Earnings Call Transcript - VICR Q3 2023

Operator, Operator

Welcome, everyone to today's webinar entitled Vicor Earnings Results for the Third Quarter Ended September 30, 2023. My name is Jono and I'm your producer for today. I would like to advise all parties this conference is being recorded. And now, I would like to hand it over to Jim Schmidt, Chief Financial Officer. Please go ahead.

Jim Schmidt, Chief Financial Officer

Thank you. Good afternoon and welcome to Vicor Corporation's earnings call for the third quarter ended September 30, 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 third and nine months ended September 30. This press release has been posted on the Investor Relations page of our website, www.vicorpower.com. We also filed the 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 28, 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, October 24, 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 Q3 financial performance, after which, Phil will review recent market developments, and then 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 third quarter of $107.8 million, up 1% sequentially from the second quarter of 2023 total of $106.7 million, and up 4.6% from the third quarter of 2022 total of $103.1 million. Advanced Products revenue decreased 13.5% sequentially to $58.4 million, while Brick Products revenue increased 26% sequentially to $49.4 million. Shipments to stocking distributors increased 50.5% sequentially and 81.5% year-over-year. Exports for the third quarter decreased sequentially as a percentage of total revenue to approximately 62.8% from the prior quarter's 68.1%. For Q3, Advanced Products share of total revenue decreased to 54.2% compared to 63.2% for the second quarter of 2023, with Brick Products share correspondingly increasing to 45.8% of total revenue. Turning to Q3 gross margin. We recorded a consolidated gross profit margin of 51.8%, which is a 10 basis point increase from the prior quarter. I'll now turn to Q3 operating expenses. Total operating expense increased 7.7% sequentially from the second quarter of 2023 to $40.2 million. The sequential increase was primarily due to R&D spending and an increase in legal fees, which will remain at substantial levels through the completion of the investigation by the International Trade Commission of the unlawful importation into the United States of modules and systems that infringe the asserted Vicor patents. The amounts of total equity-based compensation expense for Q3 included in cost of goods, SG&A, and R&D was $693,000, $1,788,000, and $977,000 respectively, totaling approximately $3.5 million. For Q3, we recorded operating income of $15.7 million, representing an operating margin of 14.6%. Turning to income taxes. We recorded a tax provision for Q3 of approximately $1 million, representing an effective tax rate for the quarter of 5.9%. Net income for Q3 totaled $16.6 million. GAAP diluted earnings per share was $0.37 based on a fully diluted share count of 45,187,000 shares. Fully diluted EPS decreased approximately 3% sequentially compared to $0.38 in the second quarter of 2023 and increased approximately 825% from $0.04 per share earned in the same quarter a year ago. Turning to our cash flow and balance sheet. Cash and cash equivalents totaled $227.8 million at Q3. Accounts receivable net of reserves totaled $62.6 million at quarter end, with DSOs for trade receivables at 42 days. Inventories net of reserves decreased 1.9% sequentially to $104.6 million. Annualized inventory turns were 2.1. Operating cash flow totaled $23.8 million for the quarter. Capital expenditures for Q3 totaled $7.7 million. We ended the quarter with a construction in progress balance primarily for manufacturing equipment of approximately $26 million and with approximately $16.7 million remaining to be spent. I'll now address bookings and backlog. Q3 book-to-bill came in below 1 and one-year backlog decreased 19.6% from the prior quarter, closing at $174.7 million. Turning to the fourth quarter of 2023. With the reduction in backlog, including overdue backlog, we are more dependent on turns orders, and that results in less visibility to our near-term outlook. While that is the case, our current expectation is that revenue, gross margin, and operating expenses will be approximately flat sequentially. With that, Philip 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 Davies, Corporate Vice President, Global Sales and Marketing

Thank you, Jim. Let's begin with an update on our high-performance computing or HPC business, which will continue to be our major growth driver in the next few years. For the next few quarters, we will be focusing on three key areas. The first will be ramping production of our Gen 4 48-volt bus converter and factorized power point-of-load products in our new ChiP fab. The second will be completing development of our Gen 5 factorized power point-of-load solutions and delivering models and tools in Q1 of 2024. The third will be continuing to expand our customer base beyond the major accounts that dominated our revenues in the HPC market over the past five years. Regarding revenues in HPC, we expect customers using both lateral and lateral-vertical Gen 4 products to be in production through 2025 before introducing new processes, utilizing Gen 5 vertical power delivery or VPD solutions midway through 2025. In reference to the expansion of our customer base, we have continued to have substantial discussions with large data center, AI, and network processor companies on their challenges in powering next-generation high-current products. All of these companies recognize they need scalable access to more adept power system technology to effectively address the technical and operational challenges of generative AI at scale. The one major technology challenge that is foremost in everyone's minds and heard repeatedly was power density and power delivery. Power delivery to the processors, power delivery to the AI accelerator cards, and their rack systems. And last but not least, power delivery to the data centers while driving towards a carbon-neutral objective. HPC customers are becoming aware that our current Gen 4 lateral-vertical solutions can reduce power losses in an AI-enabled data center by 1 to 3 megawatts while enabling high processor performance. Future processes will, however, require full vertical power delivery or VPD to continue power loss reduction. Vicor's first-generation VPD solutions introduced in 2020 required complex stacked packaging to incorporate bypass capacitors in a gearbox layer due to insufficient current multiplier density. Putting their customers at risk, competitors are going down the same route with even lower current density based on multi-cell multiphase solutions running into greater mechanical and thermal challenges as they try to deploy VPD using thick, heavy, and thermally inefficient stacked packages. Our Gen 5 MCM technology steps up current density by over 3x and reduces the multiplicity of bypass capacitors needed, eliminating a stacked capacitive layer and enabling a second-generation VPD solution to the power system requirements of the AI card that is thinner, more thermally adept, reliable, and cost-effective. Customer engagements for our Gen 5 VPD solutions are happening at an accelerating pace. And our objective in the coming quarters will be to secure significant design wins. In view of the current density and performance gaps enabled by our 5G solutions and evolving AI-powered system demands, I am confident that within a few years, we will gain a dominant share of the AI power system market. One of the major objectives in the design and development of our 5G product line was to have a scalable, low-cost, short-cycle time and vertically integrated ChiP fab with a short time frame for capacity expansion. We will need this capability to meet the supply chain demands of our customers, who are in two distinct groups at the moment based on different priorities. The first group where the priority is supply chain flexibility is focused on a multisource, multiphase VR technology, and the second group, where the priority is competitive advantage from product performance is focused on the power system attributes needed to enable superior AI. Due to competitive market forces, our belief is that the first group will soon embrace the level of innovation and scalability enabled by 5G power system solutions from a multiplicity of ChiP fabs. I am very pleased with our progress in other key markets, which are critical to developing a robust and flexible business portfolio of our own. We have reached a very important milestone in our automotive business development, achieving PPAP qualification for three of our platform power modules for 800 volts to 48-volt power conversion, which enables production for these products in the second half of 2024. As in previous quarters, we continue to develop new collaborations with OEMs and Tier 1 suppliers who value lightweight, high-density power system solutions. These collaborations will enable design wins for 2026 production and beyond. Towards the end of Q3 and early into Q4, we have seen demand strengthen in our broad industrial, aerospace, and defense markets for both large OEMs and smaller customers who purchased through our channel partners. Demand in China remains weak for both legacy brick and Advanced Products. And we have been shifting our focus in recent quarters towards the Korean and Asia Pacific markets, where we see new opportunities for our advanced power modules across a broad range of industries. Our new sales and marketing team in Japan has been making excellent progress, developing new pipelines of opportunity with large industrial automation accounts, and are on track to add significant revenues in the coming years. Momentum with our operational excellence initiatives continues with teams working on specific performance improvements with our top 100 customers. And with new products set to launch in Q4 and Q1 of 2024, we are on track to meet our OGSM goals. Customer visits from our top 100 accounts to view or audit our new ChiP fab have been averaging one per week in recent months. This pace will pick up in 2024 as we ramp production and have the ability to host more customers. Visitors have left impressed with our new fab and its capacity and scalability. They understand their need to access our fab capacity for power systems with power density and performance attributes that cannot be supported by multi-source multiphase solutions that cannot keep up with our current density and PDN flexibility. They also understand our commitment to operational excellence that's clearly reflected in the equipment, process, and systems of our ChiP fab.

Jim Schmidt, Chief Financial Officer

Okay. Operator, we're ready for questions now.

Operator, Operator

And the first question is coming from Jon Tanwanteng.

Jon Tanwanteng, Analyst

First one, I was just wondering how qualifications have gone at the new facility. Can you talk about when you'll start shipping volume through the vertical plating capacity and kind of the initial demand that you're seeing and the response that you're seeing from customers?

Patrizio Vinciarelli, Chief Executive Officer

I think we had trouble hearing part of your question. Could you repeat it, please?

Jon Tanwanteng, Analyst

Sure. I was wondering how the qualification process went for the initial customers for the new vertically integrated plating capacity and when you expect to start shipping volume on that new equipment.

Patrizio Vinciarelli, Chief Executive Officer

Okay. So as Phil pointed out in his prepared remarks, we've had visits at an accelerating pace, frequent visits, weekly visits. As he mentioned, these visits have generally gone quite well. Visitors are impressed with the equipment, the processes, and the systems we put in place to achieve much shorter cycle times and scalable capacity. This is very evident to every visitor that has come through the fab. The fab at this point in terms of its vertical integration is what I would say essentially complete. But that's not to say that all the equipment has been delivered and installed. The strategy that the operations team has pursued in terms of enabling initial capacity has been to get the core equipment with respect to our three-dimensional integrated packaging capabilities in place while deferring some of the other measures in order to facilitate some of the challenges by some of the vendors. That automation is coming in and is getting installed over the next few months. But while we are, in effect, not totally done, we are done to a very large extent. We can, at this point, make complete units, including all of the three-dimensional package integration steps that are essential to our 4G products in terms of vertical integrating processes that have been outsourced as well as enabling our 5G platform capability, which has some very exciting new process steps.

Jon Tanwanteng, Analyst

To be clear, are you already shipping or are you still in the qualifications and maybe finishing out stages of the facilities? Are you producing out of that piece that you've been working so hard to in-source over the last year or two?

Patrizio Vinciarelli, Chief Executive Officer

We are using it for some of our in-house needs, I would say, most of our in-house needs at this point. And beginning to selectively use it for certain customers who are seeking short cycle times and rapid turnaround to service their needs, but not on a mass scale yet.

Jon Tanwanteng, Analyst

Just to follow on, Patrizio, when do you think the book-to-bill will start to creep back over 1 and do you see that your backlog is increasing again?

Patrizio Vinciarelli, Chief Executive Officer

Well, that could happen relatively soon. It could take a little longer. We're not going to make any specific prediction. I think it's a complex landscape, and there are a number of variables at play. So I think we need to be non-committal with respect to that.

Operator, Operator

The next question is coming from John Dillon.

John Dillon, Analyst

I'm wondering if you can give us a little more color on the bookings. For example, how do the bookings look for the next couple of quarters? Are we going to see sequential increases in the bookings or do you expect them to be flat or down?

Patrizio Vinciarelli, Chief Executive Officer

We may see substantial increases. Again, we don't want to be very specific because of uncertainties that are outside of our control. But there is a range of scenarios that include a pretty steep climb. But then again, it may take a while longer.

John Dillon, Analyst

Can you provide more details about the bookings? What’s happening? It seems like there might be a significant increase in bookings. I understand the concept of bookings, but more clarification on this would be appreciated.

Phil Davies, Corporate Vice President, Global Sales and Marketing

So John, this is Phil. So as Patrizio said, it's a complex landscape of older programs ramping down, newer programs coming up. There's a whole host of things out there complex-wise in terms of the deployment of next-generation solutions. So as Patrizio said, it's better to just take a little bit of a wait-and-see approach to that at the moment, given the complexities that we're looking at.

John Dillon, Analyst

I guess I understand that. The problem is there's a bunch of people who are short on the stock and the shorts are running around saying, you guys aren't going to see any bookings increase and you're out of the GPU business. Maybe you can just answer that question a little bit better because they're pretty vocal about the demise of Vicor, and they're really betting against you and the company. So I'm just wondering if you can help us out a little bit here, give us a little color on what you see as far as GPU land is concerned.

Patrizio Vinciarelli, Chief Executive Officer

John, as you know, I think you've been an investor for a long time. We don't run a company based on what the shorts might do or any near-term type of consideration. We take the long view. We are very committed. We believe we are in a very unique position, the only position that can support critical market needs. So that's how we run the company, that's how we operate. We're not going to get into any debate regarding that, which to us is quite obvious with respect to the tenure of our technology, the need for it. The customers that are literally flocking to us in terms of their next-generation AI needs, it confirms what we believe and is objectively supported by numbers such as current density and PDN flexibility, and vertical power delivery capabilities that are without equal in the industry. So that's what I think investors should be reliant upon. But obviously, they have a choice to believe us or not believe us. We believe ourselves and time will tell with respect to that.

John Dillon, Analyst

I completely understand. I was involved in programs when there was voltage drop, and I understand that all too well. And I don't know if all the investors do, but I completely understand and I'm content with the technology.

Patrizio Vinciarelli, Chief Executive Officer

So if some don't, that's going to be too bad for them. But I think we need to move on to the next topic.

Operator, Operator

And the next question is coming from Quinn Bolton.

Quinn Bolton, Analyst

I guess, first question. Last quarter, you guys seemed pretty excited about this new AI platform that you expected to ramp in the fourth quarter of '23 and throughout 2024. Can you just give us any updates on that program? How you're feeling about it? Is it still on track? Have you started to see more bookings associated for that? And a related question, there are now two platforms on the market, one by NVIDIA, one by AMD that I think both are rated at 1,000-watt TDP. It seems like 1,000 watt is kind of the key power level where you guys bring some real advantages, especially with lateral vertical. Can you confirm whether this AI platform is indeed a 1,000-watt here?

Phil Davies, Corporate Vice President, Global Sales and Marketing

So Quinn, this is Phil. So the first part of your question, I think, was what we talked about on the last call. And in my prepared remarks, I basically said that the first area of focus was to ramp in Q4, our 48-volt bus converters and factorized power solutions. So I hope that answers that question pretty clearly. The second, in terms of power, we're seeing 1,000 watt GPUs and network processors and all sorts of ASICs and mixes of CPU, GPU combos out there. As Patrizio talked about, we have the technology to address those that offers, as I mentioned in my prepared remarks as well, significant power savings with lateral vertical solutions of the scale of megawatts in data centers, which is really critical to any data center company. And with our Gen 5 technology coming along, I mean the level of engagement now is very, very high. As I said, we're having substantial conversations now with customers that will diversify us away from the two big guys that we've been doing business with for the last few years. So as I said, I'm very confident in the future and where we stand. And it's a bit of a complex landscape, as I said, because you've got new programs starting up, old programs ending. There's a bunch of other stuff going on out there with technology and product introduction. So as I say, we're confident in our position in the market.

Quinn Bolton, Analyst

I have a question regarding your legal proceedings, particularly the ITC complaints against Delta. It seems that one of your major motherboard customers has shifted to a two-stage architecture, moving away from factorized power. Delta appears to have secured some sockets from your business. Can you provide any insights into the motherboard market? Specifically, how much of that market do you anticipate will transition to two-stage architecture, and how much will remain with single-stage? It appears a significant customer has moved on from Vicor during this switch to two-stage architecture, resulting in Delta taking over the 12 or 48 to 12-volt module.

Patrizio Vinciarelli, Chief Executive Officer

So as you may know, Vicor pioneered the MBM bus converter. We have substantial IP. We've asserted three different patents coming at it from three different directions. And they're not the only patents we have that cover that technology. We have licensed it. There are OEMs that they are paying royalties for those MBMs, and they are the ones that have certainty or continuity of supply. There are other ones that have been taking chances, and those are going to go line down in the next year. That's what's going to happen.

Phil Davies, Corporate Vice President, Global Sales and Marketing

Quinn, I believe that when our Gen 5 technology is launched next year, the CPU requirements which have been increasing, reaching 500 to 600 amps for some motherboards, will prompt many customers to reconsider their two-stage approach due to the performance benefits offered by our Gen 5 solutions. I believe the market is shifting from a two-stage to a single-stage approach and will ultimately return to a single stage.

Patrizio Vinciarelli, Chief Executive Officer

Yes. I second that. So to be clear, in answer to your question, the MBM is not as much as we love it, we invested, right? But you hear it from me first, it's not the long-term solution to three-amp square millimeter, high-density VPD, scalable, robust cost-effective VPD for the next-generation AI. It is not since it's societal. It's an attempt to, in effect, drive multisource multi-phase capability that is fundamentally handicapped. it’s not really turning out to be when you get up to the kilowatt level or the 1,000 amp level. Truly multisource. It has brought about significant trade-offs in terms of performance, which are not sustainable in a competitive landscape.

Operator, Operator

And the next question is coming from John Dillon.

John Dillon, Analyst

On the last call, you stated you had a lateral and a lateral vertical opportunity to a major customer. And I was wondering if that was for the same.

Patrizio Vinciarelli, Chief Executive Officer

John, sorry to interrupt you, but it's hard, at least for me to hear what you're saying. Phil, can you hear?

Phil Davies, Corporate Vice President, Global Sales and Marketing

Yes. It's coming across a little bit muted and mumbled, John. If you can do something with your speaker there, that would be great, yes.

John Dillon, Analyst

Yes. Is this a little bit better?

Phil Davies, Corporate Vice President, Global Sales and Marketing

Yes, it is. Yes.

John Dillon, Analyst

On the last call, you stated you had a lateral and a lateral vertical opportunity with a major GPU customer. And I was wondering, was that for the same GPU, or was it for two separate GPUs?

Phil Davies, Corporate Vice President, Global Sales and Marketing

So what we talked about there was that we have lateral and lateral vertical solutions for not just one customer. We are bringing that solution forward, and we have customers looking at both of those solutions. And certainly, the number of customers looking at lateral deployments are a little bit higher than the number with lateral vertical, but we have both.

Patrizio Vinciarelli, Chief Executive Officer

And that's also the way in which systems have evolved, but make no mistake in the future and the future is coming next year. It's no longer with lateral PDNs. In fact, all of the design activities that we're engaged in at this point is beyond lateral PDN. I'm on a call with an important potential customer tomorrow. We're not even going to consider or entertain a lateral PDN. It's either lateral vertical or what we call second-generation VPD, which is a more advanced, more scalable, more robust form of VPD that falls on the heels of the first-generation VPD that Vicor pioneered and other companies have tried to copy.

John Dillon, Analyst

So, does the major customer have two different designs with you, one for a specific purpose? Are they working with that customer on two different GPUs, with one using lateral and the other using lateral vertical? Or will the same GPU be initially used in a lateral configuration and then shift to lateral vertical?

Patrizio Vinciarelli, Chief Executive Officer

John, we're not going to talk about any one customer. I'm sorry but bear with us. That's not the level of specificity that we want to get involved with.

John Dillon, Analyst

And then one last question then. When do you expect the GMs, the gross margins to improve with the new factory?

Patrizio Vinciarelli, Chief Executive Officer

Well, I think we are on a general upward trend. That's not to say that we're going to see a positive improvement each and every quarter. But we have been in the low 50% range. And I think the three of us here feel, Jim and myself, have line of sight to considerably higher numbers, partly due to the unique fab capabilities that we put in place, a considerable investment but also significantly in terms of the 5G point-of-load technology that takes us to a much stronger position in terms of not just performance but cost-effectiveness. And some of that is going to be passed along to customers in the form of more cost-effective solutions. But at the same time, those more cost-effective solutions at a lower price point in terms of cents per amp to a customer will result in substantially higher margins for Vicor.

Operator, Operator

The next question is coming from the attendee who joined over the phone. So please introduce yourself before you take your question.

Unidentified Analyst, Analyst

Hi, Richard Shannon with Craig-Hallum. I have a couple of questions. Following up on the topic of bookings, last quarter you seemed confident that backlogs would improve by the end of the third quarter or the fourth quarter. Now, it appears you’re less certain about that. If I understood one of your previous answers correctly, you’re still expecting the design with a major customer to be active. It seems there could be a few straightforward reasons for this, such as the design being delayed, your share of the opportunity being smaller than anticipated, or possibly other factors. Can you clarify these dynamics in relation to your last conference call?

Patrizio Vinciarelli, Chief Executive Officer

I think I made clear that we really don't want to go into the level of detail. And to be clear, well, I appreciate the reason for the interest, the curiosity, it's really got very little to do with Vicor's opportunity in the medium and long term. And that's what we're really focused on.

Unidentified Analyst, Analyst

I'll jump to another question. Looking a bit further ahead, Phil, I want to refer back to your prepared remarks regarding the timeframe for 5G technology ramping up. I believe you mentioned '25, if I understood your comments correctly. Is this expectation aligned with the initial ramp-up of 3-nanometer accelerators you anticipate in the market, or are there some other dynamics you expect to intersect with?

Phil Davies, Corporate Vice President, Global Sales and Marketing

No. I think that 5G is, I believe, looking at what it's capable of doing to the market, it's going to be very ubiquitous. I think we'll see design-ins, as we've talked about, even down in the low hundreds of amps because of the density and cost-effectiveness, and performance level of the technology. So it's going to be ubiquitous across all sorts of different high-performance computing markets. But with regards to what we see from a deployment perspective, '24 will be obviously a big design win year for us with an increasing number of customers and then a ramp to production in the '25 timeframe. Some customers are really in '25, other customers are sort of midway through the year. So it will be a mix and a blend of both domestic and international customers, actually. So again, that's going to set the scene for us to take really significant share in the ever-expanding AI market. That's what we're looking at right now, Richard.

Operator, Operator

And the next question is coming from Quinn Bolton.

Quinn Bolton, Analyst

I just wanted to follow up on Richard's question, Philip. If 2024 is intended as a transition year for Gen 5 design and 2025 marks the comprehensive rollout of Gen 5 technology, do you anticipate that quarterly revenue will remain relatively stable at current levels until the Gen 5 rollout, or do you believe there is potential for growth in quarterly revenue as some of the Gen 4 lateral and lateral vertical solutions are introduced to the market? I'm not asking you to pinpoint a specific quarter for growth, but rather how you view revenue over the next four to five quarters. Is the ramp-up of Gen 5 necessary for a significant increase in quarterly revenue, or is it possible to see growth sooner with Gen 4 lateral and lateral vertical solutions?

Phil Davies, Corporate Vice President, Global Sales and Marketing

Quinn, as we've mentioned, the current situation is quite intricate. However, we are confident in our Gen 5 along with the Gen 4 lateral and lateral vertical solutions. We'll monitor how things progress, but I believe that this technology is essential because you cannot overlook the potential savings in megawatts for your customers when considering deployment. This represents a crucial advancement for us towards Gen 5, and we have excellent products that we will be launching this quarter and into the next. Therefore, we have a pathway leading us to Gen 5.

Operator, Operator

The next question is coming from Jon Tanwanteng.

Jon Tanwanteng, Analyst

I was wondering, Jim, if you could break out the actual legal expense in the quarter and kind of what you expect the run rate to be as the ITC does its investigation over the next couple of quarters?

Jim Schmidt, Chief Financial Officer

Incrementally, Jon, I won't quote an exact number, but it's in the millions of dollars, and it's very substantial for us as a smaller company. But we believe it's what we're taking on because of the strength of our position.

Jon Tanwanteng, Analyst

Do you expect it to increase from what you did in the past quarter here?

Patrizio Vinciarelli, Chief Executive Officer

Yes, we're prepared to invest as much as necessary. Again, in one way of looking at this, the intellectual property side of our business is profitable, right? The operating expense relating to a certain intellectual property is more than covered by intellectual property-related income. And we expect that to continue to move in the right direction, particularly as it becomes evident to OEMs who have been taking a wait-and-see attitude with respect to how this may all play out, that they're going to be left in the lurch by companies that have stolen our technology.

Jon Tanwanteng, Analyst

Could you elaborate on the enthusiasm you're observing for the Gen 5 VPD? How does the range of customers you're engaging with today compare to where you were at a similar stage during the development of the current generation of AI processes? Would you say there is significantly more volume and opportunity now due to the increased number of competitors and the expanding size of the opportunity? Please help me understand how the opportunity for Gen 4 compares to Gen 5.

Phil Davies, Corporate Vice President, Global Sales and Marketing

Yes. The current density improvement is driven by significantly higher currents across various processes such as networking, AI, and CPU. The market is growing rapidly, especially in AI. As AI technology advances, there is a corresponding need for more CPU and networking enhancements, leading to a substantial overall increase. Our Gen 5 technology boasts three times the current density of Gen 4, and we've received impressive feedback from major clients in data centers and AI processors when they see our packaging capabilities. Their response has been overwhelmingly positive, particularly regarding how much current we can fit into a compact design. Currently, clients are focusing on vertical power delivery, and Gen 5's design allows them to avoid disturbing the capacitive layer beneath their boards by utilizing small current multipliers without mechanical or thermal concerns. The reaction to our technology has been remarkable compared to competitors, particularly those from China that have attempted to replicate our multi-chip modules but are taking the wrong approach with bulky stacked packages. Customers are recognizing the advantages of our Gen 5 technology, leading to significant excitement and confidence in capturing substantial market share.

Patrizio Vinciarelli, Chief Executive Officer

First-generation VPD is a horror show from a manufacturability perspective and from an IP perspective as well. So there too, unscrupulous foreign suppliers are putting not just themselves but major OEMs at substantial risk with respect to continuous supply, both in terms of the viability of the solution from a robustness perspective and from the perspective of viability from an IT perspective or non-infringement perspective, I should say.

Jon Tanwanteng, Analyst

So it's fair to say that the pull is much stronger on Gen 5 than it was in the Gen 4, Gen 4.5 that you have out there?

Patrizio Vinciarelli, Chief Executive Officer

Yes. I think that customers are going to get both performance and power savings. And we talked about all the advantages of reliability, of cost that add on to all of that. And with our scalable ChiP fab, we're going to be able to work with customers on flexible supply chain solutions. So we're sitting in a very good place, Jon.

Operator, Operator

Next question is coming from the attendee who joined over the phone. So please introduce yourself before you have your question.

Unidentified Analyst, Analyst

Richard Shannon from Craig-Hallum again, guys. Phil, I wanted to ask you about one of your statements in your prepared remarks here about the 5G technology and kind of targeting two different groups with different priorities here. The last part of that statement was you believe the first group will embrace level of innovation for 5G from a multiplicity of ChiP fabs. Since you only have one, at least that you've talked about, are in plan, can you parse the statement a little bit more and tell us what you mean by that and over what time frame we could see a multiplicity of ChiP fabs, please?

Patrizio Vinciarelli, Chief Executive Officer

I will attempt to address your question, although it's important to note that we lack clear visibility on this matter. Please bear with me as I provide a general answer. It required many years and significant investment to establish the first ChiP fabrication facility. This initiative resembles the semiconductor fabs that most of us are familiar with. The technical complexity and the challenges related to equipment and processes mean that bringing the first fab to fruition demands substantial time, effort, and resources. However, the positive aspect of having achieved this is that replicating the effort can be accomplished in a much shorter timeframe with a high level of predictability. While the required investment is considerable, amounting to hundreds of millions, it is relatively minor from the standpoint of original equipment manufacturers seeking sourcing flexibility based on their system capabilities and value propositions. Therefore, we expect to see more than one fab enter the market to create an ecosystem where large OEMs, unable to solely depend on the initial Vicor fab's capacity for valid reasons, will have access to power facilities for additional capacity.

Unidentified Analyst, Analyst

I will analyze that statement and ask about it later, Patrizio. I want to follow up on one of your previous answers regarding your engagement with customers who prefer vertical-only solutions, either first or second generation. Are you essentially saying that you are not encountering anyone with enough power needs, perhaps around 1,000 amps, who is interested in lateral solutions at all, or are you only in discussions with those focused solely on vertical solutions?

Patrizio Vinciarelli, Chief Executive Officer

So they are typically looking at programs on different time scales, in some cases, a few months or the better part of the year or a year and a half with different kind of requirements. And our focus is to engage where we can contribute substantial value through, in particular, 5G solutions with their unique set of attributes. And those are particularly differentiated when you get past the lateral, right? It can be lateral-vertical. We demonstrated that with lateral-vertical relative to lateral at current levels of roughly 1,000 amps, you can achieve something at the order of nearly 150 watts of PDN, both direct and indirect power savings. Those are very substantial. And those when applied across data centers, result or can result in the megawatt scale savings that Phil referenced earlier. So there is a value proposition there. And that can be done with our 4G technology, even though the current density of that technology is a small fraction of current density with 5G. So it is a bet, a lot of vertical. There is a value proposition there, and we can engage there to enable customers to achieve their objectives. But the much bigger opportunity is looking a little beyond the next few months or six, nine months. Our systems are going to go into production, as Phil said, late next year or early in '25 that we're with 5G MCMs, a few amps per square millimeter, the whole new world of capabilities that are enabled and in turn enable solutions that around go around. They've got all the attributes, right? They're scalable. They are robust from a mechanical perspective, they're robust from a thermal management perspective and they are more cost-effective.

Phil Davies, Corporate Vice President, Global Sales and Marketing

So Richard, this is Phil, just to add on to that. A couple of weeks ago, I got invited to a big data center, the company's strategic supplier day where they had their executives presenting on the future road maps and the challenges of building AI out in their existing data centers as well as adding more data centers going forward. And as you can imagine, as Patrizio mentioned here, we're talking about data centers of the 20-megawatt plus level, and getting power into those while also trying to get carbon neutral is a massive challenge. So if you look at the amount of compute that's going to be needed to support AI going forward, both on the CPU side and on the GPU or ASIC side, plus the network processing. Even if you save 10 watts or 5 watts per the CPU, that's a massive savings. When you multiply the amount of compute in a data center, it gets over megawatts very quickly. So even to save 10 watts or 15 watts in a 400 amp or 300 amp CPU motherboard, and you can do it vertically, why not do it vertically if you can offer that to your customer base. So that's the change that's going on in the market.

Patrizio Vinciarelli, Chief Executive Officer

To add to that, historically, the answer to Phil's, it's a historical question, why not do it that way? Is that you couldn't do it that way. You need technology that has got both the high current density, the high bandwidth that enables a significant fraction of the caps that historically have taken out the socket to be swept away.

Phil Davies, Corporate Vice President, Global Sales and Marketing

So power savings is going to be it as this stuff gets deployed because you can't power it. You're competing also with all the EVs out there, the same grid supports all of that plus the data center. So they're also trying to use renewables, but really significantly reducing the impact on a megawatt scale is a massive value-add for any of these data center hyperscalers. It's really important.

Jim Schmidt, Chief Financial Officer

Okay. Operator, I think we need to proceed.

Patrizio Vinciarelli, Chief Executive Officer

Maybe one more.

Jim Schmidt, Chief Financial Officer

Maybe one more question, please, and then we'll have to wrap it up.

Operator, Operator

So the last question is coming from Jon Tanwanteng. Jon?

Jon Tanwanteng, Analyst

I'm sorry. I didn't have my hand raised. That wasn't me.

Operator, Operator

Sorry. In this case, we have no more questions.

Patrizio Vinciarelli, Chief Executive Officer

Okay. Thank you.

Jim Schmidt, Chief Financial Officer

Thank you, everyone, for joining the call.

Operator, Operator

Thank you, everyone. That marks the end of your webinar. Thank you for joining, and have a nice day.