Lam’s Q3 report was nothing too spectacular, with a slight revenue beat in the quarter and a solid EPS beat. Q4’s guide pointed to relatively flat revenue and a slight sequential decline in EPS.

We have a 4% placeholder on Lam, which may be a tad early for the material rebound that is expected 2025-ish. Primarily, Lam’s rebound is dependent on NAND recovering. Discussions around the incoming NAND rebound were important, as well as the discussions on DRAM.

China is both an opportunity and a risk for Lam. China’s revenue contribution remained above 40% in the quarter, though Korea’s contribution increased 500 bp sequentially to 24%, suggesting major memory manufacturers may be increasing WFE (wafer fabrication equipment) spend. Given the high exposure to China, there is risk in more customers being added to the banned entity list, which would result in a loss of revenue for Lam.

Overall, this is not the standout quarter for Lam and we didn’t expect it to be. Instead, we were provided important clues as to when the standout quarter might occur. The story is intact, the fundamentals have likely bottomed, yet the stock is overvalued and has been for some time. Therefore, primarily due to valuation concerns, we realize the allocation we currently have is unlikely to be our lowest entry.

Revenue and EPS:

Lam’s revenue peaked in Q2 FY2023, with the current FY2024 Q4 guide pointing to flat revenue for three straight quarters as Lam digests a trough in NAND spending coupled with strong China and DRAM demand. Fiscal Q1 is expected to break this trend with revenues projected to push back to $4 billion and higher.

• Revenue of $3.79 billion beat estimates by 1.6%, representing a YoY decline of (2.1%) but a QoQ increase of 0.9%.
• For fiscal Q4 (June 2024 quarter), Lam guided for revenue of $3.8 billion, +/- $300 million, representing YoY growth of 18.5% and approximately flat QoQ growth at midpoint. Prior to earnings, our information shows QoQ growth in the September quarter of 6% and December quarter of 7%.
• GAAP EPS of $7.34 beat estimates by $0.50, representing YoY growth of 22.1%. Non-GAAP EPS of $7.79 beat estimates by $0.49.
• Q4’s GAAP EPS was guided at $7.20, +/- $0.75, representing YoY growth of 20.6% and a QoQ decline of (1.9%) at midpoint. Non-GAAP EPS was guided at $7.50, +/- $0.75, implying YoY growth of 25.4% and a QoQ decline of (3.7%). Same as revenue, the September quarter and December quarter is when QoQ growth returns.

Margins:

GAAP operating margin contracted slightly on a QoQ basis despite GAAP margin expanding due to customer mix in China. Q4’s margin outlook was also mixed, pointing to operating margin expansion and gross margin contraction.

It’s important to note that 46% is the normalized gross margin for Lam although customer mix can result in as high as 48% gross margin. Per management: “You're absolutely right, and thanks for mentioning the 46%. That's sort of where gross margin was after we had done some of the Malaysia stuff and before China popped up with those smaller customers. And so the fact that we're above that level is largely customer mix.”

• Fiscal Q3’s GAAP gross margin was 47.5%, representing a 70 bp QoQ and 600 bp YoY expansion from 41.5%.
• For fiscal Q4, Lam guided for a GAAP gross margin of 46.7%, representing an 80bp QoQ contraction but a 120 bp YoY expansion.
• GAAP operating margin was 27.9% up 350 bp YoY from 24.4%.
• Q4’s GAAP operating margin was guided at 28.3%, for a 40 bp QoQ and 170 bp YoY expansion compared to 26.6% in Q4 of last year.
• GAAP net margin was 25.4%, essentially flat QoQ and expanding 440 bp YoY.

Cash and Debt:

• Operating cash flow was $1.38 billion in Q3, compared to $1.76 billion in the year ago quarter. Lam’s OCF margin contracted from 44.6% a year ago to 36.5%.
• Free cash flow was $1.28 billion, compared to $1.61 billion in the year ago quarter. FCF margin contracted from 41.5% a year ago to 33.7%.
• Cash and equivalents totaled $5.67 billion.
• Debt and finance leases totaled $4.98 billion.

The company allocated $860 million to share repurchases and paid $263 million in dividends in the March quarter. Management also added: “And I would just mention, we continue to track towards our long-term capital return plans of returning 75% to 100% of our free cash flow.”

Key Metrics:

DRAM Revenue Dips QoQ:

We highlighted DRAM as one of the primary growth drivers for Lam coming out of this memory trough over the course of the next few quarters as Samsung, SK Hynix, and Micron work to significantly boost HBM3 and HBM3e production to meet elevated demand from Nvidia and AMD’s GPUs.

However, DRAM contributed only 23% of systems revenue in fiscal Q3, or ~$551 million, compared to 31% of revenue, or ~$713 million, last quarter.  Through the first three quarters of FY24, DRAM revenue totaled ~$1.737 billion, an increase of ~73% YoY.

Management stated the following about the sequential weakness in DRAM: “I do just want to mention one thing. We are characterizing 1 customer's investment in specialty DRAM as a nonvolatile investment since it has a nonvolatile component to the device.”

The weakness is also relative as during peak revenue in the Q2 FY2023 quarter, DRAM was 11% of revenue. So, even with this sequential weakness, it’s more than doubled in percentage of revenue from what it was at the cyclical top.

Non-Volatile Memory (NVM) Sales Pick Up:

Though DRAM’s contribution dipped sequentially, NVM sales offset much of this, rising from 17% of systems sales last quarter to 21% in Q3. Overall, memory accounted for 44% of Lam’s total systems sales in the quarter, down from 48% last quarter but up from 32% in the year-ago quarter.

Overall, systems sales rose to a ~63% contribution to total revenue, up from 61% in the prior quarter and marking a third consecutive quarter of increasing contribution. This suggests demand remains healthy.

Earnings Call:

Key Product Commentary and Timing for 2025-ish:

HBM and DRAM:

Our thesis is two-fold and management explained both points nicely in the call. The first is that we want to participate in the high bandwidth memory (HBM) boom being driven forth by AI acceleration. Our Members are quite aware of this trend as we’ve been hammering on it for a few quarters.

Here is what management stated about how Lam participates in this trend: “With respect to DRAM, AI servers use high-bandwidth memory or HBM to increase read write speed and reduce server power consumption. HBM stacks multiple DRAM dies using TSVs enabling 15x more data throughput than standard DRAM. However, HBM also requires an approximately threefold increase in wafers per bit compared to conventional memory. With this in mind, it's important that our SABRE 3D and Syndion tools not only provide best-in-class plating and etch capabilities, but also deliver industry-leading throughput and productivity to keep overall costs low for our customers. We are the leading player in TSV applications for HBM and expect our HBM related shipments to grow more than 3x in calendar year 2024.”

It was stated on the call that HBM is only 1-2 points of overall bit demand, and thus it’s “small today but growing quite rapidly.”

In terms of timing, especially as it relates to the CHIPS Act, which in turn will drive more equipment sales, the following was stated:

“And so we've always said these are more of a 25, 26, 27 time frame for — from the equipment side, especially the shorter lead time tools like we provide. So you see the fab coming up a lot of construction connectivity, you see long lead time tools go in. And then we know that our time will come. I mean — and so I think it's still a '25, '26, '27 opportunity for us. more of a 25, 26, 27 time frame for — from the equipment side, especially the shorter lead time tools like we provide. So you see the fab coming up a lot of construction connectivity, you see long lead time tools go in. And then we know that our time will come. I mean — and so I think it's still a '25, '26, '27 opportunity for us. 

But the important thing is, while that's a lot of extra money maybe what's really exciting about is most of that is targeted towards to the leading-edge nodes […], but it's at nodes where we believe that we will actually do better from a SAM and market share perspective. And so we're patiently waiting. But we know it's going to come. You can go visit the sites, the fab buildings are there, and they're feverishly working to get them ready for equipment.”that we will actually do better from a SAM and market share perspective. And so we're patiently waiting. But we know it's going to come. You can go visit the sites, the fab buildings are there, and they're feverishly working to get them ready for equipment.”

The bigger picture at full utilization is that GPUs and AI servers will drive 8X DRAM and 3X NAND, which will equal “$1 billion to $1.5 billion incremental WFE” for every 1% server penetration, according to Lam.

NAND/Storage:

Non-volatile memory’s (NVM) acceleration this quarter could imply that the NAND uptick is already beginning, with a greater contribution expected in 2025. Since Korea commands a significant global share in both DRAM and NAND, its increased revenue share, at 24% in Q3 (up from 19% last quarter and 16% two quarters ago), hints at NAND spending and utilization resuming given that DRAM sales were weaker. 

According to management, “More advanced AI applications need faster, more power-efficient and higher-density NAND storage. NAND-based enterprise solid-state drives or eSSDs, are 50x faster in read write capability, 2 to 5x more power efficient and use 50% less space at the system level compared to hard disk drives or HDDs. Today, over 80% of enterprise data is stored on HDDs. And we expect this mix to shift in favor of SSDs as NAND capability and cost continues to improve.”

In terms of timing and the 2025 rebound that is expected industry-wide, Lam stated the following:

“I mean, clearly, we all know that the NAND spending has been incredibly weak for the last 12 to 18 months. And so we're in the very early stages of starting to see that recover. And I think if you look at what most of our — we rely on our customer commentary that they make publicly for a lot of this, but they talk about the fact that maybe 90% of the bits they're shipping are at the leading edge. 

But when we look at the installed base of our systems, that was my comment. I believe that there is still going to be a large portion of the installed base that will move forward to the next technology nodes. It's the most efficient way for our customers to to do that is to upgrade what they already have. And I think you'll see that move forward and therefore, NAND WFE move up in '25. But because it comes through a large — to a large degree, through upgrades, Lam's capture rate of every dollar of WFE spend will be much higher than in a greenfield capacity added. So when I think about Lam's opportunity to outperform in 2025, in NAND, I think it is obviously with high confidence because of the type of spending we would expect to be seen in 2025. And in the other market segments, it's also pretty high because of the — as I mentioned, the technology inflections that are occurring […] And so I just feel like there are a number of growth drivers for the company besides the one that is the most obvious, which is a NAND recovery in 2025.”And I think you'll see that move forward and therefore, NAND WFE move up in '25. But because it comes through a large — to a large degree, through upgrades, Lam's capture rate of every dollar of WFE spend will be much higher than in a greenfield capacity added. So when I think about Lam's opportunity to outperform in 2025, in NAND, I think it is obviously with high confidence because of the type of spending we would expect to be seen in 2025. And in the other market segments, it's also pretty high because of the — as I mentioned, the technology inflections that are occurring […] And so I just feel like there are a number of growth drivers for the company besides the one that is the most obvious, which is a NAND recovery in 2025.”

Gate All Around Technology Nodes:

In August, our deep dive discussed how gate-all-around transistors are replacing FinFET transistors. The company stated that shipments for gate-all-around nodes will exceed $1 billion this year. Per management, this is just starting:

“we're really just starting at gate-all-around. Our comment was $1 billion of shipments into the gate-all-around nodes this year. And it's across all of our types of products that help enable gate-all-around smaller technology nodes. And so what we've said is that every technology node, etch and depth intensity grows and our SAM opportunity expands.”

Utilization is Improving, Further Supports 2025 Recovery

Lam offered a lucid discussion around how utilization rates are showing signs the 2025 recovery is on track.

In the opening remarks it was stated: “In NAND, we continue to expect year-on-year growth in WFE spending in calendar 2024. Encouragingly, we have seen an uptick in fab utilization. And in the March quarter, this has translated into double-digit percent growth quarter-over-quarter in our spares revenues. As supply and demand continues to normalize through the remainder of the year, we see a strong setup developing for 2025 NAND spending. As supply and demand continues to normalize through the remainder of the year, we see a strong setup developing for 2025 NAND spending.”

There was follow-up on this in the Q&A:

However, through this downturn, the cuts in fab utilization were so severe that we actually saw spares revenue come down, which surprised us a bit, so maybe to your point of expectations.

We knew that as soon as customers started to utilize the fabs and bring some of the tools back online, we would see spares increase. We said that would be the first sign that the end market was really starting to improve. And so the reason we called it out was that, obviously, it's — it further confirms, I think, what you're hearing from our customers, which is that utilization is starting to improve.it further confirms, I think, what you're hearing from our customers, which is that utilization is starting to improve.

It doesn't tie to WFE because utilization of what you have is one issue. When you choose to spend more to either upgrade technology or add capacity is a second decision. We've said that, that is likely still more of a 2025 event on the equipment spend side. But you have to get the first indication, which is utilization improvement, spares improving and then the rest would comeWhen you choose to spend more to either upgrade technology or add capacity is a second decision. We've said that, that is likely still more of a 2025 event on the equipment spend side. But you have to get the first indication, which is utilization improvement, spares improving and then the rest would come.

China Sales Remain High

It was discussed in-depth that China is first-half weighted and revenue from this region is expected to declining as the year progresses.

In the Q&A, it was brought up that perhaps management is expecting more weakness as the year progresses due to customers being added to the blacklist. It was not confirmed directly but also was not denied.

Question
Timothy Arcuri (Analysts)Question
Timothy Arcuri (Analysts)

So I wanted to ask about China. So it's going to modulate through the year, the mix, but it sounds like it's still going to be up year-over-year for domestic China this year. So I guess my question is, we've seen some headlines on a few entities being potentially added to the entity list. And I'm wondering if these comments reflect the potential addition of these entities? Or does it basically say, hey, if the status quo remains, this is what your assumption is, meaning that if there were entities added that, that would be downside to these comments?And I'm wondering if these comments reflect the potential addition of these entities? Or does it basically say, hey, if the status quo remains, this is what your assumption is, meaning that if there were entities added that, that would be downside to these comments?

Answer
Timothy Archer (Executives)Answer
Timothy Archer (Executives)

Yes. Tim, I mean, obviously, we can't forecast changes in U.S. trade policy with respect to China that we don't know about. And so we're basically giving you our best view of what we think our China business will be through the rest of the year and recognizing that there could be changes that we don't foresee. And so we're basically giving you our best view of what we think our China business will be through the rest of the year and recognizing that there could be changes that we don't foresee. 

Well, what I will say is we — obviously, we've built up what we believe is a strong government affairs team were plugged into all the relevant discussions. And I think over the last couple of years, you've seen we have a pretty strong track record of working with the U.S. government responding to export control policy and that's just what we plan to do going on into the future.

Conclusion:

Lam has broken key support and it’s likely we trim some of the position with the goal of adding back at lower levels. Across the board, Lam is trading about 2X higher than its median top line and bottom-line valuations. The PE Ratio is 34 compared to a 3-year median of 19. The forward PE Ratio of 30 is easily the highest it’s traded in three years. It’s the same scenario for the top line. This report may not be enough to justify these valuations in the near-term. Therefore, you can expect us to actively manage this position as we try to seek whatever alpha we can find in the current market.

For reasons clearly outlined above, we expect this will be a high allocation for 2025. The company carries a level of complexity that we are comfortable navigating, and it’s to our benefit that management is being quite clear on when to expect their largest segments to rebound. Therefore, whatever we trim will be added back at lower levels.

Damien Robbins, Equity Analyst at the I/O Fund, contributed to this analysis

Recommended Reading:

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• Lam Research: Eyeing Strong 2024 Exit Boosted by Memory Rebound
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• Micron Q2: Memory Rebound in Full Force with HBM3e

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

AEHR came in as expected and beat in some cases. Management reiterated guidance of at least $100 million for 50% year-over-year growth. Given the company added its sixth customer this quarter, the market may have wanted a raise. If we are patient, it’s likely AEHR will see a raise over the next two to three quarters. Management alluded to more orders likely being placed and delivered this fiscal year. This is detailed in the earnings notes below.

AEHR has a large and obtainable TAM relative to its market cap, which we’ve covered in the past when we stated: “SiC wafer market is expected to grow 35X by 2030 – that’s not a typo. “Forecast from William Blair estimate that the silicon carbide market for devices in electric vehicles alone, such as traction inverters and onboard chargers is expected to grow from 119,000 6-inch equivalent silicon carbide wafers for EVs in 2021 to more than 4.1 million 6-inch equivalent wafers in 2030, representing a compound annual growth rate of 48.4%. This equates to almost 35 times larger in 2030 than in 2021.”

As industrial uses for SiC ramp, the TAM could be closer to 6 million wafers needed every year by 2030. This was discussed on the call as the past two customers were not EV related. Batteries were also discussed on the call, and we’ve included these notes below.

Revenue:

Revenue of 93.3% beat estimates of 80.4%. These beats are easier on small numbers. The difference was about $1 million in revenue at $20.6M reported compared to $19.25M expected.

Product revenue declined $1.7M QoQ to $19.4M in revenue. Services was flat at $1.27M in revenue.

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. We also reminded our Members going into the earnings call that AEHR’s revenue can be lumpy.

EPS:

EPS was in line:

• GAAP EPS of $0.16 is up from $0.02 in the year ago quarter.
• The adjusted EPS of $0.18 beat estimates of $0.16 EPS.

Margins:

The gross margin this quarter is weak at 48.4%, and this is the lowest gross margin since Q1 of last year.  The Fox-XP system’s automated WaferPak aligner caused the decrease in margin. The automated aligners are built externally. Per the CEO: “the first units have a higher incremental cost to us than the ones going forward.” When the CFO was asked 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.”

Operating margin was also softer than it’s been in previous quarters at 20%. The CFO stated opex was higher due to “increased headcount related expense and R&D programs.”

• Gross margin of 48.4% compares to 51.5% last quarter and 42% in the year ago quarter
• Operating margin of 20% compares to 25.3% last quarter and 4.3% in the year ago quarter. This resulted in operating income of $4.12 million.
• Net margin of 22.6% was also softer on a sequential basis but up nearly 700% year-over-year (due to small numbers).

Cash Flows:

The operating cash flow of $3.9 million was down 28.6% year-over-year. However, cash on the balance sheet of $51 million is up from $36.2 million in the year ago quarter and up 6.5% sequentially.

Key Metrics:

I suspect the key metrics is why we are seeing the weak price action after hours. Inventory is higher than usual at $31.56 million, up $7.6 million QoQ. Often, this can be a flag for a semiconductor stock yet management has stated their plan is to increase inventory to meet upcoming demand. Per the CEO: “ I mean we are able to ship more than anybody else. We literally can ship up to, call it, 50, 80, 100 testers, call it, wafers or blades of capacity a month, we are shipping more per month than the combined number of installed base of every other competing alternative has ever shipped.”

Bookings in Q1 of $18.4 million declined (-3.7%) year-over-year. Bookings were up from $15.2 million last quarter. Backlog of $22.3 million was up 14.4% year-over-year yet was down sequentially. We had discussed that these are lumpy in our pre-earnings report. The effective backlog of $24 million was a bit lackluster given management had stated they received $15 million in effective backlog for Q1 three months ago.

Earnings Call:

AEHR’s key metrics matter, but the stock tends to move intra-quarter with new order announcements. If AEHR gets more orders in the next two quarters, it will be very positive for the stock as we are hovering at a baseline guide of $100 million this year. As investors, we are already sold on the product’s potential but I do include a few more notes on that regard, as well.

Comments on Upcoming Orders, New Customers and Q2 Revenue Recognition

In the opening comments, the CEO stated the following: “Acceptance and production release of these FOX XPs with the integrated aligners and the associated revenue recognition provide a solid start to our second quarter revenue and pave the path for revenue recognition immediately upon all future shipments of these products to this customer and forecasted shipments to additional customers this fiscal year.”

An analyst asked for more clarification and AEHR stated that $8 million in revenue was being recognized in September due to a deferred situation on two aligners.

Separate from this $8M, this was also a bullish statement on the call: “We continue to feel confident that this customer will move forward with us using the FOX-XP multi-wafer solution for their high-volume needs, including initial purchase orders and system shipments this fiscal year.”

And management hinted again they may see more order than what is currently being forecast:

“Our meetings also included face-to-face meetings with potential new silicon carbide companies who have now told us that they intend to place their first purchase orders with us over the next several months, including some that want us to ship systems, WaferPaks and aligners to them this fiscal year.”

New Customers:

AEHR announced their sixth customer for silicon carbide this quarter. Customer #5 and Customer #6 are not EV customers, which is generally seen as a positive because it increases TAM by 2.8 million wafers in addition to the 4.5 million wafers estimated for the EV market.

“These additional applications expand our market opportunity beyond the 4.5 million 6-inch equivalent silicon carbide wafers that William Blair forecast will be needed per year by 2030 just for electric vehicles. These new applications are driving an additional 2.8 million 6-inch equivalent wafers annually by 2030 to address industrial, solar, electric trains, energy conversion and other applications.” 

With that said, ON Semi is 88% of revenue, and thus it’s quite apparent EV-related customers have a larger need for AEHR’s testing equipment as new customers have not been able to shake ON’s large customer share. ON was 79% last quarter so this is increasing – although, as stated, AEHR is lumpy and so this could decrease again next quarter.

More on 800-volt Batteries:

In the call, management elaborated on the need for silicon carbide by 2025 to 2026. Specifically management stated it was due to 800 volt EV batteries. Management stated: “Per UBS in 2023, 91% of the batteries sold in electric vehicles are forecasted to be 400 volts and only 9% are 800 volts. But by 2026, UBS expects a percentage of 800-volt battery cars to be above 30%, which is why it appears so many silicon carbide suppliers are timing their major ramps to be in the 2025 to 2026 time frame.”

The 800-volt battery needs to be tested up to 1,200 volts AC. AEHR’s WaferPaks are able to test and burn-in wafers up to 2,000 volts whereas competitive systems spark and create damage at 900 volts. We’ve covered AEHR’s product extensively (see recommended reading below) yet this was another mention of AEHR’s competitive advantage that is notable. 

This was also a big statement on the call product-wise: “In fact, we've never lost a head-to-head evaluation to a competitive product since introducing our FOX-NP and XP configured with the silicon carbide and gallium nitride test resources.”

Conclusion:

Overall, AEHR has a bright future but small caps are very volatile. This is where technical analysis helps quite a bit. For example, we moved to the sidelines during a drawdown in H1 2022 and then re-entered the stock and captured a 151% move from the August 2022 low. We will continue to use technical analysis especially for small caps, which carry much more risk than a large cap stock.

Interesting enough, Knox had stated last week that the $37 to $38 level is what he’s expecting to see. This level needs to hold for the earnings report to be a buy.

For real-time trade alerts and access to our 1-hour webinars, upgrade to Advanced Market Signals.Advanced Market Signals.

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

Earnings Coverage:
Fiscal Q4 Earnings: Strong Top Line, Strong Bottom Line
Fiscal Q3 Earnings: All Eyes on Next Fiscal Guide
Fiscal Q2 Earnings: Silicon Photonics and Inventory/Capacity – read this for why AEHR is outperforming its competitors. 

AEHR Customer:
ON Semiconductor: Powering the EV Highway

For those new to AEHR, please reference Recommended Reading for product thesis, previous earnings coverage and more. All of our Must-Read Theses for the I/O Fund Portfolio are located here.are located here.

AEHR is the rare small cap that has top line growth coupled with bottom line strength. We recently discussed what comprises a defensible portfolio in tech in our Q3 Kickoff webinar. AEHR fits the criteria we outlined in the webinar, and has seen a high allocation at times in our portfolio because of how many boxes it ticks. It’s both the consistent revenue growth andand the bottom-line growth that causes this stock to defy the odds.

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.

As also pointed out in our previous write-up, by withstanding higher temperatures combined with lower switching losses and lower thermal resistance, silicon carbide (SiC) can handle more power while using less energy. SiC reduces the power consumption and reduces the size of power supply systems that require high-voltage conversion, which makes SiC especially compatible with electric vehicle (EV) on-board chargers and solar photovoltaic power systems. 

Financials:

AEHR will be going through a few quarters of rapid growth.

Revenue:

• This quarter, the company is expected to report revenue of $19.3 million, for growth of 80.4%. The next few quarters are also expected to be strong on growth (see below).
• Fiscal year estimates have remained unchanged since the last earnings report at 58.4% growth for $102.9 million in revenue. Management provided guidance for at least $100 million in revenue, or 50% YoY growth.

Notably, the next two years look stable for AEHR at 55% growth expected in FY2025 and 42% growth in FY2026. There are only two analysts covering the stock for FY2025, and only one analyst covering the stock in FY2026. However, it helps to see there isn’t a sudden drop off in growth expected (as of now). There was a downward revision of 17% over the last month for the upcoming quarter, however, with fiscal year estimates remaining steady, it’s a matter of this revenue being recognized later in the year.

Pictured Above: AEHR is approaching a few quarters of rapid growth

EPS:

EPS of $0.23 in the last quarter beat expectations by 7%. In the upcoming quarter, the company is expected to report EPS of $0.16. Overall, earnings will nearly double in FY2024, per management guidance of “GAAP net income of $28 million for at least 90% earnings growth.” As growth investors who want defensible companies this is music to our ears.

Margins:

As stated, AEHR is one-of-a-kind in terms of being a small cap tech stock with strong margins.

• Gross margin last quarter of 51.5%. This can be impacted by 1-2% based on product mix and freight costs. Overall, it’s been ticking upward and has been in the low 40% and mid 40% range a few times over the past eight quarters.
• Operating margin last year of 20.6% has seen stellar margin expansion from 15.4% for the previous fiscal year. The operating margin last quarter was 25.3%.
• The company pays stock-based compensation of 3% for an adjusted operating margin of 27.4%.
• Net margin grew 380 basis points last fiscal year to 22.4%. The net margin for the quarter was 27.4%. 

Cash Flow:

Operating cash flow has been lumpy overall but was very strong last quarter for 800% growth to $5.87 million. This led to a cash flow margin of 26.4%. However, this is unusual. The previous op cash flow margins were 3% and 15.4% in FY2022 and FY2023, respectively.

Similarly, the free cash flow margin last quarter of 21% was higher than usual. For previous fiscal years, the FCF margin trended at 2% in FY2022 and 13.3% in FY2023.

This helped the company’s cash position grow 52% in the most recent quarter to $47.9 million. The company has no debt.

The company has also been exercising at the market (ATM) offerings. The company sold $7.9 million worth of shares in the third quarter and expects to sell shares worth $17.7 million in the upcoming fiscal year.

Key Metrics:

The company has been increasing its inventory in anticipation of heightened demand. The inventory stood at $23.9 million last quarter, for an increase of $2.3 million. Per the January earnings call: “We are increasing inventory to support our expected growth in the second half of fiscal 2023, and we continue to purchase inventory to ensure adequate supply to meet current customer and future customer market demand.”

Bookings in the fourth quarter were $15.2 million, up from $4.4 million in the year ago quarter. These are lumpy but can cause the stock to move quite a bit during a good quarter. What we want to see is FY2024 exceed FY2023, which was at $87.7 million. The highest quarter in company history was fiscal Q3 ending in February at $33.3 million.

Last earnings call, management stated there was more than $15 million in bookings received in the first six weeks of Q1. Let’s see if this quarter can meet or exceed the company’s previous record of $33.3 million. This has led to an effective backlog of $40 million.

Backlog is also lumpy at $24.5 million, up 121% last quarter. As long as these trend upward, the lumpiness is to be expected. In the previous quarter ending in February, the backlog was $31.6 million.

What to Watch For:

Bookings and Backlog are important for this stock. As stated, these can be lumpy but have been trending at historical highs for the company.

AEHR received an order on September 18th that will likely be discussed on the call. The order will be filled by end of calendar 2023. According to the press release, this is an initial order from a new customer. The customer is “a US-based multibillion-dollar semiconductor supplier serving several markets including automotive, computing, consumer, energy, industrial, and medical.”

Look for AEHR to increase its number of customers as we move along over the next few quarters. According to a Craig-Hallum analyst, AEHR may be engaged “with up to two dozen” potential SiC customers.

We’ve been reporting for quite a few quarters that H2 2023 is expected to be strong for the automotive supply chain. Let’s hope this materializes. In the January call, this was stated: “And as we had — if you look at the amount of capacity that everybody’s talking about to hit in 2025 calendar-wise, most people are just really focused on second half 2023 and into 2024 is where just a lot of capacity is coming online and so it may be less to do with the timing of us as the timing of that silicon carbide ramp. And our goal is to get qualified before that ramp happens and have a ton of capacity and material on hand to be able to address it.”

Additional catalysts are silicon photonics and gallium nitride, which have been covered in the recommended reading below.

Recommended Reading:

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

Earnings Coverage:
Fiscal Q4 Earnings: Strong Top Line, Strong Bottom Line
Fiscal Q3 Earnings: All Eyes on Next Fiscal Guide
Fiscal Q2 Earnings: Silicon Photonics and Inventory/Capacity – read this for why AEHR is outperforming its competitors.

AEHR Customer:
ON Semiconductor: Powering the EV Highway

Our next quarterly webinar with analyst Beth Kindig will be held the week of October 16th. Details will be sent via email.

Portfolio Manager Knox Ridley’s next Positions Report will hit your inboxes October 5th. Keep an eye out for his thoughts on AEHR and other positions the I/O Fund owns headed into earnings. In this webinar replay from last week, he also discusses AEHR.webinar replay from last week, he also discusses AEHR.