Ladies and gentlemen, thank you for standing by. Welcome to the third quarter 2026 Vicor earnings conference call. At this time, all participants are in a listen only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you would need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to turn the conference over to Jim Schmidt, Chief Financial Officer. Please go ahead.
Thank you. Good morning and Welcome to Vicor Corporation's earnings call for the third quarter ended September 30, 2026. I am Jim Schmidt, Chief Financial Officer, and I am in Andover with Patrizio Vinciarelli, Chief Executive Officer, and Phil Davies, Corporate Vice President, Global Sales and Marketing. Earlier this morning, we issued a press release summarizing our financial results for the three and nine months ended September 30, 2026. This press release has been posted on the investor relations page of our website, www.vicorpower.com. We also filed a Form 8-K today related to the issuance of this press release. I remind listeners this conference call is being recorded and is the copyrighted property of Vicor Corporation. I also remind you various remarks we make during this call may constitute forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995.
Except for historical information contained in this call, the matters discussed on this call, including any statements regarding current and planned products, current and potential customers, potential market opportunities, expected events and announcements, and our capacity expansion, as well as management's expectations for sales growth, spending, and profitability, are forward-looking statements involving risk and uncertainties. In light of these risks and uncertainties, we can offer no assurance that any forward-looking statement will in fact prove to be correct. Actual results may differ materially from those explicitly set forth in or implied by any of our remarks today. The risks and uncertainties we face are discussed in Item 1A of our 2025 Form 10-K, which we filed with the SEC on March 2, 2026. 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 20, 2026. 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 will now turn to a review of our Q3 financial performance, after which Phil will review recent market developments and Patrizio, Phil, and I will take your questions. In my remarks, I will focus mostly on the sequential quarterly changes for P&L and balance sheet items and refer you to our press release or our upcoming Form 10-Q for additional information.
As stated in today's press release, Vicor recorded product and royalty revenue for the third quarter of $197.1 million, up 37.5% sequentially from the second quarter of 2026 total of $143.4 million, and up 78.5% from the third quarter of 2025 total of $110.4 million. Advanced products revenue, which includes royalty revenue, increased 47.5% sequentially to $138.9 million, and Brick Products revenue increased 18.4% sequentially to $58.3 million. Royalty revenue increased 119.1% sequentially to $66.6 million. A fraction of this increase, due to initial royalty payments from the new licensee, was non-recurring.
As we add more licensees, growth and royalty revenues will be less lumpy. Shipments to stocking distributors increased 24.8% sequentially and increased 16.2% year-over-year. Exports for the second quarter decreased sequentially as a percentage of total revenue to approximately 36.1% from the prior quarter's 46%. For Q3, advanced products share of total revenue increased to 70.4%, compared to 65.7% for the second quarter of 2026, with Brick Product share correspondingly decreasing to 29.6% of total revenue. Turning to Q3 gross margin, we recorded a consolidated gross profit margin of 68.3%, a 1,030 basis point increase from the prior quarter. Q3 gross margin increased 1,080 basis points from the same quarter last year.
Gross margin improved both as a result of increased royalty revenue as well as better product gross margins as we achieved gains in volume, efficiency, and mix. I'll now turn to Q3 operating expenses. Total operating expense increased 29.6% sequentially from the second quarter of 2026 to $62.5 million. Within operating expense, legal expense, a substantial portion of which is contingent on royalty revenue, increased by approximately $11.1 million from the second quarter to $16.1 million. On a run rate basis, we expect legal expense to average approximately 20% of royalty revenue in the near term. The amounts of total equity-based compensation expense for Q3 included in cost of goods, SG&A, and R&D was $1,203,000, $2,655,000, and $1,483,000, respectively, totaling approximately $5.3 million.
Turning to income taxes, we recorded a tax provision for Q3 of approximately $15.4 million, representing an effective tax rate for the quarter of 19.6%. Net income for Q3 totaled $63.3 million. GAAP diluted income per share was $1.33, based on a fully diluted share count of 47,609,000 shares. Turning to our cash flow and balance sheet. Cash and cash equivalents totaled $513.1 million at Q3, an increase of $59.6 million sequentially. Accounts receivable net of reserves totaled $102.5 million at quarter end, with DSOs for trade receivables at 34 days. Inventories net of reserves increased 6.2% sequentially to $110.9 million. Annualized inventory turns were 2.3. Cash flow provided by operating activities totaled $69.7 million for the quarter. Capital expenditures for Q3 totaled $16.1 million.
We ended the quarter with a construction in progress balance primarily for manufacturing equipment of approximately $26.4 million, and with approximately $48.6 million remaining to be spent. I will now address bookings and backlog. Q3 book-to-bill came in above one, and one-year backlog increased 7% from the prior quarter, closing at $406 million. 2026 is the year in which Vicor's innovative products and technology licensing practice came into focus within the industry. With incremental capacity, we expect a 10% increase in Q4 product revenue, and at least $43 million in royalty revenue, assuming no new license agreements are closed this quarter. To achieve the product revenue growth objective, we are expecting another double-digit sequential increase in product revenue in our advanced products portfolio. In Q3, we achieved operating ratios for both profitability and expense approaching our long-term financial model. Further revenue growth will result in further margin expansion. Phil?
Thank you, Jim. Demand across our main business segments and in our IP licensing practice is strong, with $100 million in bookings in the first two weeks of Q4, which included a large order for second generation VPD modules from our lead customer. The purchase of two sites for ChiP Fab- 2 and ChiP Fab- 3 reflects the need to expand capacity in support of increased demand. Substantial capacity expansion will be necessary based on AI industry trends and customer enthusiasm for our second generation VPD. Meetings held with major hyperscalers and OEMs at last week's Open Compute confirmed that first generation VPD systems using VRs, which infringe Vicor patents, are struggling to keep up with the requirements of next generation AI systems. Our targeted audience was impressed by Vicor second generation VPD with its distinct manufacturability and performance advantages.
Open Compute this year focused on 800 volt DC rack distribution through inefficient intermediate bus voltages from 12 volts to six volts, or possibly 1.8 volts, to a point of load approaching 0.5 volts, underscoring the inherent limitations of VRs and IVRs. Lack of adequate current density and current gain at the point of load sets the stage for broader adoption of Vicor second generation VPD, providing high current density and much higher current gain. With its transient performance eliminating voltage undershoots, Vicor proprietary ALL-FPA enables a 10%-15% reduction in AI processor power loss, with over 40 times the current gain of IVRs and three times the current density of VRs. Demo systems for second generation VPD and ALL-FPA have been set up in our Silicon Valley applications laboratory and are available for selected OEM and hyperscaler engagements.
On the licensing front, we granted our first VPD license to a leading AI OEM based on stage two unit royalty rates, and responded to inquiries from two hyperscalers seeking all-inclusive licenses, quoted at stage two and stage three prior to the recent ITC decision to investigate VPD infringement. Even though leading OEMs have already obtained a license to our VPD patents, others may not have yet realized that they are importing or planning to import infringing products. Catching their attention, Vicor has requested the ITC to issue a limited exclusion order barring importation of unlicensed computing systems that infringe Vicor's VPD. Like the ITC did before in an earlier investigation involving our NBM patents. As hyperscalers and other OEMs come to realize the impact of an importation ban, they will take licenses based on escalating royalty rates established in our licensing practice, which favors early adopters.
The decision to focus on a set of top 100 customers and top channel accounts, or TCAs, with our global distribution partners across our four markets and four regions globally is clearly paying off with both bookings and opportunity pipeline growth. Our customers are on the cutting edge of high growth applications with the toughest power delivery challenges and specifications. Our leading ATE customers for ASIC and memory test systems, which now represents over $100 million in annual revenues, shows no signs of slowing down. We are actively discussing capacity reservations to ensure supply in coming years. Major new product introductions are also underway in our industrial and aerospace and defense businesses, with market expansion now occurring with new non-traditional companies that have entered the A&D market with new autonomous technologies. Successful execution is achieved with focus, and we are very focused.
Thank you, and we will now take your questions.
Thank you. As a reminder to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. The first question is going to come from Quinn Bolton with Needham & Company. Your line is open.
Hey, guys. Congratulations on the strong product and licensing outlook. I guess I wanted to start, Jim, you had mentioned that the royalty revenue in the third quarter of $66.6 million did include some catch-up royalties. Wondering if you could help size that in the third quarter, and then I have a couple of follow-ups.
It might be best to just think about the $43 million that I mentioned, Quinn, as the baseline amount that we can count on now with no new deals, as a starting point for Q4.
Got it.
Quinn, thinking about this, what is the meaning of non-recurring? I think that which was labeled non-recurring has been recurring pretty periodically. As we pointed out in Q3, there was a contribution that is non-recurring, but then early in Q4, we got some other contribution. I think we should all expect that our licensing income is going to be growing while we are still in a licensing arrangement with a relatively small subset of all the hyperscalers and OEMs. It is still going to be lumpy. There is going to be more non-recurring contributions. It is not going to be until there is a crossing of the chasm with respect to the need to license Vicor technology for freedom to operate in AI applications, given the strong component of Vicor IP that is inherently involved in these systems.
With some lumpiness, this is going to be a significant growth business that we are now estimating to reach levels next year and the year after that, beyond the levels that I forecasted a year ago.
Quinn, I'll just add to what Patrizio said. It's better for, I think, the audience and the analysts to think about the royalty stream as recurring now and not a non-recurring activity, just to put it in perspective. The nature of the agreements are recurring.
Got it. Yeah. No, I think, I understand that if you sign new licenses, there may be catch-ups with those additional license agreements. But the $43 million sounds like a good go forward base, and then obviously we can add on to that as the company signs new licenses. I wanted to turn to the second and third ChiP Fab. I think we're all expecting you to announce a second site, so it was great to see you announce about the second and the third site. Can you give us a sense for the second site? When would you think that that facility would come online and begin contributing to product revenue? Is that a sort of 12-month timeline? Is it 18 months? What's a good sort of timeline for investors to be thinking about with that second site?
We're likely going to have some initial equipment deployment in Q2 of 2027.
Would that be able to produce sort of full set, or is that just first equipment deliveries, Patrizio?
Yeah. It's going to be incremental steps with respect to those processes where we first ran into capacity limitations in Fab-1. So in Fab-2, we're going to bring up lines that address the shorter term limiting factors and move on from those to other ones.
Got it. So it may not be full production, a mimic of Fab-1, but you'll bring in those production steps where you're most constrained. So the impact would be to increase the company's total manufacturing beginning the second quarter.
That's right. Yeah. Obviously, for those process steps where we still have ample capacity at Fab-3, there is no need, there is no rush to deploy additional equipment there. So we're going to be able to do it incrementally, and more cost effectively and more predictably.
Got it. And then the last one for me, Phil, you mentioned good meetings at Open Compute last week and just wondering if you could address what kind of demand are you seeing for the factorized power or the 48-volt solutions as the VRs and IVRs do look increasingly challenged. When do you think you might see adoption of a second gen VPD outside of your lead customer, based on some of those conversations?
Conversations are still early, Quinn, in that regard. We do have line of sight to new chips that are under development that are further out, if you like. But I do think that there could be opportunities in the shorter term based upon the inefficiencies of VRs and IVRs. We will be taking a look at that as we move forward.
Again, we are looking at all these opportunities in the frame of reference of capacity limitations over the next 12 months. It is not that we can engage with any hyperscaler OEM that has got a need. Virtually all of them do because as you know, while there has been a lot going on with respect to 800 volt bus and converting that to six volts or 12 volts or back to six volts on the way to 1.8 volt. The real issue with respect to enabling AI does not have to do with what happens, in effect, some distance away on a volt bus or even intermediate bus.
The real constraints have to do with the point of load, and they have to do, as we have been articulating, because of the fact that IBA, the intermediate bus architecture, which is how the competitive industry has been doing it has gathered any attention between efficient power distribution and efficient duty cycle and the requisite current density, and current gain at the point of load. As I have been saying for quite some time, I think all the focus about it on the volt is really missing the boat with respect to the real challenge. It is not that there is not a benefit to 800 volt. There is a benefit. It is a few percentage points of system efficiency, but an inept point of load power system will keep AI from progressing on its performance trajectory, and that is where we are focused on.
Understood. Thank you, Patrizio.
Thank you.
Our next question is going to come from Justin Clare with ROTH Capital Partners. Your line's open.
Hey, good morning. Thanks for taking our question here. First wanted to start off, backlog increased to $406 million this quarter, and was just wondering if you could discuss the visibility that you have now into fully utilizing Fab-1, when you expect to reach that milestone. Just looking beyond the backlog, what visibility do you have into additional customer orders or commitments from customers that would support that full utilization?
As of yesterday, the backlog is actually closer to $400 million, but beyond that, we see robust demand. Phil and I were on a call yesterday with a major customer, seeing demand doubling every year for the next several years. They have a lot of visibility with respect to the request for their systems. The challenge in the short term is to bring up additional capacity, do so ahead of demand. Sorry, I have a cold. Taking care of customers. We have many customers, most customers that are single source with us, where we have obviously a particular responsibility with respect to ensuring that we're not going to be gating their growth.
A lot of it is directly AI related, but some of it is indirectly AI related in that the AI growth path is fueling, as you know, a growth path for all of the portions of the industry that play one support role or another.
Got it. Okay. Just shifting to the capacity announcements here that you made for Fab- 2 and Fab- 3. I was wondering if you could just clarify. You indicated that those additional sites could increase capacity nearly 5x. Is that 5x figure related to physical manufacturing space, production output, or revenue-generating capacity? Just wondering if you could potentially share what the revenue potential might be as you move from Fab- 1 to Fab- 2 and Fab- 3, assuming full utilization of those facilities.
Around Fab- 1, we are space constrained. In other words, we have relatively small parts of land. So we made sure with both Fab- 2 and Fab- 3 to avoid getting limited by, in effect, elbow room within that particular site. Both sites have significant upside that could support even more than a 5x expansion. Again, the methodology for expanding capacity, as you might recall, we looked first at just industrial parcels, then looked at buildings in order to reduce the time to accessing a new facility. We ended up doing one of each within a triangle. It is about 30 mi off to the west and to the north of Fab- 1, a relatively short distance, but with a significant level of independency with respect to power feeds and all that would be a consideration regarding redundancy with respect to these increments of capacity.
The 5x is a conservative number. It could be more than that because again, unlike Fab- 1, we are not going to be limited by elbow room within either one of these sites.
Got it. Okay. Just one more. Wondering if you could share what you expect in terms of the capital investment for Fab- 2 and Fab- 3 and what the anticipated timing of that investment would be.
We are not prepared to share any details today. We're in the planning phase with respect to Fab- 2. I think possibly as of our next conference call, we will share some quantitative data with respect to capital investment. It's safe to say that we're going to be able to fund Fab- 2 and, in due course, Fab- 3 without need for raising any capital. We're adding cash at an increasing rate. Fab- 2 with this investment is well within our capability. We want to make it that with respect to our cash flow.
Good. Thank you.
Thank you. The next question is going to come from Richard Shannon with Craig-Hallum Capital Group. Your line's open.
Well, hi, guys. Thanks for letting me ask a couple questions as well. Jim, I'd love to put the numbers you mentioned in your prepared remarks here to get to a fourth quarter revenue number. You mentioned a royalty number. I think you mentioned advanced products growth or total product growth, I'm not sure which one. That was coming up with revenues kind of in the $180 million-$185 million range for the fourth quarter. Am I doing the math right? Or if not, can you correct me?
I'm going to give you a specific answer, but I do want to make clear, Richard, that the number I quoted for 10% product revenue growth is total product revenue growth. Okay? What I said about advanced products product revenue growth within advanced products will be yet again another double-digit increase in that category of product.
Let me give you more color with respect to this. As we discussed earlier, the licensing side of the business has got lumpiness potential for additional deals. We're taking the long-term horizon. We're not in a hurry to get any deal done. As time goes on, the cost to hyperscalers and OEMs for VPD license goes up at a pretty fast clip as we progress through the investigation at the ITC. But there could be deals done this quarter.
For that reason, we really can't give you a guidance that we would be comfortable with given the level of uncertainty. For that reason, what we provided with in terms of helping you set expectations is, with respect to the product side, that which we can predictably expect to deliver, which is a low double-digit increase in product revenue, right? Product revenue. Separate and apart from licensing income, for which we provided a minimum of $43 million, and that assumes no new deals are done within Q4.
Richard, one other point to mention. The $43 million, as we've said, and Patrizio just said, doesn't rely on any new deals, but inherent in the licensing agreement we have, there's potential for incremental royalty revenue just as a function of the existing arrangement. We can't predict that exactly.
That's right. It could be that the number that we are forecasting at the minimum of 43 ends up larger than that even without new deals. It's a very conservative number.
It's a baseline, and that's what investors like to see, so I just want to verify that. Thank you for that. My second question is related to licensing, kind of the notion of run rate here. You mentioned kind of a $43 million run rate, again, assuming nothing else gets done, and let's start with that notion in mind here. You've mentioned that most of the licenses you've done here in the past have been two-year terms here, and I think the first one is coming up for renewal or will be expired in the not-too-distant future. I wanted to get a sense of your expectation of renewals of those, so that we can assume a real recurring run rate that's going to go for many quarters in a row. If you could comment on that'd be great, please.
Yeah. I think it's becoming more and more apparent that Vicor's pioneer role with respect to a density power system is multifaceted, right? As recently as a year ago or even within a shorter timeframe, all the focus was on NBMs as part of IBA. As a stepping stone to the point of load for competitive alternatives. Again, we don't use NBMs because the factorized power system doesn't require intermediate bus converter. But virtually all of the competitive alternatives do. The focus clearly has recently shifted to VPD, which is on a different scale of significance, right? Its significance in terms of enabling AI power systems is much greater than NBMs because it's not the intermediate bus converter, but it's the point of load system, which is where the spotlight, where the focus should be.
There is greater value associated with that, and we're capturing that value. We've captured that value with the first VPD license. We'll be capturing that value with additional VPD licenses or inclusive licenses that involve the combination of NBMs, VPD, and other Vicor technology that over time is also to become an issue for unscrupulous competitors to contend with.
Okay, great. Thanks for that detail. That is a good one.
Thank you.
Thank you. The next question will come from John Dillon with DMB Capital. Your line is open.
Hi, guys. Congratulations to the whole Vicor team. Incredible quarter. Phil, my question is really for you. It is, with the exception of Vicor, I have never heard of any company claiming that power supplies could enable higher performance processors. Yet Cerebras just announced a new CS-4 AI processor, and Angela Young, the Senior VP of products, stated that the Wafer Scale Engine stayed the same as the CS-3. The CS-3 had the same memory and logic, but it had 2x the increase in speed, and with three of these together, they had 10x the throughput of three wafers. She contributed a big part of the increase was their ability to deliver higher density power to the same wafer. Phil, I find this extraordinary.
Can you walk us through that and let us know what the reactions are from your new target customers now that you're demonstrating the benefits of the second gen VPD?
John, we're not going to make any comments that are specific to any customer, right? I'm going to answer your question in general terms, with specificity. Every generation of AI processor is stepping up its current requirements by a dramatic percentage increase. What used to be very high current requirements not that long ago of a few hundred amps, right? Following the era of Intel processors that were barely consuming 100 amps. It's now at the 1,000 amp level and on its way to thousands of amps. Then there are leading-edge applications such as Wafer Scale Engines, where you're dealing with tens of thousands of amperes going to 100,000 amperes. That's where the action is. That's where inference and other high enabling capabilities get realized and fundamentally, fueled by current. The fuel by current at ever-decreasing voltages, which makes factorized power with current multiplication the Vicor technology of choice.
Conversely, fundamentally handicaps, the competitive approach where the upper voltage is in effect averaged down by mixing a low voltage source, i.e., one that is inefficient in terms of its power distribution with ground, which is fundamentally zero volts. That kind of Vicor technology is inherently anti-gap with respect to keeping up with AI demands. Conversely, our Vicor technology was envisioned a long time ago, and we kept on improving it. We got lots of new developments related to factorized power, its IPs, its components, and these are reflected in the level of performance that we're bringing out with every new generation. The initial demonstration vehicles for second-gen VPD reached 3 amps per square millimeter. We are not that far away from 5, 6 amp per square millimeter capability.
We're going from what used to be in a timeframe where we were powering a GPU many years ago with current multipliers to the level of 3.5 millimeters. We're now 1.5 millimeter. In six months, we're going to be at 1 millimeter. So it's this kind of Vicor technology, the packaging Vicor technology, power conversion engines, control systems, unique components that enables AI.
John, just to build on what Patrizio said, I think that was on display last week at Open Compute with our meetings with several big customers in terms of their level of excitement around our second-generation VPD. They've been waiting a while to see it. We've been focused on our lead customer. But now we're here. We've got the demo system set up. They were excited by what we showed them. So I think it's now up to us to roll this forward and to bring these deals home.
Within our capacity constraints.
Yes.
Our near-term capacity constraints.
Okay, now, before you've talked about pricing per watt. So at twice the power with the second gen solutions, are average selling prices going up?
Let's not get into that. I think what we can say is that our total competitive standing, which obviously leads with performance but needs to deal with cost, is becoming stronger and stronger. Because we have the right approach to solving these point of load challenges. With the right approach, inherently, there are scalability and cost advantages that we will materialize as we scale up from a nearly full Fab-1 to a Fab- 2 and a Fab- 3. We're going to have the economies of scale. We believe we're on the right track, and the rest of the industry is foolishly going down a dead-end road.
Excellent. How is that progressing? That will be my last question.
Again, as we talked about, John, IVRs, it's very early days for IVRs in terms of really delivering solutions to customers. They're intrigued by using IVRs on some of the rails. I think for the high current rails, we have the best solution. It might be all Vicor, it might be some Vicor and some IVRs. We don't know yet. We'll see how that plays out. But IVRs have a way to go yet in terms of proving their performance claims.
We had several meetings last week on the IVR front with two IVR companies and a hyperscaler interested in solutions, IVR solutions, using one of these two companies. We were told by the hyperscaler that when it comes to feeding the IVRs at 1.8 volt, we would be the only solution. I think it remains to be seen. The jury's still out with respect to how soon these IVRs will become a practical reality. The good news is that this hyperscaler saw that we have a solution that doesn't involve IVRs. Fundamentally, they can come to us for either alternative, one that involves IVRs with that which IVRs provide, which is to be honest and fair, they provide flexibility, at least now in theory, but in reality, they will over time provide flexibility. But that flexibility comes at a significant cost.
When everything is said and done and you deal with the real numbers and not the marketing numbers, the insertion cost to, in effect, process power through an IVR stage is close to It's upwards of 10%, and it could be pretty close to 15%. For that 10%, 15% of extra power dissipation, all that you're getting, all that the customer is getting is a current gain of 2.5. It does provide flexibility, but from a power system efficiency perspective, it's a very challenged proposition. We're open-minded, though. We're perfectly willing, eager to play a support role with respect to IVR application. Fundamentally, the same point of load technology enables us to deliver thousands of amps at 0.5 volts, with the requisite current density, bandwidth, and all the right attributes. That same technology can deliver 1.5 volt to an IVR.
If customers, for whatever combination of reasons, want to go down that path, we'll be there to support them.
Excellent. Thank you very much.
Thank you. Our next question will come from Richard Shannon with Craig-Hallum Capital Group. Your line's open.
Well, great. Thanks for letting me ask a follow-on here. In the press release and in the call here today, you've used a couple of terms that I'm unfamiliar with, stage two and stage three licenses. If you can explain those, that'd be a big help here.
Yes, I'd be happy to. Actually, if you go to our website, we now have a licensing page, and on that licensing page, you can get an answer to the question. It's a quantitative answer to the question as it relates to royalty rates, which change as a function of the stage. So fundamentally, for any Vicor patent in our portfolio that has not been asserted, a prospective licensee can take a license at stage 0. That's the most cost-effective license. It's most cost-effective because Vicor hasn't had to get into deals with law firms to assert that IP and go through, in effect, the enforcement effort.
But if the patents are being infringed and we have to assert them, to assert that there's a cost to doing that, as time progresses and the enforcement effort advances, we increase the royalty rate in relationship to what we call stage X. So after stage zero comes stage one, stage two, stage three. So stage three begins when the ITC institutes an investigation. The first roughly 10 months of that timeframe, which is during all the phases of the ITC process before a hearing, we have increments in the royalty rate, as you can see from the website page, the level of about 5% per month.
As we get into the hearing and then the initial determination by the administrative law judge at the ITC, the final determination, an exclusion order, an enforcement of the exclusion order by Customs and Border Protection, the cost to a, in effect, late licensee that, in effect, has taken a wait and see attitude or has approached this from the perspective of taking his chances, it keeps escalating because our cost has gone up. With that, we deserve to fetch more with respect to the patent and its value. All of this is intended to encourage early adoption, encourage licensee not to take the chances, not to roll the dice. We got a track record of knowing what we're doing, and we're going to keep doing that.
We're very determined, and we're very well-equipped with partners that have a vested interest in the right outcome, which is not the case for our opponents. That's how the various stages of this process relate to time and the cost of the license, so its royalty rate. If you look at the webpage, there are curves that define this progression. Part of the reason for this is to have a level playing field, right? It's very important that we treat each and every licensee fairly. All of these licensees have got most favored licensee provisions, which means that you can grant to a following licensee a license on better terms than a prior licensee under similar conditions. Well, similar conditions, among other things, means at what stage the prior licensee took a license as compared to a new licensee.
We have documented our practice, among other things, to ensure that we have a complete transparency and fairness and consistency in our methodology.
Okay. Patrizio, thanks for that detail here, and I see the webpage here, very comprehensive and complete. So thank you for that. My follow-on question is regarding the AI OEM that you signed the license with in the third quarter. A two-part question. The first one is, why was that seemingly mostly a non-recurring or one-time license versus something that might be ongoing? Second of all, can you state which stage this third quarter AI OEM was licensed at?
We didn't say that that's non-recurring to the contract. Maybe the source of potential confusion was my comment to the effect that that which has been characterized now several times as non-recurring keeps recurring. So by definition, it's not non-recurring. But beyond that, what we recorded in Q3 from this first pure VPD license is far from non-recurring, whichever way you want to look at that word. In fact, there was, at the beginning of Q4, another significant license PO that came from the same new licensee. So these licensees are structured, whether they're all-inclusive or per unit, to be, in effect, proportionate to the use of the technology by the licensee. And obviously, as time goes on and licensees make greater use, they pay royalties in direct proportion to that. We have different ways of making this happen.
Fundamentally, two approaches, either on a per unit basis or by estimating what the use by the licensee is going to be over a couple of years and having an all-inclusive license that deals with that timeframe before we take on the next couple of years.
Richard, just to amplify what Patrizio said, it is better to think about the royalty revenue as recurring. It is a licensing practice that is now up and running. It is generating royalty revenue. It is proportional to the use of what otherwise would have been infringing technology. So it is very important everybody understand that. We have used a couple of quarters of catch-up, but really think about this as recurring revenue now. It is in the P&L.
It will keep on coming at increasing levels. So I think it was perfectly appropriate, let us say, a couple of years ago, to look at a lump sum contribution in one quarter as non-recurring. Back then, that was obviously the conservative way to think about it. But now, to Jim's point, obviously there has been a lot of recurrences of non-recurring things, and they are no longer non-recurring.
Thank you. Our next question will come from Justin Clare with ROTH Capital Partners.
Hey, thanks for taking the follow-up here. Just wanted to follow up on the capacity expansion here, particularly for Fab- 3. Wondering how we should interpret the land acquisition that you made for Fab- 3 at this point. Is that a commitment to add additional capacity, or should we view that more as an option to potentially accommodate longer term growth? Then just trying to think through how long it might take for you to get to fully utilizing 5x the capacity that you have with Fab- 1.
We bought the land. We closed a week ago or thereabouts. But we're not going to act on it in terms of putting up a building there for now. The logic of having that flexibility was, in effect, to make the most out of the process that we went through earlier this year in investigating these various options that carry different trade-offs, right? On a new campus, we have total flexibility with respect to the complement of buildings, how they relate to each other in terms of next Fabs. That's very valuable in terms of medium, longer term planning. It is distinct from the need to act in the very short term with respect to expanding capacity within an existing building.
We now have the wherewithal to take very short term steps with a timescale of five, six months on the one hand within existing infrastructure, including a 330,000 sq ft building, as well as doing it from the ground up in a different site. We're going to act first on the Fab- 2, which is in Merrimack, to the west of Andover, and it's yet to be determined when we'll want to pull a trigger on Fab- 3. Again, Phil and I yesterday were having a call with the CEO of a major customer, wanting to, in effect, reserve capacity over the next few years. These kinds of discussions are going to facilitate decisions with respect to when to pull the trigger on the next incremental capacity.
It might be worth mentioning the call they had was not with an AI customer.
Yeah.
Okay.
Phil?
Okay. Interesting. Thanks. Just one other follow-up. You mentioned that you plan to, I think, start adding equipment in Q2 for Fab- 2. Just wondering, do you anticipate running at near full capacity for Fab- 1 next year, that kind of justifies the ramp-up of Fab- 2 into next year?
Yes. Yeah. Unfortunately, for the near term, we have certain capacity limitations, right? They are, to be clear, dependent on specific platforms related to particular process steps. They are such that we can grow revenues, as Jim pointed out earlier. We expect low double digits increase in product revenues this quarter. As we've been explaining over the last several calls, we're getting closer to getting to full capacity utilization of Fab- 1, hence the need to step with some of the process steps into Fab- 2 starting Q2 of next year.
Got it. Okay. Thank you.
Thank you. This is all the time that we do have for questions today. This will conclude today's conference call. Thank you for participating, you may now disconnect.