Vicor Corporation, Q2 2008 Earnings Call Transcript

| About: Vicor Corporation (VICR)

Vicor Corporation (NASDAQ:VICR)

Q2 2008 Earnings Call Transcript

August 11, 2008 5:00 pm ET

Executives

Jamie Simms - CFO

Patrizio Vinciarelli - CEO

Analysts

Ron Opel - Marston Capital

Jim Bartlett - Bartlett Investors

Steven Glass - STG Capital

Mr. Baxter - Ardour Capital

John Dillon - JB Associates

Don McKenna - D.B. McKenna & Company

Dick Feldman - Monarch Capital

Daniel Gorman - Private Investor

Operator

Good day, ladies and gentlemen, and welcome to the Vicor 2008 second quarter earnings result conference call. My name is Lutrice and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this call. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Mr. Jamie Simms, Chief Financial Officer. Please proceed, sir.

Jamie Simms

Thanks. Good afternoon, everyone, and welcome to Vicor's quarterly conference call. As mentioned, I am Jamie Simms, Chief Financial Officer; and with me today is, our Chief Executive Officer, Patrizio Vinciarelli, and our Chief Accounting Officer, Dick Nagel. Earlier this afternoon, we issued a press release outlining our financial results for the quarter ended June 30, 2008.

This press release is available on the Investor page of our website, www.vicordepower.com. We also have filed a Form 8-K with the Securities and Exchange Commission in association with issuing this press release. Before we begin, I remind all of you, today's conference call is being recorded and is the copyrighted property of Vicor Corporation. Any rebroadcast, reproduction or other transmission of this conference call in whole or in part without the prior written consent of Vicor is prohibited.

In addition, I also remind you various remarks we may make during this call about future expectations, trends, plans, prospects for the Company and its business constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are denoted by such words as will, would, believes, should, expect, outlook, estimate, plan, anticipate, and similar expressions that look toward future events or performance. These forward-looking statements merely reflect our current beliefs, expectations and estimates, which we share with you during our quarterly conference calls.

Forward-looking statements are based on current information that, by its nature, is dynamic and subject to rapid and even abrupt changes. Our forward-looking statements are subject to risks and uncertainties, which may cause actual results to differ materially from those projected or implied in our statements. Such risks and uncertainties discussed in today's press release as well as our most recent reports on forms 10-K and 10-Q filed with the SEC.

A replay of this conference call will be available beginning shortly upon its conclusion through August 26, 2008, by calling 888-286-8010 and using the pass code 44989156. In addition, a webcast replay of the conference will be available on the Investor Relations page of the Company's website, beginning shortly upon its conclusion. However, the information provided during this call is accurate only as of the date of this call. Vicor undertakes no obligation to update any of the statements made during this call, and you should not rely upon them after the conclusion of this call. Patrizio and I have each prepared remarks, after which we will take your questions. Patrizio?

Patrizio Vinciarelli

Thank you, Jamie. Good afternoon, everyone, and welcome to our second quarter conference call. As you may have seen, we announced earlier today the appointment of Jason Carlson to our Board of Directors. Jason will serve on the Board's Audit and Compensation Committees. Jason is currently CEO of Emo Labs, is set up here in the Boston area, doing some quite innovative things in audio speaker technology.

Prior to joining Emo Labs in 2006, he was President and Chief Executive Officer of Semtech Corporation, an important vendor in analog and mix signal semiconductors, largely for power management applications. Earlier in his career, he had leadership roles with Cirrus Logic, the inventor of analog and mix signal semiconductors for consumer industrial applications.

Jason has a track record of accomplishment, ranging from his role as a private company executive to being part of entrepreneurial teams that have built successful companies. Because he understands power electronics and technological innovation, two defining characteristics of Vicor, we are quite pleased to have Jason join us. Jason, I know you are listening, so allow me to publicly welcome you to Vicor.

I will now turn to Vicor's performance in the second quarter and our outlook for each of the business units. As anticipated, due to booking trends in Q1 and early Q2, Vicor's revenue for the second quarter declined as the global economy softened. Revenue from our Brick Business Unit experienced a 6% decline sequentially.

However, bookings in July came in 35% ahead of April levels, pointing to improved demands for our expanding brick product line. I am particularly pleased to report the achievement of a milestone in the evolution of our brick business with the recent booking of a $3.2 million order for the VIBricks. As you may recall, VIBricks combined the optical attributes of V-I Chips with the [tonal] management and mechanical flexibility of bricks.

This order, scheduled to ship this year, represents validation by an early adopter of the VIBrick power concept and our V-I Chip inside strategy to expand the market opportunity for our Brick Business Unit. With V-I Chips under the hood, VIBricks provide unique vehicles to grow the range of our system requirements that can best be addressed within the established brick power component and power system product line.

We expect to be expanding the VIBrick power line over the coming quarters to enable designers to take advantage of Factorized Power components in Brick-like packages. We are confident VIBricks will provide a major growth opportunity for our brick business unit, and that this market initiative is totally synergistic with disruptive products from V-I Chip and Picor.

To close on the Brick Unit, I remind listeners that we spoke last quarter regarding the prospect that brick revenue growth may be modest for the full year. As you would expect, we remain concerned about overall global economic conditions, and at this point, anticipate low single-digit growth for the Brick Business Unit in 2008.

It will take a far-reaching VIBrick product line and significant design wins to break out of the approximately $20 million in annual revenues to which the brick unit has been recently anchored.

In the interim, despite the declining Q2 revenue, the brick's unit gross margin as a percentage of revenue actually increased from the Q1 levels, while generating the cash flow to finance continuing investments in V-I Chip and in Picor.

Next, I will comment on our V-I Chip unit, which is central to our strategy to achieve widespread adoption of component-based Factorized Power system solutions. We emphasized last quarter the circumstances involving a major V-I Chip program getting postponed, so it should not be a surprise that V-I Chip revenue declined roughly 27% from the prior quarter.

Nevertheless, we are making progress with other programs and anticipate record V-I Chip revenue for the second half. And we also anticipate closing 2008 of essentially double the level of revenues for 2007. As discussed, we had planned to be ramping higher levels of V-I Chip shipments in Q2. Having put infrasture in place to meet this anticipated demand, our V-I Chip unit continues to absorb the cost of underutilized production capacity, and accordingly, generated a higher operating loss in Q2.

Also, a number of our expense categories are higher as a percentage of revenue than we had planned, as we've been adding headcount in important areas such as applications engineering. However, we consider these expenses as investments in the future. We are confident that V-I Chip will experience robust growth in 2008, 2009, and 2010, and improved its gross margin with economies of scale.

Our confidence is based on specific visibility to design wins with early adopters of Factorized Power, as well as the ongoing expansion of relationships with licenses and partners. This will bring about a global presence and facilitate widespread adoption of V-I Chips and Factorized Power as de facto standards in key end markets.

I am also pleased to report that Picor, our fabless semiconductor unit, recently introduced its first family of Cool-ORing, Power Path Management products, addressing the requirements of redundant power architectures for high availability systems such as [IANT] computing, telecom, communication, and wireless infrastructure.

Cool-ORing power management products reduce power disaffection, eliminate the need for costly thermal management, and reduce bore level real estate versus conventional Active ORing solutions. The introduction of this product family is a significant first step in Picor synergies the product roadmap.

To conclude my prepared remarks, as said in our press release, we are disappointed to experience a net loss for the second quarter. However, temporarily high R&D expenses, increases in applications engineering and marketing headcount, as well as the marginal drag posed by underutilized capacity, represent appropriate investments in development of our products and markets.

As discussed last quarter, we expect overall revenue growth may remain modest until the first half of 2009. However, early adopters have embraced our ability to address the power needs with our performance for components as building blocks of efficient power distribution and power systems.

Vicor is well capitalized, and with our Brick business model and the momentum we are seeing in these rapid technology products pioneered by V-I Chip and Picor, very well positioned for the future. I will now turn the call over to Jamie, who will address our P&L and balance sheet in some detail. Jamie?

Jamie Simms

Thank you, Patrizio. Company revenues for the second quarter of $49.3 million, decreased 7.8% on a sequential basis from $53.5 million for the first quarter of 2008, but increased from 54.4% from $47.2 million for the corresponding year-ago period.

As Patrizio mentioned, our Brick Business Unit experienced a roughly 6% decline in revenue from the first quarter of '08, but generated roughly the same level of revenue it had in the second quarter of '07. As stated, there was no particular product, market, region, or customer that was noticeably or notably weak for the second quarter, and our belief is that revenue decline due to broadly-based economic weakness. Notably our Power Systems business conducted largely through our Vicor integration architect units has experienced improved performance for the first half of the year with both revenue growth and margin improvement.

While we benefited somewhat from the decline of the relative value of the U.S. dollar in 2007, our international sales as a percentage of sales actually declined slightly from 43.4% to 41.8% from the first to the second quarter. In contrast, international sales represented 37.6% of sales for the second quarter of 2007. I should point out that the decline of the dollar is a two-edged sword, as we have operations and personnel around the world, and the associated in-country costs are, of course, denominated and paid in local currencies.

The book-to-bill ratio for the second quarter of 2008 was just above unity at 1.01 to 1, a slight improvement over the 0.99 to 1 ratio for the first quarter of 2008, but below the 1.09 to 1 ratio for the second quarter of 2007.

Our backlog at the end of the second quarter of 2008 was $46.3 million as compared to $46.1 million at the end of the first quarter of this year. Our gross margin in absolute dollar terms increased to $21.1 million for the second quarter from $22.5 million for the first quarter -- excuse me, I said decreased to $21.1 million for the second quarter from $22.5 million for the first quarter, but increased from the $19.6 million earned for the corresponding period a year ago.

Our gross margin as a percentage of revenue increased on a sequential basis from 42% for the first quarter to 42.8% for the second quarter, compared to 41.5% for the second quarter of 2007. As always, product mix factors into any period's gross profit margin, but the overall strength of our gross margin is a result of our ability of our manufacturing team to adapt quickly and efficiently to changed requirements.

We continue to pursue reduced bond cost and part count, reduced cycle times, reduced manufacturing overhead, and overall manage our costs quite well. For the second quarter, we incurred an operating loss of $765,000, down sequentially from first quarter's operating profit of $897,000.

The operating loss was largely a consequence of reduced revenue for the quarter, as many of our operating expenses do not vary with sequential changes in revenue. Some categories of expense, for example, applications in engineering for V-I Chip, have increased so that we can provide support to our broadening customer base.

Research and development expense, which is largely associated with our V-I Chip unit, increased sequentially, but the increase for the quarter was largely associated with development activities that should not be re-occurring. Therefore, we expect to spend a dollar amount on R&D in both the third and fourth quarters of this year, similar to what we spent in Q1.

Our net loss for the second quarter was $1,323,000 or $0.03 per diluted share compared to net income of $620,000 or $0.01 per diluted share for the first quarter of 2008, and net income of $974,000 or $0.02 per diluted share for the corresponding period a year ago.

The second quarter net loss reflects substantially lower interest income, resulting from lower investment balances and lower interest rates, especially related to our holdings of illiquid auction rate securities. Vicor generated cash from operations of approximately $3.8 million, down 11.3% from the $4.3 million generated in the first quarter of 2008.

Turning to the balance sheet, we have no debt and believe we have more than adequate resources and liquidity to fund our operations while paying a recurring dividend. Our cash in short-term securities totaled $35.7 million, down from $39.8 million at the end of the first quarter of 2008.

Please note for the second quarter presentation, we reclassified cash and cash equivalents that are restricted by bank covenants, totaling $919,000 as long-term assets. As discussed last quarter, as of March 31, we reclassified as long-term assets, the illiquid auction rate securities that had been carried as short-term.

In accordance with accounting guidelines, we have valued these securities again this quarter, and booked an additional temporary impairment of approximately $250,000, bringing the total temporary impairment to $2.25 million.

Management considers this difference between carrying value and par value to be temporary, and has recorded the amount as an unrealized loss, no taxes, in accumulated other comprehensive loss or income, which is in the stockholders equity section of our balance sheet. As such, the impairment was not a charge on our income statement for the quarter.

Management is not aware of any reason to believe any of the underlying issuers of the auction rate securities held are presently at risk of default. We've continued to receive interest payments in accordance with the terms of the securities. Management believes the Company ultimately should be able to liquidate all of its auction rate security investments without significant loss, primarily due to the collateral securing a substantial majority of the underlying obligations.

However, current conditions in the auction rate securities market have led us to conclude that the recovery period for the securities exceeds 12 months. As many of you may have seen, there have been many recent headlines regarding settlements between investment banks that had acted as market makers for these auction rate securities and notably, the Massachusetts and New York Attorney's General regarding the resolution of outstanding balances.

We have not yet been contacted formally by either of the investment banks with which we had invested, regarding resolution of our specific circumstances, but based on the significant steps being announced by many of the investment banks involved, we are hopeful we will have some sense by the end of the year of when and how we will become liquid. This concludes management's prepared remarks, so we're happy to take your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of [Ron Opel] from Marston Capital. Please proceed, sir.

Ron Opel - Marston Capital

Good afternoon.

Patrizio Vinciarelli

Good afternoon.

Ron Opel - Marston Capital

The prospect of doubling V-I Chip revenue for this year, does that include an assumption that the large order that had been pushed out will come in during the second half? Or is it possible that you would double the V-I Chip revenue without that order?

Patrizio Vinciarelli

We expect to double the V-I Chip revenue without that order.

Ron Opel - Marston Capital

Is that order still potentially in place?

Patrizio Vinciarelli

Yes. The timing of it, though, slipped out at the beginning of this year and the prospect with respect to that is still uncertain. So, in our current plans, we are not factoring in any immediate business from that particular program. But fortunately, other programs have been progressing at the fastest pace; and in fact, it has our forecast, still looking for an essential double in top line for V-I Chip for the year.

Ron Opel - Marston Capital

Does this represent -- will this be going to the markets that you have been talking about in general?

Patrizio Vinciarelli

Yes. It has to do with the markets where we have achieved early penetration and not respectively on a program or program basis, some programs progress faster than expected and other programs take at least some temporary setbacks.

Ron Opel - Marston Capital

And I'm wondering if you would be willing and/or able to expand on the comment in the press release about confidence being based on ongoing expansion of relationships with licensees. Specifically, with respect to continuing prospect for license revenue this year and any other color that you could give us concerning those licensees and partners?

Patrizio Vinciarelli

There is progress on several fronts. There has been no change with respect to our outlook since we last spoke at the end of the first quarter. There are activities on different fronts with different licensees and these initiatives bode well for the medium and the long-term. There is no appreciable current income from any of the licensing initiatives that we have in place. In one instance, or a couple of instances, the accounting treatment for some initially can be such that they get spread out over a 15-year timeframe. So, we're looking at the opportunities with respect to these initiatives as bearing fruit as time progresses.

Ron Opel - Marston Capital

Thanks. I'll get back in the queue.

Operator

And our next question comes from the line of Jim Bartlett. Please proceed, sir.

Jim Bartlett - Bartlett Investors

Yes, just a follow-up on Ron's question, so I understand that the deferred order, you said you do not expect to get it this year. Do you still expect that to come to fruition?

Patrizio Vinciarelli

We expect a reception of activity with respect to that particular program, the timing, as I mentioned in answer to Ron's question, is uncertain. We can only speculate that the economic environment plays a role with respect to that particular program. Even though with respect to other programs in a similar market, things have actually progressed better than anticipated. And I would also like to point out that the expectation of doubling revenue for V-I Chip this year is taking place, again, in spite of the setback in that particular program. So, it is suggested that on average, our expectations were pretty much on track.

Jim Bartlett - Bartlett Investors

Great. Just to follow up on the VIBricks, certainly that $3 million order is a terrific order. Was that one you referred to was an early adopter in the last conference call that for some time in October, I believe, it was mentioned?

Patrizio Vinciarelli

Yes, I think in the last conference call, we made some vague reference to two prospects for brick products based on V-I Chips under the hood. And we've, in the month of July, received a first order. I think in the last quarterly call, I had anticipated a production start in October and it now looks like the production start is going to be in September.

Jim Bartlett - Bartlett Investors

Great. You also mentioned that you'd had tremendous interest in the website activity on VIBricks and were hopeful that it was genuine customer interest. Could you just give us a time line on what you think for the VIBrick revenues in terms of one with the existing product line you have now? And then also maybe a sort of a time line on what other products do you need to flesh out the Brick V-I product line?

Patrizio Vinciarelli

There is consensus that a major component of our VIBrick product line is going to be a product that we expect to have late this year that involves an AC/DC capability in both V-I Chip and VIBricks form. When it comes to the big marketplace that AC/DC product capability greatly expands the market opportunity, not just in terms of an AC/DC system, but also in terms of providing empowered connectivity from the wall plug to the point of load through a complete Factorized Power system capability. So, we anticipate that that is going to be a very significant product introduction and product development in terms of the big market.

Jim Bartlett - Bartlett Investors

And you said you expect that both for the brick and the V-I Chip later this year?

Patrizio Vinciarelli

Yes.

Jim Bartlett - Bartlett Investors

Great. Thank you very much.

Operator

And our next question comes from the line of Steven Glass from STG Capital. Please proceed.

Steven Glass - STG Capital

My question has been answered, but thank you.

Operator

And our next question comes from Mr. Baxter from Ardour Capital. Please proceed.

Baxter - Ardour Capital

Thank you. You had talked about rolling out some of the new V-I Chip inside or in the brick business. How long do you see it taking before most of the brick business has the new products rolled out?

Patrizio Vinciarelli

Until most of the brick…

Baxter - Ardour Capital

However much of the brick business you are focusing on rolling out with new V-I Chip technology, how long do you see this rollout occurring over the next three, four, five quarters or…?

Patrizio Vinciarelli

Okay, so to be clear, with respect to our legacy big business, we don't anticipate any significant change with respect to that. And we don't anticipate any cannibalization of that business. That business inherently has a very long time scale associated with it as we all recognize, given our -- in effect, how long the product life cycle has been for our legacy bricks. So, what we are talking about here is an expansion of capabilities associated with a VIBrick power line that builds up on V-I Chips through a V-I Chip inside or a V-I Chip under the hood strategy.

What's been rolled out thus far are very early products that are based on having on the inside our very first generation V-I Chip. And these are only full chips. There is no half chips or double chips. They are only first generation chips in the realm of AC to DC power conversion. As mentioned earlier, in answer to the earlier question, we anticipate that the AC to DC V-I Chip and VIBrick capability by providing a level of connectivity that does not exist today will greatly expand the market opportunity.

That is an imminent event. It's an imminent event in a variety of ways, in terms of bricks that perform the basic AC/DC function as well as configurable products that at the system level leverage the V-I Chip capability. And we expect that JAW capability to begin to be a factor in terms of expanding the reach of the Brick Business Unit in calendar 2009.

Baxter - Ardour Capital

All right, thank you. And I guess one other follow-up, the Cool-ORing with Picor was described as a first step in this roadmap. Can you just give some broad brushstrokes of that roadmap going forward?

Patrizio Vinciarelli

Well, I wouldn't want it to in effect take the wind out of the sails of Picor with respect to their roadmap from a competitive perspective or other perspective. So, we are going to have to be patient and wait until after the product gets announced and released and to make additional disclosures with respect to that. Suffice it to say that from my point of visibility, this is a very exciting product roadmap, but as suggested in the press release, is very complementary in many ways to other initiatives that were in place leveraging capabilities on a scale that is smaller than V-I Chip's and quite complementary to it.

Baxter - Ardour Capital

All right, thank you.

Operator

And our next question comes from the line of [John Dillon with JB Associates]. Please proceed, sir.

John Dillon - JB Associates

Patrizio, a follow-up question to your AC to DC comments. Just the other day, I had a micro-TSA chassis and it had an external 350 watt power supply. And the 350 watt AC to DC power supply was about 88 cubic inches or 11 inches by 4 inches by 2 inches. Is your brick business going to be able to significantly reduce the size and weight of those power supplies?

Patrizio Vinciarelli

Yes. As you can infer from what has been disclosed already with respect to our focal point in terms of the AC/DC effort, which has been flat-panel display applications in the 300 watts range, what we're able to do in terms of thickness and overall volume and power and density far exceeds the capability of some conventional technology. So, those same developments, as relevant as they are in the consumer electronics space with respect to 13 displays in different ways and to some extent, for other reasons, are significant in other end markets, the industrial market, other markets, where a denser, more efficient AC/DC power system capability has long been needed.

John Dillon - JB Associates

Are you talking about cutting that size in half or by down to (inaudible) about one-quarter of the size of this thing?

Patrizio Vinciarelli

Well, that to some extent depends on power levels. Because the figures are made of AC/DC power conversion are very much dependent on power level. So to get a little bit more quantitative, low power levels, a power density of 5 watts or 10 watts per cubic inch may be considered state-of-the-art today at higher power levels, the power density with conventional technology might extend out to 20 watts per cubic inch. With V-I Chip technology, we can enable power densities far in excess of either of the above.

John Dillon - JB Associates

Okay. I'm looking forward to seeing that, because the market really needs something like that. Can you give us an update on the LCD status? Has anything changed on that since last call?

Patrizio Vinciarelli

No, things are progressing along. We recently made some very good progress in terms of simplification and cost reduction, the attainment of the application, performance goals. And so, things are progressing well.

John Dillon - JB Associates

What was the first flat channel display (inaudible)?

Patrizio Vinciarelli

As we discussed in the last quarterly call, the earliest that would have happen would be in the 2009 timeframe. And with respect to more specific plans and forecasts with respect to that, we're going to have to take a little bit of a wait-and-see attitude.

John Dillon - JB Associates

Okay. In regard to that, you were talking about with the LCD market, you had a power supply that could actually put out different voltage levels. And it seems like there is a real need for the market in that, because you have the current FPGA's which can take a couple of different voltage levels and associated memories can take a couple more. Will you have a chip that will be available for, let's say, a micro-TSA card or a PCI express card that will be able to be cost-effective and have multiple voltage levels?

Patrizio Vinciarelli

Well, with the LCD TV application, we have targeted a chip set solution that comprises an AC/DC chip that is referenced as the PFN, and the multiple output regulator chip, [DMOR] that provides a multiplicity of as many as five outputs. And this targeted the class of applications again in the LCD TV space. When it comes to other application requirements, that technology can be adapted to address those requirements.

The PFN is common than any other chip, is a common denominator devised that we expected to establish a de facto standard in the marketplace. The point of low device that confers the output of the AC/DC V-I Chip into a single app with our multiplicity of outputs that are required by specific applications, that is dependent on the application requirements. And for that particular purpose, depending on the volume of the application, if the volume isn't large enough to justify the development of a tailored chip, or standard PRM, BTM based solutions can be deployed to deliver the required voltage.

And in some cases that maybe attainable even without involving a BTM just from the applicator appearing. So, depending on the application requirements, Factorized Power systems can be deployed to advantage in order to provide whatever multiplicity or outputs are required by the application. And depending on the volumes, there is the ability to achieve economies of scale by developing a tailored chip, particularly when it comes to a multiple app requirement.

John Dillon - JB Associates

Thanks.

Operator

And our next question comes from the line of Don McKenna with D.B. McKenna & Company. Please proceed, sir.

Don McKenna - D.B. McKenna & Company

Patrizio, I wanted you to go back if you would, to the brick business and if you took out that $3.2 million order that you received, would I be reading that right that the rest of the business would be running about 10% ahead so far this quarter from what you normally anticipate?

Patrizio Vinciarelli

I'm not sure I can interpret that. You're referencing the July bookings rate?

Don McKenna - D.B. McKenna & Company

Yes.

Patrizio Vinciarelli

The July bookings rates being 35% ahead of April. So, you have netted out the 3.2.

Don McKenna - D.B. McKenna & Company

Right.

Patrizio Vinciarelli

I don't have a specific percentage increase. I think your back of the envelope math is probably as good as I could make out in real-time here. But I can tell you, in general terms, that even in the absence of that order, the bookings rate for what you might call legacy products took a turn for the better in July. And in fact, as I look at what we call the field factor for Q3 and Q4 and the balance of the year, because of the level of activity in July, which was quite robust overall, it is much improved relative to where we stood at this time last quarter.

Don McKenna - D.B. McKenna & Company

Thank you. And on the V-I Chip, if we expect to still double, that would anticipate then about a 50% increase in revenues in the second half over the first?

Patrizio Vinciarelli

It would anticipate, let's see, I don't have a precise number on the top of my head…

Jamie Simms

It's supposed to grow but it's not a double.

Patrizio Vinciarelli

I think at this quarter it represents roughly a 50% to 60% increase from the Q2 level.

Don McKenna - D.B. McKenna & Company

Great. Well, thank you very much.

Operator

And our next question comes from the line of Ron Opel from Marston Capital. Please proceed sir.

Ron Opel - Marston Capital

Patrizio, do you see the possibility or the likelihood of applying your well established mass customization capability to VIBricks and V-I Chips?

Patrizio Vinciarelli

Well, the mass customization capability would be a logical attribute for VIBricks, not a logical attribute for V-I Chips. A way of thinking about this is that the chips require very significant development. And the good news is that once that investment is made, they become common denominator building blocks for a variety of power system requirements. And that is where the mass customization opportunity of VIBricks comes about. So, mass customization is really to do with, in effect, taking common denominator out of V-I Chips and configuring them through higher level assemblies, i.e. VIBricks, into the complementary requirements to meet an application that can leverage those devices in a brick-like format, or in a configurable product platform.

Ron Opel - Marston Capital

I realize this is possibly competitively sensitive, but can you say whether or not that $3.2 million order for VIBricks is for a consumer electronics market?

Patrizio Vinciarelli

No, it is not for the consumer electronics market but I cannot say anything beyond that. So, it is not for consumer electronics.

Ron Opel - Marston Capital

Okay. And just one final question, you haven't mentioned there's not been a lot of conversation in the recent past about -- or in the press release, let me put it that way, about automated testing markets. Do you still have strong expectations for applicability of the new technology in these markets? And do you see the likelihood of orders coming in?

Patrizio Vinciarelli

Yes. We see activity as mentioned I think most recently in the Q1 conference call. We see strong activity with most significant companies in that space, in the U.S., in Japan, it is a national fit for V-I Chips and Factorized Power. It enables capabilities that competitively are very attractive to every one of these companies. As you know, that is a very competitive marketplace. And enabling faster throughput at lower noise levels, greater capabilities is very important. And that is one reason why it is being targeted early on by the V-I Chip marketing team as an important market for early adopters and early penetration.

Ron Opel - Marston Capital

And have you identified any new potential high-volume V-I Chip applications over the course of the last quarter or so?

Patrizio Vinciarelli

In the test market?

Ron Opel - Marston Capital

No, in general.

Patrizio Vinciarelli

In general? I would have to think a little while, probably longer than I can in real time here…

Jamie Simms

I don't think anything that wasn't already on the whiteboard.

Patrizio Vinciarelli

Yes. I think pretty much we've had a good sense of where the early opportunities lie in the order progression. I think our marketing team is exercising, our V-I Chip marketing team, good discipline with respect to going after these markets and these opportunities in an orderly fashion, as implied by earlier remarks with respect to the level of adding expenses. We have made significant hires, particularly on the applications engineering front, a lot of new people and a lot of talented additions to expand their bandwidth with respect to holding customer's hands and supporting the application efforts and computing in the test market and the other markets that are being prioritized by the V-I Chip marketing team.

Ron Opel - Marston Capital

Okay, thanks very much.

Operator

And your next question comes from the line of Jim Bartlett from Bartlett Investors. Please proceed, sir.

Jim Bartlett - Bartlett Investors

Just following up on the new hires you mentioned. What was the headcount at the end of the second quarter and how would that compare with the first quarter and year-end?

Patrizio Vinciarelli

I don't have headcount for V-I Chip in front of me. But I can tell you off the top of my head that in terms of the applications engineering people, they more than doubled in the last eight or nine months. In fact, I had lunch today with one new hire that just joined us. We have been investing in good resources, greater capabilities there because of the need for that bandwidth to expand the rate of progress with respect to a variety of customer applications.

Jim Bartlett - Bartlett Investors

And what's the absolute number?

Patrizio Vinciarelli

For the applications group or in general for V-I Chip?

Jim Bartlett - Bartlett Investors

Yes, V-I Chip and the applications group.

Patrizio Vinciarelli

Well, the growth in the applications group has been on a percentage basis far greater than for V-I Chip as a whole. And the underlying reason is simple, we feel that that's important in order to accelerate the rate of growth and be able to keep up with customer needs. Overall for V-I Chip has been a more modest increase. I can't be very confidant with respect to that. But percentage wise, for V-I Chip as a whole, it's not been all that significant for the applications engineering team; it's been over 100%.

Jim Bartlett - Bartlett Investors

And one of the areas that you've been very, very positive on is the high end server market. When you're referring to that, could you give us an idea of what kind of price point are you talking about and unit volume in that market?

Patrizio Vinciarelli

Well, I'm not sure…

Jamie Simms

Price points for us or price points…?

Jim Bartlett - Bartlett Investors

No, price point of the server market that you're serving. When you say high end servers, how are you defining that?

Patrizio Vinciarelli

Well, those are basically large systems with a relatively high price tag, in the multimillion dollar category.

Jamie Simms

This is your high availability, high performance computing, typically a blade architecture. And the systems themselves are $50,000 plus type price points.

Jim Bartlett - Bartlett Investors

Okay. You're saying over $50,000, then?

Jamie Simms

Right.

Patrizio Vinciarelli

In notable cases, well above that

Jim Bartlett - Bartlett Investors

Yes. No, I understand that as you're defining that.

Jamie Simms

But this is not your garden variety white box business. This is sophisticated high end performance, high availability computing. In some cases, we are talking to customers in the realm of fault tolerance, and these are very expensive, mission-critical applications that they're being sold into.

Jim Bartlett - Bartlett Investors

It would be fair to say that you're talking with or have programs with a multiple number of vendors?

Patrizio Vinciarelli

We have expanded into a longer list of customers in that space. So, as you might expect, success is spelled success. And looking at it from a different perspective, what is good for one customer in terms of figures of merit of relative performance advantages that Factorized Power can bring about, tends to be good for further applications and other customers. So, as we're seeing with the test market, suggested in an earlier answer, a broadening set of applications with a broadening customer base.

Jim Bartlett - Bartlett Investors

Great. Thank you.

Operator

And our next question comes from the line of John Dillon with JB Associates. Please proceed, sir.

John Dillon - JB Associates

Patrizio, your gross margins for the next couple of quarters, do you expect those to continue to increase?

Patrizio Vinciarelli

Well, let's look at it by business units. The big business unit actually expanded its margins in Q2 in spite of a temporary setback in the top line. So, with an expanding top line subject to the vagaries, as pointed out by Jamie in his earlier prepared remarks of product mix -- subject to that, I would expect because of this expansion top line and further expansion in gross margin, which are quite good for a matured business such as legacy bricks.

With V-I Chips, as suggested in the prepared remarks, a 50%, 60% increase in throughput should make for a significant improvement in terms of absorption of fixed costs, infrastructure costs in establishing a step in the right direction in terms of material usage and material cost efficiencies, even though the timescale for that particular development and not the absorption of the overhead, but the material component, that's obviously a longer timescale, because what is really going to make a difference with respect to that is not a 50% change in the volume of materials but a 10-fold change in the volume of materials. So, given also the economics when it comes to building material costs in the electronics marketplace.

John Dillon - JB Associates

Do you have target TM for, let's say, the fourth quarter?

Patrizio Vinciarelli

I don't think it would be wise for us to pick any particular number. I think that the earlier comments about it being a positive trend in both the Brick business unit and V-I Chip is as far as we can go at this point.

John Dillon - JB Associates

Okay, thank you.

Operator

And our next question comes from the line of Dick Feldman with Monarch Capital. Please proceed.

Dick Feldman - Monarch Capital

I have a question about VIBricks. One, what would the gross margins be on VIBricks compared to the legacy product? And I have a couple of follow-ons.

Patrizio Vinciarelli

So, there are two components to that. There is the V-I Chip margin component and then there is the VIBrick component, if you will. That has to do with, in effect, turning the bare chips into a break. So, I can tell you that the margin contribution from the second element should be good from the very beginning. The margin contribution from the V-I Chip is no different than it is for any other V-I Chip. And there the same comments that I made in answer to the preceding question would apply.

Greater volumes lead to absorption of fixed costs, which is a good thing with respect to one of the significant cost components. And then there is the bill of material where the larger economies of scale will come in place to get the margins to where we expect them to be. So, net-net, in the short-term, VIBricks will do relatively better than bare V-I Chip's. And over time, we expect them both to do quite well.

Dick Feldman - Monarch Capital

This raises an accounting issue, how do you treat the sale of a V-I Chip that goes into a VIBrick?

Patrizio Vinciarelli

Well, it takes place at an eternal transfer price of which, in effect, the nets out of our consolidated financial statements. So, the sale of V-I Chips, the big business unit is a sale to a preferred customer at prices that are commensurate to a best customer price. And that's the basis for doing business between or among business units.

Dick Feldman - Monarch Capital

Okay. One last question and that is, when you combine the V-I Chip with the capabilities of mass customization that are inherent in the architecture of the brick business, many years ago, you had said you thought the brick business was reasonably mature. With this additional capability, how would you characterize the potentials of the brick business?

Patrizio Vinciarelli

So the comments about the brick business being reasonably mature were on point, and they're still accurate today. And to be sure we're all on the same page with respect to that, I think what is realistic with respect to our big business based on legacy bricks whose architecture or whose design is literally 20, 25 years old. It is a steady business with good margins, the cash cow that we're all relying upon in order to finance the great opportunities we have with novel technology products.

Now, when it comes to VIBricks, that's an example of that opportunity. We can combine the great attributes of the brick business model, which are as valid today as they were 10 years or 20 years ago, once they can leverage a contemporary, leading edge technology such as V-I Chip under the hood.

So, you can surmise from that that the opportunity is quite significant, because with respect to each of the key figures of merit, power advances, efficiency, transfer response, and so on and so forth. A V-I Chip inside the strategy leads to bricks and configurable products that are far superior from a performance perspective to what we have been able to do with our older technology bricks, and system products, configurable products of one form or another.

So, with that V-I Chip inside strategy, as initially demonstrated by the order we recently received, there's a great opportunity to blend a mass customization model at which we are very well advanced, and a brick business model that is still very, very valid today, operating within the context of a brick paradigm that today represents a $2 billion-plus world market with an established sets of standards and capabilities and customer expectations. That all bodes very well in terms of the VIBrick opportunity.

Dick Feldman - Monarch Capital

One more question as it relates to the VIBrick. I think when you initially tried to put V-I Chips into the bricks, you were dealing with the same footprint. Has the footprint changed? In other words, are you able to go to greater miniaturization on the VIBrick?

Patrizio Vinciarelli

Yes. As you might recall from a comment that was made in an earlier conference call, I think late last year, we were able to take the packaging concept in terms of mechanical thermal management beyond the initial concept of which, as you might recall, had been inspired by a customer engagement. We went beyond that and have developed a proprietary packaging technology that makes the most of the V-I Chip attributes in terms of electrical performance with a shell that adds on to the V-I Chip capability, great mechanical thermal management capabilities.

And this flexibility not just at the single chip level, but it is very scaleable in terms of being able to combine in one package a multiplicity of chips. They can be like chips, as is the case for the first order we recently received, or they can involve combination of different types of chips, like PRMs and VTMs or PFMs and PRMs or half-size chips and full-size chips.

So, there is tremendous flexibility in the packaging concept and the thermal management system to, in effect, leverage up a disruptive power component such as the V-I Chip into a sustained technology product opportunity such as bricks and configurable products.

Dick Feldman - Monarch Capital

Would you say that looking at this versus a year and a half ago that this development meaningfully expands the market that you can address?

Patrizio Vinciarelli

I believe that this represents a very realistic opportunity to achieve a significant multiple of the baseline big business that we have enjoyed. And that statement is predicated on the size of the brick market, the significance of the V-I Chip capabilities within the brick market. I believe that the combination of AC to DC chips and the variety of Factorized Power component chips for point of load application greatly expands the reach of the brick paradigm within an established market, particularly with respect to expanding it in the AC to DC area.

So, it is very reasonable to expect that two developments should take place. One, we should be able to expand the size of the brick market from its current world level, and capture a greater share of that market for the Micro Brick Business unit. And that's a very significant market opportunity. But to caution everybody, that will not happen overnight. It will take time. The gestation period for these kinds of developments, you see years, several years.

Dick Feldman - Monarch Capital

Well, thank you and good luck.

Operator

And our next question comes from the line of Daniel Gorman. Please proceed.

Daniel Gorman - Private Investor

My question has been answered. Thank you.

Operator

Your final question comes from the line of Jim Bartlett from Bartlett Investors. Please proceed, sir.

Jim Bartlett - Bartlett Investors

Yes. In the consumer electronics show, you mentioned that you introduced an LCD TV of about 1 inch, and then at the (inaudible) show in Japan of about one-half inch. Were those prototypes basically for the same customer?

Patrizio Vinciarelli

So, to be clear, the 1-inch demonstration at CS early this year that was a live LCD TV that was assembled using our first generation PFM or AC/DC V-I Chip capability. The one-half inch 300-watt capability that we demonstrated in Japan in May that was not an actual TV set. It was the power system for a TV set with the capability to achieve for the TV set as a whole an overall thickness one-half an inch. That still involved a V-I Chip capability that, however, leveraged a second generation development to, in effect, combine in a single chip that which we were only able to perform with a combination of two chips in the January time frame.

This is part of the cost reduction initiatives that you have heard about being critical to achieve the cost expectations for what happens to be a very cost-sensitive, very high-volume marketplace. So, this has been the sequence of developments with respect to demonstrating capabilities for actual LCD TVs or a skeleton capability using more advanced chips that have been in development. And those are the ones that are now coming to fruition for introduction later this year.

Jim Bartlett - Bartlett Investors

Okay, thank you.

Patrizio Vinciarelli

Thank you.

Operator

There no further questions in queue at this time.

Jamie Simms

Thank you everyone. Thanks to everyone for joining us for this call. And we'll talk to you next quarter.

Patrizio Vinciarelli

Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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