Aehr shareholder letter, a must read

Investment Analysis Clubs Saul’s Investing Discussions
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Dear Shareholders, Customers, Partners, and Employees,

Fiscal 2023 was a breakout year for Aehr Test Systems. We achieved record financial performance for the full fiscal year. We significantly expanded our customer base with additional silicon carbide customers and saw increasing momentum with our benchmarks and engagements with prospective new customers. We successfully introduced several significant new test system enhancements that broadened our total available market and extended the competitive advantage of our FOXTM products. We see new market opportunities on the horizon that we believe can become significant additional markets for our differentiated and proprietary wafer-level test and burn-in products.

We finished fiscal 2023 with record financial performance, including record annual revenue, bookings and profit. For the fiscal year, total revenue grew 28% to $65.0 million, our highest annual revenue on record. We also generated record bookings for the year of $78.3 million. With our higher revenue, we saw significant leverage in our operating model. We also recorded record GAAP and non-GAAP profit of $14.6 million and $17.3 million, respectively. This represents year-over-year growth of 54% and 62%, respectively. We generated a record $10 million in operating cash flow, up more than 500% from the prior year, and we finished the year with a strong balance sheet, with nearly $48 million in cash and short-term investments and no debt.

Our record performance was driven by demand for our FOX solutions for silicon carbide semiconductors used in electric vehicles and electric vehicle charging infrastructure, as well as silicon photonics devices used in data and telecommunications infrastructure and a new application for multi-chip modules using optical data interconnections. Semiconductor companies are adding significant capacity to manufacture silicon carbide semiconductors to address forecasted demand, particularly for the electric vehicle and electric vehicle charger markets. The silicon carbide market for electric vehicles and its supporting infrastructure requirements are growing at a tremendous rate, with industry data suggesting a compound annual growth rate (CAGR) of close to 50% over the rest of this decade. Our unique wafer-level test and burn-in products provide complete solutions for semiconductor manufacturers for high-volume test, burn-in, and stabilization of semiconductors such as those used in electric vehicles, electric vehicle charging infrastructure,photovoltaic (solar) power conversion, and data and telecommunications infrastructure.William Blair forecasts total demand for silicon carbide wafers just for electric vehicles (including electric vehicle inverters and on-board and off-board chargers) to grow from 220,000 wafers in 2022 to over 4.5 million 6-inch equivalent wafers in 2030, a greater than 45% CAGR and over 20 times larger in 2030 than in 2022.

In addition, they expect demand for industrial applications, electric trains, energy conversion, and radio frequency amplifiers to drive another 2.8 million silicon carbide wafers in 2030. This further expands the total available silicon carbide test and burn-in market.

We significantly expanded our customer base with the addition of four new silicon carbide customers this past year, and we expect to add more in fiscal 2024. Each of these new customers is already ramping or is planning to ramp our products into high-volume production using our multi-wafer test and burn-in systems. These new customers, which include another one of the top four silicon carbide market participants, expand our market penetration beyond our initial lead silicon carbide wafer-level burn-in customer and provide us with confidence in our ability to gain significant market share of the test and burn-in market for silicon
carbide devices.

Our benchmarks and engagements with prospective new silicon carbide customers are increasing and making great progress. With essentially all Covid-related restrictions behind us throughout the world, our customer-facing meetings and our progress on new customer opportunities have grown substantially. Our increasing engagements with numerous potential customers give us confidence in our growth expectations over the next several years, particularly as the positive momentum in demand for silicon carbide in electric vehicles continues to accelerate.

We continue to engage with current suppliers of silicon carbide devices as well as companies planning to enter into this market. We are working closely with one of the largest silicon carbide players in the world on a large

wafer-level benchmark and qualification for automotive and other markets. This qualification continues to make great progress and we believe this will ultimately result in them moving to our FOX solution for their volume production.

While the majority of the silicon carbide applications driving our wafer-level burn-in capacity to date have been purchased for electric vehicles and electric vehicle charging infrastructures, we are also seeing high levels of interest for our solutions to test and burn-in silicon carbide in other markets including solar, wind, and numerous industrial applications.

In addition to our momentum in silicon carbide, we are seeing increasing interest in our products for the emerging market for gallium nitride devices. We have multiple potential new customers inquiring about our systems to test and burn-in gallium nitride semiconductors. Similar to silicon carbide, gallium nitride is also a wide band-gap compound semiconductor being applied for efficient high-speed power conversion applications.

While silicon carbide devices and modules have key advantages for the very high-power traction inverters and onboard and offboard chargers for electric vehicles and other high-power industrial applications, gallium nitride is generally believed to be superior for lower-power applications, particularly under 1,000 watts. We believe gallium nitride will be a significant market, driven by high-volume applications such as electronic power converters in data centers, solar power inverters, and power and conversion applications in standard and electric vehicles. Both silicon carbide and gallium nitride device types are forecasted to grow significantly over the next several years and into the future.

The gallium nitride market appears to be a potentially significant growth driver for our systems and WaferPakTM full-wafer Contactors, particularly for automotive and photovoltaic applications where burn-in appears to be critical for meeting the initial quality and reliability needs of those markets. With the proven cost- effective ability of our FOX-XP wafer-level burn-in solution to test thousands of devices in parallel and up to nine wafers at a time, we believe we are well positioned to capitalize on this opportunity and believe that gallium nitride can expand our total addressable market in a meaningful way.

We saw a strong recovery in the silicon photonics market and also see a major market opportunity with the upcoming application of silicon photonics integrated circuits for use in optical chip-to-chip communication. Following the weakness we saw during the pandemic, full year revenue from our shipments to silicon photonics customers this past year was up more than 45% year over year. This jump in revenue was also spread across multiple customers with much of it for new product designs and qualifications that we believe will lead to production volumes. We continue to be very enthusiastic about the current market for silicon photonics devices used in data communication, which combines electrical semiconductor integrated circuits with photonics or light-based transmitters and receivers.

We see the potential to integrate photonics integrated circuit devices into multi-chip modules as a major new market opportunity for Aehr. Multiple large semiconductor suppliers such as Intel, AMD, Nvidia, TSMC and GlobalFoundries have publicly discussed roadmaps to integrate optical devices into processors in what are being referred to as optical input/output (I/O) and co-packaged optics devices for markets such as data servers, computing, and Artificial Intelligence (AI). This new potential market is in addition to the current transceiver market for data and telecommunications.

We are beginning to see the front end of this opportunity and Aehr currently already has six customers including the market leader that have adopted our FOX-XP and NP systems for production burn-in of their silicon photonics devices. While we believe this new optical I/O market is still several years out before it

Late in the year, we received our first order from a major silicon photonics customer for a new high-power configuration of our FOX-XP system for production wafer-level burn-in of next-generation silicon photonic- based integrated circuits, which can require up to two to four times as much power for full-wafer test, burn-in, and stabilization. This customer is one of the world’s largest semiconductor manufacturers and we expect to receive orders for additional production systems as they increase production of these devices. The testing ability of this new FOX production system configuration for new high-power density devices, which can be used in new optical I/O or heterogeneous integrated packages, is unprecedented in the industry and expands the market opportunities of the FOX-XP system even further.

reaches volume production, we feel the silicon photonics test and burn-in market can become significant and could grow to be as large or even larger than the silicon carbide market later in this decade.

We introduced several significant test system enhancements that extend the market leadership of our FOX products for full-wafer test and burn-in and open new markets. Both silicon carbide and gallium nitride semiconductors address the high-voltage power semiconductor markets that are significant opportunities for our FOX wafer-level test and burn-in systems and WaferPak full-wafer Contactors. As we look to further penetrate these markets, we continue to add new capabilities to our wafer-level test and burn-in systems to address these new markets. These include the FOX Bipolar Voltage Channel Module (BVCM) and Very High Voltage Channel Module (VHVCM) options, which enable new advanced test and burn-in capabilities for silicon carbide and gallium nitride power semiconductors on Aehr’s FOX-P wafer-level test and burn-in systems.

During the fiscal year we also completed a multi-year development and began shipments to customers of our new fully automated FOX WaferPak Aligner, which enables hands-free operation of WaferPak handling and alignment and is available either as a stand-alone or in full integration with our FOX-XP system. As capacity and volume forecasts increase, eliminating all manual interfaces for automated handling can become critical to our customers. The added automation capability of our new Aligner gives our wafer-level test and burn-in offering even greater value and opens several incremental markets to Aehr, such as high-volume processors and chipsets with integrated photonics transceivers, flash and ultimately DRAM memories.

Each of these product enhancements broadens our total available market and extends our cost competitiveness and application space for our FOX products, and we continue to invest to enhance our existing market-leading products and to introduce new products to maintain our competitive advantages and to expand our applications in addressable markets.

As we move into fiscal 2024, we have a significant competitive product advantage and are well positioned for significant growth. Our customers use our products to test, burn-in, and stabilize semiconductors used for applications where safety, security, quality, and reliability are absolutely critical, including electric vehicles, electric vehicle chargers, photovoltaic or solar, power conversion, industrial, and data and telecommunications applications.

With the unprecedented unique capabilities and cost-effectiveness of our FOX-P platform, we have highly differentiated solutions for full wafer-level test and burn-in that put us in an excellent position to continue to gain significant market share of these new and growing market opportunities.

The market forecast for wafer-level burn-in products is significant. William Blair estimates that the total available market for wafer-level burn-in products for silicon carbide alone will be over $400 million by 2027. We believe Aehr has the potential to capture a significant portion of that market based on the level of silicon carbide engagements we have with customers across the globe. With the continued positive momentum that we are seeing with our current and prospective customers and the expanding growth opportunities from emerging markets, we are confident in our expectation for significant growth in the coming year.

I continue to be grateful to our employees, customers, partners and shareholders for their support.

Gayn Erickson, President and CEO

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Thanks Saul, for sharing. That’s sound very bullish and I’m convinced, AEHR has a very bright future. Although already quit a large position, I added today, using the market sell-off.

As you are preaching: add to your winners!

I appreciate if what you are doing here and hope, your arm has healed?!

Best
Nick

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CORRECTED - The paragraph that begins “Late in the year…” was inserted within the paragraph above it. They should read as follows…

We are beginning to see the front end of this opportunity and Aehr currently already has six customers including the market leader that have adopted our FOX-XP and NP systems for production burn-in of their silicon photonics devices. While we believe this new optical I/O market is still several years out before it reaches volume production, we feel the silicon photonics test and burn-in market can become significant and could grow to be as large or even larger than the silicon carbide market later in this decade.

Late in the year, we received our first order from a major silicon photonics customer for a new high-power configuration of our FOX-XP system for production wafer-level burn-in of next-generation silicon photonic- based integrated circuits, which can require up to two to four times as much power for full-wafer test, burn-in, and stabilization. This customer is one of the world’s largest semiconductor manufacturers and we expect to receive orders for additional production systems as they increase production of these devices. The testing ability of this new FOX production system configuration for new high-power density devices, which can be used in new optical I/O or heterogeneous integrated packages, is unprecedented in the industry and expands the market opportunities of the FOX-XP system even further.

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Aehr is my largest position. I have little doubt that this little company can grow into a behemoth. But, despite the great long term potential, I am holding my breath a little bit as we close in the upcoming earnings report.

My primary concern is based on their ultra-conservative revenue recognition policy. The money doesn’t go on the books with the sale of a system. It doesn’t go on the books when they deliver a system. Not until the customer has installed and put the system in to full production mode and indicate that they are 100% satisfied with the system do they record revenue (I don’t know when they actually collect the funds, I would hope it’s no later than system delivery).

Well, yes they do ultimately record the collection of revenue, but the thing that gives me pause is the timing. It’s possible that YoY revenue growth may look somewhat tepid despite how many new contracts they may have signed. Those of us who follow the company quite closely would of course not be overly concerned about this. But there’s no telling how the market might react.

And the company is tiny. $65M is the highest annual revenue ever recorded - that’s pretty much a rounding error for Nvidia. Do they have the resources to address explosive market expansion? I wrote to IR asking about their ability to add production capacity. Most of the manufacturing is done by contract suppliers. They assured me that they can address growth in demand via expansion of their contract supplier base - but these products are high precision with demanding tolerances and physically large. The availability of suppliers that can satisfy Aehr’s precision and quality demands may not be widespread. The following quotes are from Aehr’s 10-K released in August of this year:

“The Company assembles its products from components and parts manufactured by others, including environmental chambers, power supplies, metal fabrications, printed circuit assemblies, ICs, burn-in sockets, high-density interconnects, wafer contactors and interconnect substrates. The Company’s strategy is to use in-house manufacturing only when necessary to protect a proprietary process or when a significant improvement in quality, cost or lead time can be achieved and relies on subcontractors to manufacture many of the components and subassemblies used in its products. Final assembly and testing are performed at the Company’s principal manufacturing facility located in Fremont, California.”

And this from the “Risks” section:

“Our sales growth depends on our ability to obtain timely deliveries of parts from our suppliers and contract manufacturers. There is currently a market shortage of semiconductor and other component supply which has affected, and could further affect, lead times, the cost of supply, and our ability to meet customer demand for our products. While we have taken steps to obtain an assurance of supply from our key suppliers, the market shortage of semiconductor supply may impact our ability to meet customer order fulfillments, or result in a significant increase in costs of our inventories. Manufacturing issues or capacity problems experienced by our suppliers or contract manufacturers could impact our ability to secure sufficient supply of critical components. Due to the market shortage of semiconductor supply, suppliers and contract manufacturers may commit their capacity to others, limiting our supplies or increasing costs. The failure to obtain timely delivery of supplies, or a significant increase in costs, could result in a material impact in our business and results from operations.”
…
“The process of qualifying suppliers could be lengthy, and no assurance can be given that any additional sources would be available to us on a timely basis.”

In summary, they are already experiencing supply chain issues and their ability to add capacity may not be as easy as IR indicated to me.

Again, Aehr is my largest position, but it is most definitely not without risk. While this company appears to be postured to have several years of exponential growth ahead of it, there’s a lot that could go wrong.

They are very candid in their discussion of potential risks in the 10-K. Due diligence pretty much demands that you read the Risk Factors section before committing a large percentage of your investment funds. I’ve chosen to accept the risks as I feel the potential opportunities outweigh the risks. You might feel differently.

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AEHR is also my largest position. On when they book revenue, I believe it is even after delivery. It’s too late for me to hunt for tonight, but I think it was in one of the YouTube videos I watched with Gayn Erickson where he said that they book revenue after the customer has run a first test. Since they offer a total refund if the customer is not satisfied, they only book the revenue when the customer has run their first batch and has registered that they are, indeed, satisfied.

There could be some nuance in that I’m not remembering, like 1st test or x days or something, but what I remember is that the customer not only received, but satisfactorily used the product before they booked it. That is likely only for the large systems, not the consumables, but that’s my memory. I also remember him saying that none had ever been returned/refunded.

Happy to be corrected if someone finds something different.

JabbokRiver

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As I noted above, my understanding of Aehr’s revenue recognition policy is as follows:

And as you noted, this policy does not apply to consumables. I’m not sure when they book revenue from the sale of consumables, but I assume it is the delivery date or close to it.

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A common approach for industrial machines is for the customer to pay 1/3 when signing the contract, 1/3 upon receipt of the machine/system, and 1/3 after commissioning (and proving that the machine performs).

What aehr is essentially doing is providing a 100% satisfaction guarantee, which they would only do if they have 150% confidence in their technology and their own manufacturing/QA. The key to me is if they are able to maintain their level as they ramp up.

There is nothing I have come across reading about them that even hints at a problem here. Their very conservative revenue recognition should be a comfort for investors. If they ever gave data on how often, if ever, they’ve had delays in final acceptance, that would tell us a lot.

As I type this I realize I have a few questions for their IR person. I’ll get back to you all if they answer.

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If you reread my note, no-where, no-way do I suggest that Aehr doesn’t get paid. I didn’t even hint that they had a problem with product returns. What I did suggest is that their revenue recognition policy may result in a quarter with bad comps which might have a material impact on the stock price.

Yes, folks who follow this board would most likely understand that there was no problem with product or performance. Some revenue simply got delayed as they ironed out some production problems or whatever. My point was more along the lines that a lot of retail investors would not understand what happened. They would simply see a disappointing revenue print and react in knee-jerk fashion. And because Aehr is so small, that reaction holds the potential for triggering bots into a cascade of sell orders.

Maybe that’s far-fetched, I don’t know. And I hope it just doesn’t happen, I don’t want to find out. Let’s hope for a stellar quarterly report and an explosive upside for the stock price.

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Brittlerock, you seem to have a lot of concern that their suppliers won’t be able to keep with cascading orders. However, their sales the last three years went from:

$16.6 million to
$50.8 million to
$65.0 million

If they could triple sales in one year and quadruple sales in two years, I suspect their suppliers will keep up this year as well.

Saul

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Saul,
You’re most likely correct. And as I mentioned, when I inquired about this IR replied that they can ramp up production rapidly as they needn’t expand an existing factory let alone build a new one. So, my concerns are probably misplaced. Nevertheless, if you read the risks section of the 10-K they explicitly mention that increasing production capacity may present some difficulties.

I understand that the 10-K always leans towards the more extreme situations. They don’t ever want to legally expose the company for failure to reveal a foreseeable risk. I guess maybe I’m just a bit nervous because Aehr is really a very small company. Their size makes it much more difficult for them to absorb the impact of a significant problem. They have very little room for error.

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I don’t want to lay words in your mouth, but maybe AEHR is not the right company for you to invest in. Or, your stock allocation should be much lower than today. Running a concentrated portfolio is not for everyone. Tom and David often speaks about their sleep number, which correlates to the percentage of one individual stock in their portfolio. I can’t remember who exactly, but I guess it was Tom, who has a sleep number of 50%, which is very high. Saul often speaks about a maximum stock allocation of one individual stock around 20-25%.

Mine is in the middle of these two around 33-35%.

Maybe something for you to consider.

Cheers
Nick

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When your company has been purchasing machines, materials or software from a vendor, that vendor always has people out at your office showing you their road map for next year and asking about yours. That is the job of their sales reps and technical support reps. Whoever AEHR is buying material and machines from already knows what they will be expected to deliver. COVID upset that for a few years, but the norm is that suppliers know enough to plan their own production.

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Nick,
Thanks for your concern, but I do know what I’m doing with respect to carrying a concentrated portfolio and high allocations for certain companies. Aehr is just a bit over 21% of my portfolio. That’s about as high an allocation as I ever allow.

If you had taken the time to read my previous posts in this thread you would have come across the following statement:

“They [Aehr] are very candid in their discussion of potential risks in the 10-K. Due diligence pretty much demands that you read the Risk Factors section before committing a large percentage of your investment funds. I’ve chosen to accept the risks as I feel the potential opportunities outweigh the risks. You might feel differently.”

I’ve pointed out the risks of investing in Aehr mostly for the benefit of other folks who read the commentary posted on this board.

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Another way to approach the question is how each of us builds conviction in a company. If there’s something making us nervous, how related is that thing to our individual thesis for owning the company? I suspect that is slightly different for each of us.

I was somewhat late to the AEHR party because most of the folks here are focused on numbers above all else, and my real conviction comes when good numbers align with amazing management. I had never poked into the management question on AEHR and didn’t feel like I had the conviction in my own ability to analyze the numbers to jump in.

That all changed when I decided to hunt for interviews with Gayn Erickson. His transparency, integrity, and deep knowledge/experience with the tech of the company led me to trust that if they were hitting some kind of wall, he would say so. I already trusted the rest of you that the numbers were good, and I could see for myself that the opportunity was huge and that they were uniquely positioned within it. I was in at the very next opportunity after watching those videos, and have built it into my largest position.

But that is what I need for conviction and might not be what you need.

Sometimes it might be that a company just isn’t right for any one of us individually. But it also could be that we haven’t done enough of a deep dive on the things that matter most to us to build the conviction necessary to hold it.

Lastly, I apologize for not reading your initial post more closely to see that you were asking about when revenue was received rather than when it was booked.

JR

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