Vicor - Q2 2023
July 25, 2023
Transcript
Operator (participant)
Welcome, everyone, to today's webinar, entitled, "Vicor Earnings Results for the Second Quarter ended June 30, 2023." My name is Robin, and I'll be the producer for today. During the presentation, all attendees will remain on listen-only mode. If you require assistance at any time, please put a message in the chat box. With that, I would like to hand the call over to Jim Schmidt, Chief Financial Officer. Please proceed.
Jim Schmidt (CFO)
Thank you. Good afternoon, and welcome to Vicor Corporation's earnings call for the second quarter ended June 30th, 2023. I'm Jim Schmidt, Chief Financial Officer, and I'm in Andover with Patrizio Vinciarelli, Chief Executive Officer, and Phil Davies, Corporate Vice President, Global Sales and Marketing. After the markets closed today, we issued a press release summarizing our financial results for the three months and six months ended June 30th. This press release has been posted on the investor relations page of our website, www.vicorpower.com. We also filed a Form 8-K today related to the issuance of this press release. I remind listeners, this conference call is being recorded and is the copyrighted property of Vicor Corporation.
I also remind you, various remarks we make during this call may constitute forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Except for historical information contained in this call, the matters discussed on this call, including any statements regarding current and planned products, current and potential customers, potential market opportunities, expected events and announcements, and our capacity expansion, as well as management's expectations for sales growth, spending, and profitability, are forward-looking statements involving risk and uncertainties. In light of these risks and uncertainties, we can offer no assurance that any forward-looking statement will, in fact, prove to be correct. Actual results may differ materially from those explicitly set forth in or implied by any of our remarks today.
The risks and uncertainties we face are discussed in Item 1A of our 2022 Form 10-K, which we filed with the SEC on February 28th, 2023. This document is available via the EDGAR system on the SEC's website. Please note the information provided during this conference call is accurate only as of today, Tuesday, July 25th, 2023. Vicor undertakes no obligation to update any statements, including forward-looking statements made during this call, and you should not rely upon such statements after the conclusion of this call. A webcast replay of today's call will be available shortly on the Investor Relations page of our website. I'll now turn to a review of our Q2 financial performance, after which Phil will review recent market developments, and Patrizio, Phil, and I will take your questions.
In my remarks, I will focus mostly on the sequential quarterly changes for P&L and balance sheet items, and refer you to our press release or our upcoming Form 10-Q for additional information. As stated in today's press release, Vicor recorded total revenue for the second quarter of $106.7 million, up 9.1% sequentially from the first quarter of 2023, total of $97.8 million, and up 4.5% from the second quarter of 2022, total of $102.2 million. Advanced Products revenue increased 31.6% sequentially to $67.5 million, while Brick Products revenue decreased 15.7% sequentially to $39.2 million. Shipments to stocking distributors decreased 0.5% sequentially and increased 47.6% year-over-year.
Exports for the second quarter increased sequentially as a percentage of total revenue to approximately 68.1% from the prior quarter's 64.3%. For Q2, Advanced Products share of total revenue increased to 63.2%, compared to 52.4% for the first quarter of 2023, with Brick Products share correspondingly decreased to 36.8% of total revenue. Turning to Q2 gross margin, we recorded a consolidated gross profit margin of 51.7%, which is a 410 basis point increase from the prior quarter. During the quarter, we recovered approximately $2.8 million in duty drawback of previously paid tariffs. We continue to work to reduce overall tariff expense and recover previously paid duty drawback. I'll now turn to Q2 operating expenses.
Total operating expense increased 3.4% sequentially from the first quarter of 2023 to $37.3 million. The sequential increase was primarily due to an increase in R&D spending. The amounts of total equity-based compensation expense for Q2 included in cost of goods, SG&A, and R&D was $570,000, $1,626,000, and $816,000, respectively, totaling approximately $3 million. For Q2, we recorded operating income of $17.9 million, representing an operating margin of 16.7%. Turning to income taxes, we recorded a tax provision for Q2 of approximately $2.5 million, representing an effective tax rate for the quarter of 12.9%. Net income for Q2 totaled $17.1 million.
GAAP diluted earnings per share was $0.38, based on a fully diluted share count of 44,906,000 shares. Fully diluted EPS increased approximately 52% sequentially, compared to $0.25 in the first quarter of 2023, and increased approximately 58% from $0.24 per share earned in the same quarter a year ago. Turning to our cash flow and balance sheet, cash and cash equivalents totaled $203.8 million at Q2. Accounts receivable net of reserves totaled $63.8 million at quarter end, with DSOs for trade receivables at 43 days. Inventories, net of reserves, decreased 0.7% sequentially to $106.6 million. Annualized inventory turns were 2.1. Operating cash flow totaled $19 million for the quarter. Capital expenditures for Q2 totaled $8.5 million.
We ended the quarter with a construction-in-progress balance, primarily for manufacturing equipment, of approximately $23 million, and with approximately $10 million remaining to be spent. I'll now address bookings and backlog. Q2 book-to-bill came in below 1, and one-year backlog decreased 19.9% from the prior quarter, closing at $217.3 million. Turning to the third quarter of 2023, we expect revenue and gross margin to be approximately flat. We also expect a sequential increase in operating expenses, primarily as a result of funding the legal work associated with cases filed earlier this month at the International Trade Commission and in federal court in the Eastern District of Texas against foreign manufacturers of power modules and computing systems infringing Vicor patents, covering non-isolated bus converters, NBMs. Legal work associated with these cases and related legal expenses are expected to grow substantially over the next year.
Legal expenses are, however, less than the royalties paid to Vicor by licensees of our patents. In our ITC case, we are seeking an exclusion order, precluding importation into the United States of power modules, servers, or AI cards that infringe our patents. In our district court case, we are seeking damages for willful patent infringement. With that, Phil will provide an overview of recent market developments, and then Patrizio, Phil, and I will take your questions. I ask that you limit yourselves to one question and a related follow-up, so that we can respond to as many of you as possible in the limited time available. If you have more than one topic to address, please get back in the queue. Phil?
Phil Davies (Corporate VP, Global Sales and Marketing)
Thank you, Jim. Let me begin by summarizing the key messages from the annual shareholders meeting we held in Boston four weeks ago. Our business opportunities have never been stronger, given the future growth of AI and the move to 48-volt power distribution in both the high-performance computing and automotive markets. Our investments in 48-volt power distribution and power conversion technology over the past 15 years have put Vicor in a unique position with intellectual property to key innovations in power distribution architectures, including Factorized Power and Vertical Power Delivery, powertrain topologies, control systems, and power module packaging technology. Our new and the world's first ChiP fab is coming online in September, setting the stage for unprecedented scalability as we start shipping initial quantities of vertically integrated chips to lead customers for their qualification.
Our lateral vertical distribution network provides superior performance for advanced GPUs, strengthening our position as the supplier of high-performance power systems in HPC markets. In short, as an earlier generation AI program using our third-generation Factorized Power chipset ramps down, our fourth-generation chipset is expected to start shipping in Q4 into a next-generation AI platform in a lateral or lateral vertical PDN. The lateral vertical PDN will provide nearly 10% higher power system efficiency and superior processor performance. Advanced processes currently in development require current levels that can only be supported with Vertical Power Delivery through complex, stacked VPD structures that Vicor pioneered and patented. With a 300% advance in current density, Vicor's fifth-generation technology enables a more mature and scalable second-generation VPD, which will soon be key to high-performance AI accelerators.
Electrification and autonomy are opening up other markets for us, including industrial, aerospace, and defense markets. Our commitment to a set of top 100 customers globally, achieving operational excellence, supported by our new ChiP fab, is the focus of our entire company, and execution is now the name of the game. Thank you. Patrizio, Jim, and I will now take your questions.
Jim Schmidt (CFO)
Operator, we're ready for questions now.
Operator (participant)
Your Q&A session will now begin. If you would like to ask a question on the Webex, please click on the Raise Hand icon at the bottom of your screen. If you'd like to ask a question on the phone, please press star and three. We will pause for a moment to assemble the queue. The first question is coming from Quinn Bolton. Please proceed. Your line is open.
Quinn Bolton (Managing Director and Equity Research)
Jim, Phil, Patrizio, can you guys hear me?
Jim Schmidt (CFO)
Yes.
Quinn Bolton (Managing Director and Equity Research)
Okay, great. First question is, can you guys share any more details on the 4G lateral power distribution design that you mentioned in the press release for a new AI platform that ramps in the fourth quarter? Can you say, is this a new customer, or have you worked with this customer previously? Can you give us any sense of what the power consumption is for this card? Is it a, you know, a high power card? Is it a mid-range power card? Any details you can share would be very helpful.
Patrizio Vinciarelli (CEO)
It's an existing customer. It's a new generation for the existing customer. It's a chipset that can be deployed either in a lateral PDN, which is substantially handicapped from a power system perspective, to the point that it limits power delivery, power capability, processor performance, in that it gives rise to large losses within the copper of the substrate, to the GPU that it powers. It gives rise to further losses within the silicon itself, owing to the limitations of lateral power delivery applied at the 1,000 amp level.
With a 4G chipset, we can enable a lateral solution with the same handicaps, or with a vertical element using the same chipset, a lateral vertical solution, which is unique, highly differentiated, in that it improves system efficiency by about 10%, and removes a number of limitations relating to processor performance.
Quinn Bolton (Managing Director and Equity Research)
Patrizio, I guess to follow up, it sounds like it can be deployed either lateral or lateral vertical. Can you say, is the solution going to production in the fourth quarter, is that lateral first, with the potential to switch to lateral vertical sometime next year?
Patrizio Vinciarelli (CEO)
It is likely to be lateral first, followed by lateral vertical.
Quinn Bolton (Managing Director and Equity Research)
Great. You had mentioned sort of, lateral vertical improves efficiency by 10%, and I think in the press release you said that would enable a, you know, 100 W power saving. Am I right to be thinking that this AI platform could be consuming nearly 1,000 W? Is that the right ballpark?
Patrizio Vinciarelli (CEO)
I'm not going to comment about, you know, the power consumption of the platform, beyond that which is implied in the earlier comments, which is that, to your point, we expect to save in total about 100 watts, which approximately represents a 10% improvement in system efficiency. You know, one should keep in mind that, while 10% in some respects may not sound like a lot, it is a lot in a number of respects that, you know, are somewhat technical and that, would be, in effect, somewhat difficult to articulate in sufficient detail in this context today.
You know, whether it's the gradients or voltage differentials across a pin field brought about by lateral current flow across distances on a substrate with substantial resistance, dissipating a substantial amount of power, or the self-heating within that substrate that is caused by the power dissipation of the substrate and the silicon die, what we're really talking about is something we have discussed before. You, you might recall my pointing to these kinds of limitations and challenges many, many months ago. It, it's just indicative of fundamental stumbling blocks to what can be accomplished with conventional technology and its constraints within the realm of a power distribution network that is lateral.
Quinn Bolton (Managing Director and Equity Research)
Understood. I'll go back in the queue, let somebody else ask the question. Thank you.
Patrizio Vinciarelli (CEO)
Thank you.
Operator (participant)
The next question is coming from the line of John Dillon. Please proceed. Your line is open now.
John Dillon (Research Analyst)
Hello?
Patrizio Vinciarelli (CEO)
Hey, John.
John Dillon (Research Analyst)
Can you hear me? Yeah, can you hear me?
Patrizio Vinciarelli (CEO)
Yes.
John Dillon (Research Analyst)
Okay, great. Yeah, I want to follow up on Quinn's question a little bit.
Patrizio Vinciarelli (CEO)
Could you speak up a little louder?
John Dillon (Research Analyst)
Yeah. Can you hear me now better? Regarding the lateral vertical opportunity that's coming to production in Q4, is that a high volume customer, or is it more of a lower volume or more of a modest volume customer?
Patrizio Vinciarelli (CEO)
To be clear, I suggested earlier, the same chipset, which is a 4G chipset, supports both the lateral and lateral vertical. Based on customer inputs or expectation, as of now, is that the lateral implementation will go first, and that's the one we're anticipating for the Q4 ramp. I can't tell you when the other vertical would go into production, but my expectation is that it would be after the latter.
John Dillon (Research Analyst)
Is this gonna be a significant customer, or is this more of an incremental volume that you're gonna expect to see?
Patrizio Vinciarelli (CEO)
This is a significant customer.
John Dillon (Research Analyst)
Great. Great. That's excellent. Okay. Patrizio, do you think your bookings are gonna rebound strongly upon completion and the qualification of the new factory?
Patrizio Vinciarelli (CEO)
We expect bookings to pick up as in particular, the platform we just referenced ramps. Because of other contributing elements, not least of which, to your point, bringing online our first fab, it's from history, we've had operational challenges and capacity limitations. Within the last couple of years, with Advanced Products relying on unique processes that had to be outsourced. Common sense in and of itself, it would imply that as we overcome these stumbling blocks and bottlenecks, and being capable of delivering the kinds of solutions that we're uniquely equipped to provide, that bookings and backlog will build back up quite substantially.
I know there may be a concern at this point in time in the minds of some shareholders. For whatever it's worth, it's not my concern.
John Dillon (Research Analyst)
Excellent. I'll get back in the queue. Thank you so much.
Operator (participant)
There's one more question coming from Quinn Bolton on the Webex. Please proceed. Your line is open now.
Quinn Bolton (Managing Director and Equity Research)
Patrizio, I guess I wanted to ask you about the recent actions, legal actions against Delta Electronics and Foxconn, I guess both with the ITC and in the Texas courts. You know, it seems like at least your A large GPU manufacturer in the industry, current sources modules from Delta Electronics on its latest generation platform, and I guess I'd like to know, what do you think the potential effect on your relationship with this GPU manufacturer might be to the extent you're going after one of its power module suppliers?
Patrizio Vinciarelli (CEO)
I'm not going to be specific for obvious reasons, but, as implied by, you know, public disclosures, and you can read the complaint at the ITC, it's not that difficult to get to it and, you know, find out for yourself. We do have licensees of the technology, and those licensees were prudent enough to acquire a license and put themselves in a position where they could, you know, source products, including NBMs, that would otherwise infringe our patents, you know, without incurring the risks of infringement. You should not assume when it comes to data center or AI OEMs, that they're all in the same boat. One notable one is not, because it acquired the license.
The other ones, are going to have to deal with, the issues that arise when, for manufacturers, as scruples as they are, copy, products, that, are covered by effective, intellectual property.
Quinn Bolton (Managing Director and Equity Research)
Understood. Thank you. Just to clarify, the Andover qualification, do you still see that as on track for September? At the shareholder meeting, I think you said that you anticipated an increase in the number of customer visits and customer qualifications as you got into the third quarter here. You know, is that customer qualification and, you know, is that still on track, those customer audits? Thank you.
Patrizio Vinciarelli (CEO)
We've had customer visits, and we've had praise for, you know, what we're doing, the progress with respect to it. Going back to the first part of your question, yes, we are on track to make complete modules in September, late August, September. Essentially starting about one month from now. You know, we're going to be able to, you know, play that any chip.
Quinn Bolton (Managing Director and Equity Research)
Excellent. Thank you very much, Patrizio.
Patrizio Vinciarelli (CEO)
Thank you.
Quinn Bolton (Managing Director and Equity Research)
I'll go back.
Operator (participant)
All right, I will start taking questions on the phone now. If you press star and three, please state your name and company name before asking your question. The first attendee line is open now. Please proceed.
Don McKenna (Financial Advisor)
Hi, Patrizio, this is Don McKenna, D.B. McKenna.
Patrizio Vinciarelli (CEO)
Good afternoon.
Don McKenna (Financial Advisor)
I wanted to follow up on the 4G chipset coming on. When we're talking now, we're roughly, a backlog is roughly six months' worth of current run rates. What are you quoting for lead times at this point in time? Do you expect, if you're gonna ramp in the fourth quarter, that you'll be receiving these orders in the third quarter?
Patrizio Vinciarelli (CEO)
We already have backlog for the upcoming ramp, but we expect to get additional backlog. Maybe.
Phil Davies (Corporate VP, Global Sales and Marketing)
Yeah.
Patrizio Vinciarelli (CEO)
Phil, do you wanna comment on that?
Phil Davies (Corporate VP, Global Sales and Marketing)
I think that's exactly right. We have existing backlog, our plan is to obviously begin the ramp with that particular backlog. Then in Q3, Q4, we'll get increased bookings for the follow on 2024.
Don McKenna (Financial Advisor)
All right. Have you already seen, because your backlog is down now, are you quoting shorter lead times? Has that, in turn, you know, generated additional bookings for you?
Patrizio Vinciarelli (CEO)
Let's put things in perspective. We're still playing catch up. We're going to be completing the catch up play this quarter. You know, we're still with respect to orders that were placed quite some time ago because of the capacity bottlenecks that again, we're aware of and I reminded us of earlier in the call. You know, we're still playing catch up. While that is the case, and that's going to come to an end relatively soon, our lead times are still long. Once we get caught up, and which is imminent, and once we have the benefit of being in control of our destiny with, you know, our first fab, then lead times will come down.
Don McKenna (Financial Advisor)
I guess the concern is, you know, when you look at with the bookings this past quarter, we're somewhere in the, what, $55 million range. You know, do you foresee a period where the revenues for the quarter are going to diminish, or do you see them continuing to increase as we're going forward?
Patrizio Vinciarelli (CEO)
I think Jim pointed out that we expect essentially flat revenues this quarter. That's our expectation. Again, to put things in context, if we go back quite some time, we've had an anomalous situation with respect to bookings, and we pointed this out a year and a half ago, with very long lead times and capacity bottlenecks, and also in light of general industry conditions. You know, we had book-to-bill ratios of nearly two, which are obviously not sustainable. There's a process that has been going on for some time, with a timescale literally of a year, a year and a half, of building up the backlog, now bringing it back down to a sustainable level where additional bookings will bring the backlog back up.
In terms of our terms business and the relationship between the backlog and projected revenues, right now, we're not in an uncomfortable position. Obviously, we had a lot more backlog a year ago, again, that was an anomaly rather than a sustainable condition.
Don McKenna (Financial Advisor)
Understood. I'm sure you can appreciate our concern or nervousness, if you will, when we see that the incoming orders are so much lower than the revenues for the quarter, and I just hate to see any dips along the way.
Patrizio Vinciarelli (CEO)
I sympathize with in effect, the concern or the nervousness. It's certainly justifiable. Again, it's very important when dislocations of this kind, as have happened over the last year and a half, take place to be in a safe harbor with an objective view of all of the relevant factors, right? As pointed out by Phil in his earlier comments, Vicor is uniquely positioned because of the convergence of technological trends that we anticipated, invested in, and are uniquely equipped to explore. That's the safe harbor that we're operating from. That is the basis for looking forward, as suggested in my quotes to the press release, for sustained growth and, improving profitability.
Don McKenna (Financial Advisor)
Thank you.
Operator (participant)
All right, I will now take the second phone question. Please state your name and company name before asking your question. Your line is open now.
Jon Tanwanteng (Managing Director)
Hi, good afternoon. Thank you for taking my questions. It's Jon Tanwanteng with CJS. I was wondering if there was any more color or detail behind why the lateral implementation of the product, so this new AI product will be launching first. Has there been a delay in the lateral vertical? You know, any more commentary would be helpful there.
Phil Davies (Corporate VP, Global Sales and Marketing)
I'm sorry, John, I didn't fully get your question there. You're coming through a little bit muffled. Can you repeat?
Jon Tanwanteng (Managing Director)
Hi, can you hear me better now?
Phil Davies (Corporate VP, Global Sales and Marketing)
Yes.
Jim Schmidt (CFO)
Yeah.
Jon Tanwanteng (Managing Director)
Yeah. I was wondering why the lateral-only version of this new product is launching first, compared to the higher performing lateral vertical product?
Patrizio Vinciarelli (CEO)
The lateral version, even though the start of its development was over a year after the start of developments based on multi-source, multi-phase, quote, unquote, "competitive alternatives," that was, in effect, predicated on the same kind of PDN that the multi-phase, multi-source solutions are, in effect, confined to. Because of the fact that its development, even though it was belated, still started early in time, it is gathering to the finish line ahead of a more advanced PDN, which we had it projected to have the benefits it's proving out to have. Because of the fact that that only got started about six, seven months ago, from a development perspective, it is following on the heels of a lateral vertical solution that had been started nearly a year earlier.
It's rapidly catching up, and it's proving out to be as good as we had advertised it to be. In my belief, because of its much stronger trends, again, in terms of not just power system performance, but processor performance...
Jon Tanwanteng (Managing Director)
Mm-hmm.
Patrizio Vinciarelli (CEO)
it will soon, I believe, play, you know, catch up and become, the solution of choice.
Phil Davies (Corporate VP, Global Sales and Marketing)
Yeah, Jon, it's Keith. Patrizio said this earlier, it's exactly the same chipset, which is key for the lateral and the lateral vertical. It's a much improved layout, better PDN with lateral vertical, placing one of the VTMs underneath the processor that gets the benefits. We can do that because the packaging is very thin, very thermally adept, so it's got a lot of advantages being the same chipset that gets qualified for the lateral.
Jon Tanwanteng (Managing Director)
Can I ask? When you actually launched the lateral vertical product with the same chipset, does that get you a higher dollar content, per, you know, AI card for this, for this product?
Phil Davies (Corporate VP, Global Sales and Marketing)
No, the chipset has been quoted for over a year now, and that chipset is a price, fixed price, and that goes for lateral or lateral vertical implementations.
Patrizio Vinciarelli (CEO)
The lateral vertical implementation, which had been recommended to the customer earlier but did not get started until later, delivers a lot more performance. The value proposition is much greater, particularly if you look at it in terms of anticipated processor performance.
Jon Tanwanteng (Managing Director)
Got it. Should we think of the lateral product then as a, you know, similar to a drop-in replacement for the existing multi-phase solution for, you know, as a second source, and maybe your lateral vertical product, a higher performance, higher precision, higher efficiency type SKU, which may launch later?
Patrizio Vinciarelli (CEO)
The lateral solution using the same chipset is not, quote, unquote, "a drop-in," because with different components, you know, the layout itself is different. It shares a common lateral PDN, given fundamentally the floor planning that had been done, which floor planning was again predicated on a multi-source, multi-phase solution. You know, we're first, in effect, within the same general floor plan, fitting in a solution which is better in many respects, much lower noise, better performance, in general, but handicapped by the lateral PDN.
That handicap is a common denominator limitation that can be overcome, as Phil pointed out a moment ago, by, you know, taking one of the VTMs that supports, you know, the primary high current output and redeploying it to, into a vertical position, close to the center of the GPU. In that location, it can do wonderful things in terms of not just reducing PDN loss for the primary output, but also slash the PDN losses in the secondary and tertiary outputs that are also very high current by large percentages, and with that, improve overall system performance.
The outcome of all this effort, which it could have started earlier, but it did not get started until 6 months ago, will be a superior system with better performance.
Jon Tanwanteng (Managing Director)
Understood. I'll jump back to queue. Thank you.
Operator (participant)
The next question is coming from the line of John Dillon. Your line is open now.
John Dillon (Research Analyst)
Guys, can you hear me a little better now?
Patrizio Vinciarelli (CEO)
Yes.
John Dillon (Research Analyst)
Okay, great. Phil, the last conference call you discussed, the lateral vertical, that you've got a number of designs that were coming out in the third quarter, I believe. One sounds like was your high-volume customer, existing customer that's doing a re-spin that you talked about. You had, I think, five other designs that were supposed to come out. Are they still coming out, or are those slipped? Are they coming out as vertical lateral or vertical? I mean, or lateral.
Phil Davies (Corporate VP, Global Sales and Marketing)
John, those are lateral designs. The processor currents there are lower. They're slightly lower performance applications, different types of workloads. The customer count there is about the same, four to five customers, but those are lateral implementations. Again, using basically the same technology.
John Dillon (Research Analyst)
You expect those to start production in the third quarter also?
Phil Davies (Corporate VP, Global Sales and Marketing)
No, I expect those to be in production mostly like Q1 of next year.
John Dillon (Research Analyst)
Okay. Are those things that you have bookings on orders for already, or will we see the bookings next quarter for those?
Phil Davies (Corporate VP, Global Sales and Marketing)
We have a small amount of backlog, you know, maybe a few million dollars, just the early prototype-type quantities for initial ramps, and then I expect the bookings for those to be Q3, Q4.
John Dillon (Research Analyst)
But they're not as high volume as the other order that you were talking about, correct?
Phil Davies (Corporate VP, Global Sales and Marketing)
Correct.
John Dillon (Research Analyst)
Excellent. Okay, when do you expect 5G to actually be production ready?
Patrizio Vinciarelli (CEO)
We expect to have demo systems, in Q4, for internal validation and begin to share with some select customers in Q1.
John Dillon (Research Analyst)
Like, when would you expect that your customers would be able to take those and then ship those to their customers? Are we talking Q2, Q3 of next year?
Patrizio Vinciarelli (CEO)
As you know, there's a gestation period, right?
John Dillon (Research Analyst)
Absolutely.
Patrizio Vinciarelli (CEO)
Yeah, availability to customers, their own design cycle, which has characteristic time constant of, you know, in round numbers, a year.
John Dillon (Research Analyst)
Yeah.
Patrizio Vinciarelli (CEO)
We should not expect, you know, 5G to be a contributor to revenues in 2024. I think the reasonable expectation with respect to 5G contributing to revenues is 2025. Having said that, I would say the following. You might have heard me say this at the shareholders meeting. With 5G, we are enabling a much more scalable designing process. I do expect to have a number of notable applications that have had challenges with high current solutions, where once again, unscrupulous competitors have been chasing our truck in terms of our first-generation Vertical Power Delivery. I do expect those to run into trouble because they're immature ways of enabling a Vertical Power Delivery system.
With our 5G technology, we have a much better way of implementing VPD without stacking at the power system level. There could be situations sometime next year, say in 2024, where we could intersect or come to the rescue of customers that find themselves once again in trouble because of a variety of technical or IP challenges.
John Dillon (Research Analyst)
Gotcha. We may see a competitor come out with a vertical system, but there are IP challenges, and there's also technical challenges that you think they're going to run into?
Patrizio Vinciarelli (CEO)
They have both technical problems, and they have IP problems.
John Dillon (Research Analyst)
Why would a customer go with a solution?
Patrizio Vinciarelli (CEO)
Technical problems they get with NBMs.
John Dillon (Research Analyst)
Why would a customer go with a solution like that if they're technical and IP problems?
Patrizio Vinciarelli (CEO)
To some extent, I think the industry is going to go through a period of revelations, right? You know, whether it's a technical issue or it's intellectual property issue, OEMs are dependent on their suppliers to be able to follow through on solutions that can be shipped and that work technically or work in terms of, you know, ownership of intellectual property that is at the heart of their solution. Failure to be able to support the customer, an OEM customer, on either one of those fronts, is going to bring about a revolution in the industry. That's my expectation.
John Dillon (Research Analyst)
Great. Thank you very much.
Operator (participant)
All right. I will open the next phone question now. Please proceed, your line is open.
Alan Hicks (Research Analyst)
Oh, hello?
Patrizio Vinciarelli (CEO)
Hello.
Alan Hicks (Research Analyst)
Can you hear me?
Patrizio Vinciarelli (CEO)
Yes.
Alan Hicks (Research Analyst)
I had a question about, is the factory fully up and running? Are you going to be able to hit the ground running in the fourth quarter with this new customer, and fully meet their demand?
Patrizio Vinciarelli (CEO)
To be clear, the factory as a whole is. It has been up and running. My earlier comments with respect to the turn on of certain equipment and processes starting at the end of August and into September, those capabilities are incremental capabilities that we haven't had vertically integrated. They're expected to be vertically integrated in the next two months before the end of this quarter. That will give us, as I mentioned earlier, total control of our destiny with respect to Advanced Products, in particular, that are dependent on those packaging process steps. You know, there are many other facets of capacity for which we have made significant investments.
You know, as reflected in all the capital equipment that you're seeing, being added, within the last year and a half, that have already been deployed and validated.
Alan Hicks (Research Analyst)
In Q4, do you expect more of a gradual ramp or really move the needle on revenues?
Patrizio Vinciarelli (CEO)
Well, I think we're going to have a ramp. We have the capacity in the equipment to support that ramp.
Alan Hicks (Research Analyst)
Mm-hmm. Okay. Then a question on your gross margins are up over four points this last quarter. What do you attribute that to?
Jim Schmidt (CFO)
This is Jim here. That's a function of leverage associated with the volume, increase in volume, and also a favorable mix. We also have the benefit of lower freight in and tariff costs, net of the $2.8 million duty drawback, as well as a reduction in outside processing costs. All of that added up to improvement in the gross margin.
Patrizio Vinciarelli (CEO)
Increased sales.
Jim Schmidt (CFO)
Yes, increased royalties as well.
Alan Hicks (Research Analyst)
Okay. That was my next question. You had two royalties last quarter. What were your royalties this quarter? They seem to be ramping pretty much, pretty fast over last year. Is that going to be lumpy, or is that going to continue to grow?
Jim Schmidt (CFO)
I think, you'll see it in the Form 10-Q when we file on August 4th.
Patrizio Vinciarelli (CEO)
Let's reserve judgment on that, right? Let's put it this way. As you heard us say, over the last 15 years, we've made major investments in the hundreds, several hundred million in, you know, technology, all that it takes to bring it about. Thus far, what we've seen with respect to ROI, in terms of licensing intellectual property, is still early stage in terms of both the number of OEMs involved and their use of that technology. We should expect to see those numbers go up. You used the word lumpy. Yes, it could be lumpy at times.
We'll have to wait to see how events unfold with respect to the assertion of IP and, you know, the campaigns that we're embarked upon to make sure that it gets fully respected.
Alan Hicks (Research Analyst)
Okay. Thank you very much.
Operator (participant)
I will take the next phone question now. Please proceed. Your line is open.
John Dillon (Research Analyst)
My question was answered. Thank you, though.
Operator (participant)
All right, I will open the next question. Your line is open. Please proceed.
Don McKenna (Financial Advisor)
Patrizio, can you give us an estimate of the dollar value of the lost sales due to the infringement?
Patrizio Vinciarelli (CEO)
Well, so I'm not sure-
Don McKenna (Financial Advisor)
I shouldn't say can you. I say, should say, will you?
Patrizio Vinciarelli (CEO)
I'm not sure I even can, never mind whether or not it makes sense to go into those kinds of details. Again, the NBM issue is the first issue to be dealt with, and it is significant. Again, from NBMs, we're deriving licensing income as well in a growing amount. I do expect that the value we have built in IP in the next 10 years is going to be a strong contributor to our top line and even more so to our bottom line. You know, beyond that very vague statement, it would be really inappropriate of me to make predictions because there is a variety of scenarios and a broad range of outcomes.
I think we need to take a wait-and-see attitude. We do have a very well thought out plan. We've taken the time necessary to think it through in every respect, and we just began executing it. Let's wait and see what happens.
Don McKenna (Financial Advisor)
Okay, fine. Thank you.
Operator (participant)
All right, the next phone line is open now. Please proceed. All right, we'll move to the next question. Your line is open. Please proceed.
Jon Tanwanteng (Managing Director)
Hi, it's Jon Tanwanteng again. I was wondering if you expected margins to stay at the current levels organically, or is there some part of the clawback that is changing, as you move forward, number 1. I have a follow-up after that.
Jim Schmidt (CFO)
I think we just say, Jon, as I said in the guidance, we expect gross margins to be approximately flat as well. There is going to be a declining rate of...
Jon Tanwanteng (Managing Director)
It, it-
Jim Schmidt (CFO)
There is gonna be a declining rate of duty drawback because part of it was front-end loaded at recovery of years' worth of tariffs that would have been paid in the past.
Jon Tanwanteng (Managing Director)
Understood. The underlying margin should be increasing going forward, if that's the case? Understood. Okay, where do you actually expect litigation expense to be in the coming quarters, compared to this quarter, or however you wanna phrase it?
Patrizio Vinciarelli (CEO)
We're not going to be very quantitative about that beyond what Jim said at the outset, which is, we're going to have significant legal operating expenses. There may be more actions brought. We need to take a wait-and-see attitude with respect to the next year.
Jon Tanwanteng (Managing Director)
Understood. Last one for me, just the orders for the next generation products that you're talking about, the lateral vertical products, do you need your factory to be fully qualified before you see those orders, or can you ship those currently with the existing capacity, regardless if the factory is qualified or not?
Jim Schmidt (CFO)
No, I think the two pretty much line up, right? Qualification is occurring in the next 4 weeks, and so we're moving forward, you know, into Q3, Q4 on the new program. It's about the same timing, so it lines up pretty well.
Jon Tanwanteng (Managing Director)
Understood. Thank you very much.
Operator (participant)
The next one is coming from Quinn Bolton. Your line is open.
Quinn Bolton (Managing Director and Equity Research)
Hey, guys, just wanted to ask a quick follow-up on this new AI platform that you mentioned before. Should we think about that as sort of a new SKU or Vicor, a sole source through the Factorized Power, and hopefully over time, you can convert it to the lateral vertical solution? Will there be a second SKU of this product based on multi-phase, and multi-phase and Factorized Power will sort of share that business going forward?
Patrizio Vinciarelli (CEO)
We've been allocated a share of what you might call the baseline platform. That's something that, again, can be supported from a power system performance perspective, using a lateral PDN and the capacities, okay. Again, we have proven that the lateral vertical is a far superior PDN, with major improvements in efficiency. We're not talking. I mean, typically, you know, power components or power systems, you know, within a certain type of PDN, differ by one, two percentage points of efficiency. What we're talking about is a 10% difference, so it dwarfs, you know, the minimal differences that often characterize different kinds of components, right.
It's a fundamental difference in the way the power system is architected from the PDN perspective, with major benefits with respect to system performance. You can, and I can independently speculate as to what OEM's customers would wanna do with that. I don't know that I would know, or that if I did, I could tell you.
Phil Davies (Corporate VP, Global Sales and Marketing)
Yeah, one thing I'd want to say, Quinn, would be, our job is to obviously give our customer options, right? I think the lateral vertical gives the customer a great option in terms of increasing performance for its GPUs that are limited by the lateral PDN. Again, it's very important to remember, it's about 100 watts savings per AI card. You have 8 of these in a rack system. That's 800 watts of power savings. It's huge. You can really start to go after GPU performance with those savings. We've given customer options. We'll see what happens.
Quinn Bolton (Managing Director and Equity Research)
Understood. Thank you.
Operator (participant)
We have our very last question coming from John Dillon. Please proceed.
John Dillon (Research Analyst)
Thanks, guys. Follow-up to Quinn's question. With this new customer, or this existing customer, I mean, that is going initially with vertical and then, I mean, initially with lateral, then lateral vertical, can will that customer see an improvement in performance with your lateral solution, your lateral-only solution? Will they still have, you know, problems with resets and throttling the clock?
Phil Davies (Corporate VP, Global Sales and Marketing)
What we've seen and reported back to us from the engineering teams looking at this is that, our version of lateral is a better version. It's higher performance.
John Dillon (Research Analyst)
They won't see the degradation as much as they're seeing with the multi-phase solution?
Phil Davies (Corporate VP, Global Sales and Marketing)
Yeah. I it's a better solution, let me put it that way.
John Dillon (Research Analyst)
Okay.
Patrizio Vinciarelli (CEO)
You know, just to be clear, the PDN tends to be an equalizer, right? If you've got enough of handicap, it tends to play a handicapping role all around. That's really the elephant in the room, is the handicap associated with the PDN.
John Dillon (Research Analyst)
Correct. It sounds like your lateral solution, lateral only, is gonna give a little bit better PDN than the existing solution. Am I correct in assuming that, or am I hearing that, or?
Patrizio Vinciarelli (CEO)
Let me ask it this way. I would not expect the differences in performance between a lateral, multi-source, multi-phase, and a lateral Factorized Power system at these current levels, to be all that significant on the scale of the benefit of the lateral vertical. In other words, the lateral vertical removes the handicap that is fundamentally limiting our system capability and processor performance.
John Dillon (Research Analyst)
Correct. I'm trying to understand why the customer would switch from their current multi-phase solution to your lateral solution as an interim. Why wouldn't they just wait for your lateral vertical?
Patrizio Vinciarelli (CEO)
The lateral gets started earlier, even though it gets started late.
John Dillon (Research Analyst)
Yeah.
Patrizio Vinciarelli (CEO)
It still gets started earlier than the lateral vertical.
Phil Davies (Corporate VP, Global Sales and Marketing)
They need suppliers, John. They need suppliers.
John Dillon (Research Analyst)
Okay, they need suppliers, too. Gotcha. Okay. Okay, it sounds like, is this truly the end of the line for multi-phase? I mean, multi-phase keeps making improvements. I'm just wondering, is this really the end of the line for that?
Patrizio Vinciarelli (CEO)
I-
Phil Davies (Corporate VP, Global Sales and Marketing)
Sorry, John. Did you get that?
Patrizio Vinciarelli (CEO)
No.
Phil Davies (Corporate VP, Global Sales and Marketing)
The end of the line for multi-phase.
Patrizio Vinciarelli (CEO)
Yeah. Is it... No, it's not the end of the line for multi-phase, right? It's.
John Dillon (Research Analyst)
I mean, for power levels, it is now.
Patrizio Vinciarelli (CEO)
Multi-phase has been around for a long time, and it will not suddenly die. There is a role for multi-phase. You heard me say this before, it can't keep up with the performance of a Factorized Power system, particularly leveraging our 5G components with a 3x step up in current density and much better performance all around. Nor can it keep up with the industry demands with respect to escalating current requirements at decreasing voltages for, you know, all the competing AI systems that are under development, are going to be brought to market over the next few years. I see a fundamental disconnect between what the systems are going to need and what a multi-source, multi-phase can support, particularly as we get into full Vertical Power Delivery type of systems. A fast Lateral, even fast Lateral Vertical.
As you get into a full vertical system, these kinds of solutions, the multi-phase, multi-source, are going to be constrained, you know, from complexities, challenges of what we call first generation VPD, which Vicor pioneered, patented, but we have left behind with our 5G approach, which makes the whole VPD solution much simpler, much better, much more cost effective. There are handicaps at different levels standing in the way of multi-phase. It's the multi-phase power conversion methodology, the averaging down as opposed to the current multiplication. It's also the PDN, and then there is a VPD element to it, with related IP issues that is also standing low.
John Dillon (Research Analyst)
Gotcha. With the higher current levels, you really don't expect to see the multi-phase making much progress?
Patrizio Vinciarelli (CEO)
I don't expect it to go away. I think, it's going to remain an alternative, but I am confident that the technology gap between the Factorized Power system solutions using earlier generation components, on the one hand, and our 5G chipset capabilities, that technology gap relative to multi-phase, as improved as we should all expect it to be. Those improvements are not going to be able to keep up with the step up in performance that we're going to deliver next year with 5G.
John Dillon (Research Analyst)
Thank you very much, guys. Good call.
Patrizio Vinciarelli (CEO)
Thank you.
Phil Davies (Corporate VP, Global Sales and Marketing)
Okay. Thank you, everyone. Operator, I think we're ready to end the call now.
Operator (participant)
All right, everyone, that concludes your webinar for today. Thank you for joining. Have a nice day.