Aehr Test Systems is a small cap semiconductor company that is nearing an inflection point. The company has developed a unique technology that provides tangible benefits for testing emerging semiconductor components, such as silicon carbide and silicon photonics. Silicon carbide is increasingly being used in EVs while silicon photonics is being integrated into edge computing data centers. I explain the tailwinds driving adoption of these materials in greater detail below.
Aehr’s key markets: Silicon Carbide and Silicon Photonics
Aehr’s wafer level burn-in testing systems are specifically built for testing silicon carbide and silicon photonics. Silicon carbide has recently been adopted by the automotive industry, which is driving demand for Aehr’s testing systems. Aehr disclosed in its 10K that “silicon carbide (SiC) semiconductors have emerged as the preferred technology for battery electric vehicle power conversion in on-board and off-board electric vehicle battery chargers, and the electric power conversion and control of the electric engines.
These devices reduce power loss by as much as greater than 75% over power silicon alternatives like IGBT (Insulated-Gate Bipolar Transistor) devices, which has essentially changed the entire market dynamic. With this development, the Company sees most, if not every automotive company that is working on electric vehicles, moving to silicon carbide-based powertrain and charging systems in the near future.”
Tesla was the first to start using SiC in its vehicles with its Model 3, and more EV manufacturers are quickly following suit, due to SiC’s ability to withstand hostile conditions, improve efficiencies and lower failure rates. CEO Gayne Erickson explained on the Q1 call that while the SiC market had been around for years, “it really started to take off when Tesla introduced their Model 3 with a silicon carbide traction inverter in it, and then quickly shifted all of their products to it.” The adoption by Tesla was a ‘jolt’ that has spurred further adoption by others. For example, German chipmaker Infineon Technologies launched an SiC inverter for electric vehicles in May 2021. According to Yole Research, “the silicon carbide power semiconductor device market is expected to increase over 500% between 2020 and 2026, growing at a compound average growth rate (“CAGR”) of 36% to $4.5 billion”.
All of these silicon carbide chips need to be tested, and Aehr’s wafer level burn-in testing systems are the most cost-effective way to test these chips at scale.
Source: Asia Nikkei
On top of the robust growth expected in the automotive SiC market, the company also has favorable tailwinds from the rise of silicon photonics, which is also starting to ramp. In its 10K, Aehr disclosed that its lead silicon photonics customer had moved to full volume production during 2021. It added that “we also saw three different silicon photonics customers move from engineering testing to high volume production test and burn-in of their devices using our FOX-P systems. We expect all three of these customers to ramp production during fiscal 2021”. Aehr’s customers must first perform lengthy qualification tests before ramping up orders. Aehr’s silicon photonic customers are nearly done qualifying and are finally expected to start putting in large orders this year.
During the Q1 call, CEO Erickson explained how we are still in the early days of silicon photonics. He stated that “companies like Intel and Nvidia are talking about integrating fiber optic transceivers into their core and graphics processor units or CPUs and GPUs. This is very exciting and we believe an enormous opportunity for Aehr Test with our unique position of having a cost effective and proven multi wafer solution for testing and burning-in or stabilizing silicon photonics devices at a massive scale while still in the wafer form”.
Silicon photonics are being used to increase communication speeds, which is critical for edge computing as it links 30-megawatt data centers within a 120 km distance to function like a 120-megawatt data center. This enables 100G Ethernet services for cloud operators and enterprises. Microsoft and telecom operators are both customers of Inphi’s silicon photonics. Beth had previously discussed this micro trend in her in-depth analysis of Inphi. She explained that the 100G switches were launched in 2020 but were more of a 2021 story as this is when they will be deployed in volume. Importantly, these 100G switches use silicon photonics.
We see this trend starting to ramp, as Inphi accounted for 10% of Aehr’s sales in 2021, the first time it was mentioned as a significant customer. As Inphi’s thesis plays out, Aehr will also benefit from the increased demand for its silicon photonic testing systems.
As shown below, Yole Research anticipates silicon photonics to rapidly grow at a CAGR of 49% through 2026. The market is relatively small right now, as customers complete lengthy qualification tests, but once the test systems are qualified, bookings of Aehr test systems will likely significantly ramp as silicon photonics gains market share. I discuss how Aehr’s order have started to ramp in 2021 in greater detail next.
Source: Yole Research
Orders begin to ramp in 2021
Aehr’s testing technology, branded as FOX-XP test systems, was first introduced in 2016, and the company had initially sold only small orders of its testing systems (~$2 million to $5 million a quarter) as customers qualified the equipment before placing large orders.
During the fiscal Q4 Earnings Call in July 2021, CEO Erickson announced that the company’s lead silicon carbide customer had finally qualified Aehr’s FOX-XP test systems for “high-volume production” for wafer level burn-in testing for electric vehicles. This was a significant development, as it meant that orders for its test systems may soon start to accelerate.
Just five days after the Q4 earnings call, Aehr announced that it had received an $11 million order for its silicon carbide test systems with a “leading Fortune 500 supplier of semiconductor devices with a significant customer base in the automotive semiconductor market.” To put this order into perspective, it represented more than half of the company’s total orders in all of FY2020 ($16 million). In fact, since the close of Q4, the company has announced a total of $40 million orders to date (June through September), which is more than the aggregate bookings amount over the prior nine quarters.
The company’s strong orders led to an 80% increase in the company’s fiscal 2022 sales guidance, which Aehr now expects to be at least $50 million, or 3x the amount in fiscal 2021. Furthermore, attached to Aehr’s test system sales are high margin WaferPak and DiePak consumables, which are purchased multiple times over the life of a FOX testing system. Over time, management expects that sales of its consumables to be 4x the level of sales of its test systems.
This strategy of selling test systems and recurring consumables is similar to an ink and printer sales model, where the sale of the product leads to recurring sales of higher margin consumables. Aehr explained in its 10K that “as we continue to build our installed base of FOX systems, our WaferPak and DiePak [consumables] business continues to grow and is becoming a much more significant part of our business … our high margin proprietary WaferPak contactors and DiePak carrier consumables … can be up to four times the annual sales of systems. The systems typically are used for longer periods, with annual needs for new contactors and consumables. This is why we are confident that our consumable business is likely to exceed our overall systems business over time, even though both will grow in absolute dollars.”
To highlight the upside to the recent growth in orders, management explained on the Q1 Earnings Call that the $19 million order it recently received in September will likely be accompanied by a separate ~$10 million order for consumables, pushing the true order size up closer to $30 million. Importantly, these consumable purchases will also be recurring over the lifetime of the test systems, so the “lifetime bookings” value of this $19 million system sale may be closer to $60 million once consumables are considered
Continuing with this logic, Aehr’s $40 million in bookings YTD may be understated. Using Aehr’s disclosure from its 10K that recurring consumable purchases can be ~4x system purchases, then the $40m in YTD systems orders can result in a high-margin recurring sales stream of ~$160 million in consumable orders. Stated differently, the firm’s $40 million in test system bookings should also yield an additional $160 million in consumable purchases over the life of the systems, resulting in “lifetime bookings” of ~$200 million.
Importantly, orders are expected to continue to ramp going forward. CEO Erickson stated during the Q1 Earnings Call that “we believe we will add several new silicon carbide customers over the next 18 months that will ramp into production on our solutions.” He explained further that its leading silicon carbide customer is the “fourth largest in the space and not even half as large as the next largest”, meaning that new customer orders could be much larger. If Aehr’s test systems provide a competitive advantage (discussed below) then new customers will likely soon place large orders, further bolstering Aehr’s growth rate. I discuss what is driving the adoption of Aehr’s test systems in more detail next.
What is driving the adoption of Aehr’s test systems?
Aehr has a unique technology that is just now starting to ramp called FOX-XP test systems, which are used for wafer level burn-in testing of silicon carbide and silicon photonics. The main advantage of wafer level burn-in testing is that it reduces “infant mortalities”, or early failures in semiconductor equipment. Burn-in testing attempts to lower the failure rates from stage 1 of the “bathtub curve” (shown below), which increases the reliability of semiconductors.
Wafer level burn-in testing reduces chip failure, which is critical in certain industries such as EVs, 5G and datacenters. For example, if a chip fails in an EV’s drive train, then the passenger is walking home. The high costs of chip failures in EVs is driving the industry to push to zero failures and wafer level burn-in testing helps to achieve this.
“Bath Tub Curve” Representation of Chip Failures
CEO Erickson explained further on the Q1 call that he anticipates “that wafer level test and burn-in will become the industry standard for quality and reliability screening of silicon carbide devices”. He added that Aehr’s patented technology allows “customers to screen devices that would otherwise fail after they are packaged into multi die modules, where the yield impact is 10 times or even a 100 times as costly. With the most cost effective solution in the market to address this opportunity, we believe that Aehr has the chance to achieve a significant, perhaps dominant market share for silicon carbide wafer level burn-in.”
Assuming a yield impact of 10x to 100x, then early adopters of Aehr’s technology will gain a significant advantage over their peers. CEO Erickson added that customers with wafer level burn-in technology are “differentiating themselves against their competitors because they … [are] shipping a higher quality module … So other customers have figured this out, but they're still doing package per burn-in. So the discussions we're having with them in many cases is to move from package to wafer.” The 10x to 100x yield benefit awarded to early adopters can lead to a rapid acceleration in orders of Aehr’s test systems, since competitors will need to also adopt the new technology or risk falling behind. This dynamic rapidly moves Aehr up the “S-Curve” as customers rush to adopt the new technology and orders rapidly increase.
The qualification of the lead customer in July 2021 may have been the beginning of Aehr’s growth story (pictured below). While bookings are relatively low right now at ‘just’ $40 million, the company may be entering a period of growth, which is why the I/O Fund has taken a position. I discuss Aehr’s most recent financial performance and forward growth projections in greater detail next.
Aehr’s Potential S-curve Growth Rate
Aehr’s financials and valuation
As mentioned above, Aehr reported a surge in bookings, as fiscal year YTD bookings (June through September) have grown to $40 million, or more than the prior nine quarters combined. These bookings are expected to convert into sales this year, which led management to raise its FY2022 sales guide to at least $50 million.
In the most recent Q1 quarter, sales increased 181% YOY to $6 million, while gross margin came in at 40%. Operating expenses are largely fixed, and operating income was a slight loss of $1 million during the quarter, while EPS was a loss of -$0.02, which beat by a penny.
Aehr has a history of losses, which makes sense as customers have been placing small orders for the company’s test systems as they qualify the equipment for high-volume use. With customers starting to ramp orders, the company has forecasted that it will be profitable going forward.
Specifically, CEO Erickson stated that the company breaks-even at around $28 million in annual sales, and for every dollar in sales above $28 million, it expects ~50% of that to flow down to earnings. Simply put, the $50 million guide for FY2022 sales should lead to ~$11 million in earnings. Moreover, since Aehr has a history of operating losses, the company has significant net operating loss (NOLs) carry forwards, which lowers the amount of taxes that the company must pay.
Taking this math a step further, the $11 million in earnings will equal about ~$0.43 in after-tax earnings per share (EPS). At ~$13/share, Aehr is valued at 29x forward earnings and 6x forward sales, which seems reasonable for a company expected to grow 200%+ this year. As discussed above, the company has numerous tailwinds as the SiC and silicon photonics markets rapidly grow at a 36% and 49% CAGR through 2026, respectively.
Above is a table of comparable semi-conductor equipment providers that are expected to grow at similar rates to Aehr. Relative to the above comparable companies, Aehr trades at a premium valuation based on forward sales and earnings. However, Aehr has exposure to markets that are expected to rapidly grow going forward (silicon carbide and silicon photonics) which supports a premium valuation. Aehr is also expected to grow faster than the peer median.
Below is a table of peers that Aehr competes against. Aehr is competing against some very large companies, however, Aehr is well positioned to benefit from the above-mentioned tailwinds. If Aehr can capture a dominate position in these rapidly growing markets, its market cap may close in on some of its peers. For reference, just six years ago in 2015, Teradyne’s market cap was much smaller at ~$4 billion, highlighting how semi-conductor testing equipment providers can grow into large companies in a relatively short period of time. It is also noteworthy that Aehr’s CTO used to work at Teradyne.
What sets Aehr apart from the competition is that its wafer level burn-in testing equipment can scale better than competing products. CEO Erickson explained that Aehr’s systems are “architecturally different and unique” as the systems test 18 wafers at a time, while competing products test one to eight wafers at a time. This is significant as each test system has the footprint of a Toyota Prius, so customers who are scaling and need to test 500+ wafers a day will need 500 Prius’ of footprint in a wafer fab, which is expensive and difficult to accomplish.
CEO Erickson explained further that “we've made an enormous investment in this platform over the last decade, and particularly with the last handful of years. We have IP and patents protecting that capability, both in the tester and the proprietary contactor that enables it and we intend to defend it.” To give you a better sense of how long Aehr has been developing its unique, proprietary technology, the company received funding from DARPA back in 2001 to develop wafer level burn-in testing, and its first product wasn’t introduced until 2016.
While Aehr trades at a premium to some of its peers, the company’s technology has the potential to be a homerun if it can quickly scale with customers and provide the promised cost savings. If early adopters realize strong cost savings and higher quality products, then this will likely lead to more customers rapidly adopting Aehr’s technology. Furthermore, if Aehr can continue to capture market share in the rapidly expanding silicon carbide and silicon photonic markets, then its market cap will likely grow and mimic some of its other semi-conductor testing peers.
Risks and conclusion
A key risk going forward is supply chain risk, which isn’t unique to Aehr, but nonetheless may impact Aehr’s ability to convert the recent ramp in bookings into sales. The company has $10 million in inventory on its books, which helps get the ball rolling but is well below the $40 million in orders it has received in the past few months. The firm also has just $6.5 million of cash on its balance sheet, which helps explain why Aehr recently announced a $25 million share offering to raise more cash.
CEO Erickson explained on the Q1 Call that customers were happy to see the cash raise as it added conviction that Aehr will be able to have the necessary working capital to support its rapid growth in bookings. However, the capital raise will weigh on Aehr’s stock price in the near term.
In regards to the supply chain concerns, CEO Erickson stated that “Aehr has the manufacturing infrastructure and supply chain in place to ramp to significantly higher revenue levels. We have been ordering long lead components for systems and WaferPak, particularly for the enormous opportunity we see for silicon carbide that is gaining momentum, and we have been able to maintain reasonably lead times to meet customer requests.” The company likely has enough capacity to honor the orders that have come in thus far, and it also has the vendor relationships in place to support a further increase in customer orders going forward.
Looking forward, the company has two strong tailwinds propelling it: silicon carbide and silicon photonics. The recent qualification of Aehr’s lead silicon carbide customer may have been the tipping point that drives rapid adoption of its technology, as early adopters can gain a significant cost saving advantage.
Silicon carbide is quickly becoming the material of choice for EVs, which itself are expected to rapidly grow going forward. Furthermore, silicon photonics is also in the early stages of ramping and has exposure to strong microtrends such as datacenters, 5G and edge computing. Taken together, these two markets should help support sales of Aehr’s test systems, which in turn will lead to recurring sales of Aehr’s high-margin consumables. The company’s stock has increased following strong results, but its valuation is not overstretched. In fact, given the firm’s strong growth rate and forecasted profitability, it appears cheap relative to peers. It is also noteworthy that forward growth estimates do not fully encapsulate sales of consumables, meaning that the company’s true sales multiple is cheaper than reported.
Disclosure: Bradley Cipriano and the I/O Fund own shares in Aehr Test Systems and do not have plans to change their respective positions within the next 72 hours. You can access the I/O Fund’s positions herehere. The above article expresses the opinions of the author, and the author did not receive compensation from any of the discussed companies