, candidly, it flipped around and for a period of time, it was actually an uptick, right, which was a little hard to imagine and explain, but had to do with the wafer pack and the shift to new customers and some other things.

Literally in the last seven days, they have reconciled their plans, etcetera. And we've tried to thoughtfully reflect that in the latest one. But again, I actually said in my prepared remarks, their revenue to us is pretty close to what we were expecting when this all came out. So if you want to say the bulk of the $15 million to $25 million decrease was not from them, that was actually from other customer forecasts that have changed over the last, like three to four weeks candidly.”

This matched what was said in the press release:

“In the last sixty days, we have seen how the slowing of the growth rate of the electric vehicle market has had a negative impact on the timing of several current and new customer orders and capacity increases for silicon carbide devices used in them. […] The net of this is that we now expect a delay in the timing of new orders from current and new customers that will most likely impact this fiscal year’s revenue.”

In addition, Aehr says it believes it has a “large opportunity” with one of the market leaders in SiC, and while Aehr feels “confident they will move forward with our FOX-XP multi-wafer solution for their high-volume needs, [the] timing is taking longer than anticipated. We remain confident that we will receive initial purchase orders from them in fiscal 2024; however, it is not clear whether they will have the infrastructure ready to take shipments from us within our fiscal year that ends on May 31st.”

Revenue & EPS:

Revenue growth remained strong in Q2 as margins improved, though backlog and bookings decreased significantly QoQ. AEHR is lumpy with management announcing new orders intra-quarter, so we’ve seen these lows before on backlog and bookings, but it’s not exactly ideal.

• Revenue increased 44.6% YoY to $21.43M, beating estimates by 2.6%
• GAAP EPS of $0.20 increased 53.8% YoY
• Non-GAAP EPS of $0.23 increased 43.8% YoY, beating estimates of $0.19 by 21.1%

Given the fiscal year guide was lowered by $20M at the midpoint, analyst revisions will likely look like this:

• Q1 FY2024: $20.62M reported
• Q2 FY2024: $21.43M reported
• Q3 FY2024: $15M to 16M down from $20.89M consensus
• Q4 FY2024: $22M to $23M down from $26.91M consensus

I’m taking this from a comment in the call that 40% of what’s left will be in Q3 and 60% will be in Q4. Per the CEO: “Q4 will certainly be bigger than Q3. Maybe but not majority, maybe at 60, 40 spreads or something like that.”

Margins:

• Gross margin of 51.1% increased ~270 bp QoQ, but decreased ~230 bp YoY. Per the CFO, this was due to a high inventory reserve, up 24% from last year. This is a concern, should inventory continue to increase, it can weigh on pricing.
• Operating margin of 25.5% increased ~550 bp QoQ and ~200 bp YoY. The QoQ increase in operating margin was primarily driven by a (19.7%) reduction in R&D expenditures relative to Q1.
• Net margin of 28.4% increased ~570 bp QoQ and ~330 bp YoY, reaching the highest level since 28.6% in fiscal Q4 2022.

Cash & Debt:

• Cash and equivalents of $50.5M, a marginal (1%) QoQ decline from $51M in Q1.
• Debt remained at zero.
• Operating cash flow is implied to be ($0.54M) in Q2, with Aehr reporting $3.9M in operating cash flow in Q1 and $3.36M in operating cash flow in the first six months.

Key Metrics:

Bookings were $2.2M in Q2, a QoQ decline of (88%). This represented the lowest quarterly bookings in more than eight quarters.

Backlog was $3.0M in Q2, a QoQ decline of (86%) and YoY decline of (81%). This represents the lowest backlog in more than eight quarters.

Earnings Call:

ON Semi Won’t Be the Top Customer Next Year:

The boldest comment on the call was not regarding the miss, but rather regarding the fact their number one customer will not likely be their number one customer in FY2025. This either means AEHR sees EVs being so weak that ON will reduce its SiC forecast again, or that other industries will step up and place new orders that exceed ON’s roughly $80M. It’s likely a mix of both scenarios. Here is what was said:

“Christian Schwab: 

[…] So given their public comments, I guess, let's start with that, how would you anticipate that customer materiality in fiscal year 2025?”

“Gayn Erickson: 

I mean, we — I believe that they will still be material. I don't know that they will be the dominant customer [Technical Difficulty] they'd be or they not be. My guess is, they will not even be the largest, as some of the other customers are kicking in with their ramps. One thing we've tried to look at is, how fast is the market growing itself. I mean, silicon carbide is growing, let's say 40% a year topline revenue. Can we grow faster than that? I think there is examples where we can, but I think it would be more realistic to think that we grow alongside the market itself. But as we displace potential package part burn-in, et cetera, there is opportunities […] But we do think that they will still be a significant customer for us next year. We believe that they — and are consistent with what they have been telling people their growth plans are. But we think that there'll be other customers, most likely there'll be bigger than them next year.”

My translation: I would rather wait to see what this transition looks like than speculate on how it will play out when ON Semi is no longer the top customer. I believe ON Semi will have to come down in revenue from where we currently are otherwise next year’s fiscal year would be higher as a customer that rivals ON’s current revenue contribution would have a larger impact. It comes down to the backlog being very slim and also bookings. We track key metrics for a reason, and it’s not prudent to ignore them.

Auto Inventory Levels:

Auto inventory levels for December are high. In the United States, the total supply of unsold new vehicles was up 57% from the same time a year ago. Inventory is 17 days higher than it was a year ago.

According to SP Global, Ford has cut its EV production for F-150 Lightening in half and Chevrolet EV inventory is up 19% QoQ.

SP Global is also reporting that dealer inventory across all vehicles is up 60% year-over-year to 2.3 million units.

Conclusion:

The main negative for Aehr’s fiscal Q2 stems from the reduced FY revenue outlook, marking a significant reset in growth expectation from the high 50% range to the high teens to 30% range. This was certainly a negative surprise but what’s most concerning is the low bookings and backlog as we don’t have any history of owning AEHR with key metrics that are not supporting the $38 million in orders the company has to procure by the end of the fiscal year in May. AEHR is capable of getting orders in quickly but we prefer to see evidence.

Margin improvement was a positive, with gross margins recovering above the 50% range, while reduced R&D expenses aided leverage down the line. There is no argument that AEHR has an extraordinary ability to operate efficiently for its size, and this is one of the reasons we monitor the company closely.

It’s likely we close the position and reopen again in six months. Today, AEHR is a silicon carbide story relying squarely on the EV market. Unfortunately, with what we know today, the EV market suppliers are weaker than expected, and AEHR commentary is hinting it could continue.

We prefer to wait for evidence of a recovery rather than speculate on when this will happen. We will monitor AEHR closely for when the company secures orders from other large customers and industries. In other words, we will wait for a breakout, which is most likely to happen in the early part of AEHR’s next fiscal year.

Ultimately, we want to focus on putting stronger horses in the stable over the next six months. We suspect AEHR will break the $18 level Knox outlined and we will respect this stop and revisit later.

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Silicon Carbide is powering a revolution in electric vehicles and AEHR is at the forefront. The company is a beneficiary of the switch from Silicon-insulated gate bipolar transistor (Si-IGBT) to wide-bandgap Silicon Carbide MOSFETs for electric vehicles components. The result in switching to Silicon Carbide (SiC) is that charging is quicker and the range of miles for electric vehicles increases with SiC. 

AEHR has seen a ramp in demand over the past three years because silicon carbide is replacing silicon in electric vehicles. Tesla was the first to adopt silicon carbide for the 2018 Model 3 by working with ST Microelectronics to add SiC MOSFETs to an inverter design. The result was a more compact, lighter inverter at 4.8Kg compared to Si IGBT inverters that weigh 2-3X more (8kg to 12kg). SiC inverters offer 97% efficiency, resulting in more range, and this is achieved without the need to increase battery capacity.

During Q1 earnings, management reiterated the FY 2024 guidance of at least $100 million, representing over 50% year-over-year growth.

Since that earnings report, AEHR’s largest customer, ON Semi, provided a guide on SiC for 2023 that is 20% lower than the original guidance. As a reminder, ON is about 80% of AEHR’s revenue, and we’ve pointed out in nearly every write-up on the stock that customer concentration is the primary risk. Quick math indicates that if ON misses by 20% on SiC, then AEHR would miss by about $16M if we figure $80M of AEHR’s revenue is from ON Semi.

The risk that is involved with such high customer concentration is what the market is reacting to, but ON Semi’s call was not as bad as it sounds.

Here is what ON’s management team stated:

“We are taking a very cautious approach as we are starting to see pockets of softness with Tier 1 customers in Europe working through their inventory and increasing risk to automotive demand due to high interest rates.”

And later stated, “[…] for the full year, a single automotive OEM's recent reduction in demand will impact our $1 billion target, and we now expect to ship more than $800 million of silicon carbide in 2023, 4x last year's revenue. In '24, we expect the growth of our silicon carbide business to double the market growth.”

Management stated they plan to “double the market growth” in 2024, and more details were discussed further in the call:

Gary Mobley 

Hassane, I want to pin you down on your market forecast for silicon carbide for next year to really get an insight into what your expectations are. I know you cited in your footnotes of your presentation today, a lot of Yole forecast, and Yole is forecasting roughly 43% growth in silicon carbide for next year. So are you expecting to grow your silicon carbide revenue 80% next year? Is that the proper read here? 

Hassane El-Khoury

Well, it depends on what the Yole is. But yes, we are expecting a 2x market.

The CEO stated this again during the call:

“Hassane El-Khoury

Yes. Silicon carbide is — what we are looking at is silicon carbide in '24, basically growing about 2x the market. So it's still on track to the target that we've put out in Analyst Day of growing 2x the market, that we still have that visibility in '24.”

From this point forward, the conversations were positive, including SiC having a high utilization rate that is higher than ON’s corporate average, and that SiC will remain supply constrained in 2024, which is a positive read through for a company like AEHR that supplies ON Semi with wafers and wafer equipment.

Here is what was said about the utilization rate for SiC versus silicon:

“Quinn Bolton:

Got it. And then on the silicon carbide business, you talked about overall utilization rates being managed down to 68% for the next few quarters to manage inventory. I assume, given the outlook for EVs still growing in the fourth quarter into next year, that the silicon carbide is probably immune from some of those lower utilization rates, but wanted to clarify that? And if utilization remains high in silicon carbide, could you actually see a scenario where silicon carbide moves above corporate average in 2024? 

Thad Trent:

Yes, that's a good question. So the utilization for silicon carbide in Q3 was up, where silicon was down, and that pulled the total up. As we look forward, we don't see the silicon carbide utilization decreasing. We will be bringing on additional capacity next year to support '25 and beyond. But I don't expect that utilization to decline. I think it's the silicon that will actually decline, that gets us down into that 65% to — mid-60% to high-60% range.”

What the Market Wants to See Tomorrow

Given that ON Semi forecast a fairly weak Q4 for SiC with the $200 million miss, the market will want to see AEHR maintain its fiscal year guide. The selloff is anticipating that ON’s miss will flow through to AEHR in the upcoming report. That’s the roughly $16 million mentioned above. 

ON Semiconductor’s Q4 guide missed analysts' expectations by 9%, but to reiterate SiC missed by 20%. This miss puts increased pressure on AEHR’s management to deliver a confident outlook for the remainder of the year.

Below, is an interesting comment from ON’s management team during the earnings call, which if I’m interpreting it correctly, would indicate that the miss on SiC may not affect ON’s strategic plans to build wafer inventory. If so, AEHR has a chance of being unscathed (I’m being ever the optimist here, but there is some indication this could play out, per the comment below):

“Hassane El-Khoury

Sure. So it is all — I guess all of our '24 by now. For the '24, we have visibility on exactly what program, what voltage, what volume and what mix we need. As far as the inventory, Thad talks about ramping strategic inventory for silicon carbide, we stage inventory primarily in, I would say, in two spots. One is blank wafers or substrate, wafer substrate, which is fully fungible across any customer, any platform with any volume. And as we get closer, we stage inventory at Epi, which is when we, I guess, partitioned with the voltage levels of the product. 

So this is where we maintain inventory to give us full flexibility should the shift change. Because we've always said, when we would have one or two platforms at a customer, if one vehicle sells better than the other, the customer would want to shift while still using onsemi. So we give that flexibility to be able to shift on between platforms at a similar OEM or between OEMs. So the best place to keep that inventory is blank wafers and/or Epi.”

Ideally, we hear updates on new customers. On Semiconductor constituted 79% of FY 2023 revenue, down from 82% of FY2022. Management said in the last earnings call that the last two new customers did not need their wafers tested on the company’s system before moving forward compared to the requirement for the early customers.

Bookings will be closely watched as last quarter was weak (more below). Backlog growth is also lumpy but will be looked at closely.

Revenue and EPS

The company’s Q1 FY2024 revenue grew by 93% YoY to $20.6 million and beat consensus by 7.1%. Management went out of their way to remind investors that this is the strongest first quarter they’ve ever reported and that first quarter is typically seasonally weak. They also highlighted the record shipments of FOX WaferPak Contactors, a key component for testing wafers and also provides recurring revenue for the company.

Gayn Erickson said in the earnings call, “As we've noted before, our proprietary WaferPak Contactors are needed with our FOX wafer level test and burn-in systems to contact with the individual die on the wafer and are designed specifically for a given device. As our customers win new designs from their customers, Aehr eventually secures orders for new WaferPaks to fulfill these new wins. With each new design, our customers will need enough new WaferPaks to meet the volume production capacity need for those new devices.”As our customers win new designs from their customers, Aehr eventually secures orders for new WaferPaks to fulfill these new wins. With each new design, our customers will need enough new WaferPaks to meet the volume production capacity need for those new devices.”

The company is expected to report $20.89 million in the November quarter, representing YoY growth of 41%.

Q1 GAAP EPS was $0.16 and is up from $0.02 in the year ago quarter. Adjusted EPS grew by 260% YoY to $0.18 and beat consensus by 12.5%. Overall, earnings are expected to nearly double in FY2024, per management guidance of “GAAP net income of at least $28 million, representing earnings growth of greater than 90% year over year.”

Margins

Q1 FY2024 gross margin came at 48.4% compared to 42% in the same period last year and 51.5% in the previous quarter. The higher revenue percentage of WaferPaks helped to improve the margins, and on the other hand, the WaferPak automatic aligners that are built externally led to a decrease in the margins. When an analyst asked the CFO in the earnings call if the gross margin would return to 50%, he affirmed this by saying, “So we're still targeting 50% above the margin for the year, and that's what we're looking at.”

The operating margin was 20% compared to 4.3% in the same period last year and 25.3% in the previous quarter. The operating margin was also softer than the previous quarters as operating expenses increased 45.8% YoY to $5.9 million due to “increased headcount-related expenses to support our worldwide sales and marketing efforts and our R&D programs.”

Net income grew by 694% YoY to $4.7 million (due to small numbers). The net margin was 22.7% compared to 5.5% in the same period last year and 27.4% in the previous quarter.

Cash Flow and Balance Sheet

The operating cash flow was $3.9 million, down (28.6%) year-over-year. Cash flows have been lumpy in the past. The free cash flow was $3.6 million compared to $5.4 million in the same period last year. Cash and investments on the balance sheet were $51 million, up from $36.2 million in the year ago quarter and up 6.5% sequentially, with no debt.

Key Metrics

Q1 Inventory is higher than usual at $31.56 million, up $7.6 million QoQ. The management has stated their plan is to increase inventory to meet upcoming demand.

Bookings in Q1 were $18.4 million and declined (-3.7%) year-over-year. Bookings were up from $15.2 million the previous quarter. These are lumpy but can cause the stock to move quite a bit during a good quarter.

Q1 backlog of $22.3 million was up 14.4% year-over-year yet was down sequentially. The effective backlog of $24 million could have been better, given management had stated they received $15 million in effective backlog for Q1 during the Q4 earnings call in July.

Conclusion

Per Knox’s most recent 25-page Positions Report: AEHR’s technical pattern has always been a mess. If its earnings report is accepted by the markets, we should hold $20.45 and turn higher. If this happens, then the drop we just went through from its high was only a 3 wave pattern, and supports us pushing to new highs in a final swing higher. This is the green count in the chart, and once we break above $39, the odds will favor this scenario.

However, if we drop below $20.45, then we have a clean 5 waves down from the high, which will be concerning. If what follows is a 3 wave bounce, then we will be setting up for a bigger drop. If this happens, we will likely look to de-risk our Aehr position.

Technical Analysis by Portfolio Manager Knox Ridley, who holds a 1-hour webinar on Thursdays for Advanced Members.

Product Thesis:

AEHR: The Silicon Carbide Revolution – read this for our investment thesis

Original Analysis in 2021:

Deep Dive on AEHR – more information on our investment thesis

Our Last Earnings Write-Up can be found here:

Fiscal Q1 More Orders Likely