Alchip Technologies Ltd

TWSE:3661

Earnings Call Transcript 2022-Q3

[Johnny Shen, executive]

Okay. Let me give you some -- everybody's strong update for Q3. Yes, we can say, we had a fairly accessible Q3 with a record high revenue at $117.5 million. However, the net income of $14.6 million and EPS NT$6.2 [indiscernible] are just slightly better than quarter 2, but mainly due to a few NRE milestone delayed to Q4 plus a onetime expense after we change our stock option emphasis scheme. Our mass production demand remains very strong, especially from North American region. The ABF substrate shortage limits our master production revenue in Q3. Fortunately, capacity-related issue has been resolved.

We already received capacity support commitment from major suppliers, starting from this month. We are expecting to see tremendous revenue growth starting from November and lasting for at least 6 quarters. Alchip continuously...

[Technical Difficulty]

[Daniel Wang, executive]

Shyang-Lin you are muted.

[Johnny Shen, executive]

Alchip continuously hold a leading -- great position in VD technology business. Our business inquiry this year enormous. Majority of them are in advanced technology for 7-nanometer or below. With many design wins, we expect healthy revenue growth starting from Q4 and continuing through next year. We have also made a significant progress in automotive application. Many electric car makers start to develop their own ASIC and have approached us recently. Some of the design will be kicked off very soon. Therefore, we truly believe, starting from late year 2024, automotive application will be another booming revenue driver for Alchip.

A quick update on the U.S. BIS ascension issued by October 7. Overall, we encountered a very limited impact on our current business. The update restrictions are very specific. It clearly defines the spec and rule for our supplier chain to follow, including us, our partners, and customers. We at all business will execute normally some also we comply with the regulations.

Lastly, I would like to emphasize our neutral position and diversify business conditions. Similar to our foundry partner, Alchip will never make a product to compete with any customer. We have a fully diversified and well-balanced business from all regions, including North American, Asia Pacific, Japan and Europe. In terms of headcount, we grew quite a bit recently. In addition to China, we have implemented a more aggressive hiring plan to increase our engineering and supporting resources in Japan, Taiwan and U.S. region. We also have a plan to open additional offices in Southeast Asia. This effort will provide more efficient and cost-effective solution to meet our customers' requirements. Thank you.

[Daniel Wang, executive]

Okay. Then this is the third quarter quarterly income statement. Actually, we've already forced to announce the third quarter top line and the bottom line. So I just repeat the numbers and go into detail in the next slide. For the revenue in third quarter, our functional currency is U.S. dollars. So in third quarter '22, the revenue is $117.5 million, which is 16.2% quarter-on-quarter growth and 28% year-on-year growth.

For the operating income in third quarter is $18.6 million, which is 3.6% for the quarter decline but 21.9% year-on-year increase. And for the net income, net income is $14.6 million in third quarter, which is 0.5% quarter-on-quarter growth and 12.6% year-on-year growth. Because of the exchange rate in third quarter, the NT dollars to U.S. dollars depreciate a little bit. So the EPS is NT$ 6.2 for the third quarter. And this is the revenue breakdown by application in third quarter. Again, you can see HPC was still our main focus, which accounted for 78% of our total revenue and the niche market accounted for 6%, the network application accounted for 6% and the consumer products accounted for 9% of our total revenue in the third quarter.

In this year, the breakdown is pretty much similar to the quarterly breakdown. HPC accounts for 80% while the other 3 applications: consumer, network, niche accounts for 6% to 7% our total revenue. And this slide is the revenue breakdown by Process Node. As always, Alchip is focusing on the leading-edge technology nodes. So you can see, in third quarter, the 7-nanometer or the more advanced technology nodes. Revenue from these notes account for 69% of our total revenue. And for the 16- and the 12-nanometer, it accounted for 21% of our total revenue in third quarter, while 28-nanometer and the 40-nanometer accounts for 6% and 5%, respectively, for our third quarter revenue.

For the yearly, which is the same, 7-nanometer or more advanced technology nodes. The revenue from those nodes accounted for 66% of our total revenue this year and the 16- and the 12-nanometer revenue accounts for 21% of our total revenue this year.

And this is the breakdown by region. In third quarter, the revenue contribution from North America keeps on rising to 39% and the revenue from Asia Pacific, which is pretty similar to what we have in the second quarter. So in third quarter, the 2 major regions that contribute as the majority revenue is U.S. market and the Asia Pacific market.

For Japan, Japan accounted for 40% of our total revenue in the third quarter, while the other region total accounts for 9% of our total revenue. From first quarter to third quarter, the accumulated revenue in U.S. accounted for 36% of our total revenue, while revenue from Asia Pacific accounted for 40% of our total revenue this year.

So for the third quarter business review. Honestly, this revenue is a little bit lower than what we expected because of the insufficient supply of the ABF substrate, we mentioned it in our second quarter earnings call meeting. And throughout the third quarter, we still suffer from this issue, but we expect, this substrate in sufficient supply will significantly improve in the late fourth quarter this year.

And therefore, [indiscernible] which means the design revenue, the decided for our customers remain robust as most of the project milestone in third quarter came in on schedule. So the profit margin on that is because the higher production revenue in third quarter and the other onetime of items. I will explain it later. The third quarter gross margin was 31.7%. And compared to the second quarter, the gross margin is lower in third quarter. That's because, first of all, lowering NRE revenue contribution. In the third quarter, our NRE accounts for about 40% to 45% of our total revenue compared to the second quarter. Second quarter, the NRE accounts for 45% to 50% of our total revenue. And in third quarter, because we are aggressively adding the substrate supplier, so there are several new substrate suppliers to get into our supply chain. So we have to spend some [indiscernible] to do the qualification, which is another reason for the gross margin in third quarter. And for the operating expense front, you can see our third quarter operating expense is about $2 million to $3 million higher than in the second quarter. The first reason is, we have relatively large hiring near the end of the second quarter.

Secondly, there is a onetime of ESOP, the option policy change. It costs about $1.1 million to $1.2 million differences -- in $1.1 million to $1.2 million increase to our routine operating expense. So that's the major reason for the positive margin in the second quarter -- in the third quarter.

So for fourth quarter business outlook, first thing is, we like that actually today is already November 4. Some production revenue shifted to November from October. The October sales will suffer, again, still suffering the insufficient substrate supply. And in addition to that, because of the testing program renewal by our customer, the AI chip shipments to U.S. customers delayed to November. We shipped a very limited chips to our North American customers in November, of course, which causes relatively good -- big impact to our total revenue. But for those products, we are -- the manufacturing, the production is as normal.

So those products will ship to our customers in November, which means, in November, we expect a relatively very significant month-on-month revenue growth because of that. For the substrate supply, as I mentioned, we expect the substrate supply to significantly improve from November. The number of substrate suppliers increased from 1 in third quarter to 3 in fourth quarter [indiscernible]. Previously, prior to the end of the third quarter, we only have 1 supplier who is [indiscernible]. But in fourth quarter, we will have [indiscernible] with better capacity support. And in addition to [indiscernible], we will also have new Micron. And in December, we will have another new supplier. As I have mentioned many times, this new supplier will have a dedicated line for this product.

The production -- the shipment -- the substrate shipment will -- from this new supplier, will begin in December this year. And we have very good support commitment from new suppliers for late fourth quarter '22 and the whole year next year 2023.

So to us, if we look into 2023, we don't consider substrate supply will be an issue anymore. And in addition to substrate supply, the cohort capacity, TSMC gave us a very good support. And we also -- we don't see the cohort capacity as the issue any more again in 2023. So for designed parts, the overall design net remain, okay, good. I know, everybody have concerns about the BIS regulation, our separate session later. But based on the comment rule and the situation, the reaction by our vendors and our understanding to the regulation and the reaction of our customers, the new BIS regulation for our ongoing projects will be very limited.

So that's the BIS part and for the automotive-related application business, as we mentioned last time that we have very good chance in the position to win some automotive-related projects in both, U.S. and the China markets. We already have good progress, and we expect business from this application will become larger in the larger -- in the fourth quarter and the whole year next year. And for the fastest node migration. We still expect the process node migration from 7-nanometer to 5-nanometer to continue in 2023. For 3-nanometer, we don't see relevant revenue contribution from 3-nanometer this year and the next year. We expect the revenue contribution from 3-nanometer would likely to have a meaningful increase in 2024.

And this slide is for the BIS new regulations. First thing is, I would say -- I would like to say our understanding on these regulations. Based our acknowledgement instead of using entity list, BIS this time is by defining the steps to be the parameter for chip design restrictions on China IC vendors and another approach from BIS, based on our knowledge, the end use or they say, KYC, Know Your Customer. as regulations for identifying the MEU, the Military End Usage. So I think these 2 parts -- these 2 directions are the major change for the new BIS regulation.

In the test, the BIS you used the entity list to achieve their target. But for this time, they see change its approach.

So in conclusion, we knew these new regulations as positive to Alchip. Let me explain to you why. First of all, we see a limited impact, as mentioned and as stated in our previous slides, our China exposure this year down from 70-something percent in 2021. For this year, the first quarter to third quarter accumulated revenue from China customers already down to 26% of company's total revenue. And by sorting out our ongoing projects, only one project may need to go for ECCN classification, which is a GPU project from our China customer. And this project, the projected revenue in fourth quarter is estimated to account for about 1% to 2% of our total 2022 revenue. Of course, it is a projection -- it is a projected revenue.

So the reason why we say, we see this new regulation as a positive thing to us is because from now on, it seems everyone every parties -- every party has a clear end rule for the BIS thing, for the China geopolitical thing. In the past, honestly, we don't know which of our customer -- our China customers will be putting on station list, we don't have a clue. But right now, the targeting is on project itself. For example, for the customer, I mentioned that maybe have a project, falling into [indiscernible], which is a new class of the BIS classification, but the other project may be from the same customer, which is not into the class of subject to EAR, they can still go and the vendor has very clear can do for what projects could support and what project could not support. So to us, it makes us or our suppliers easier, much, much, much easier to avoid the potential risk. And I guess that's the whole presentation for today. And right now, we are going into the Q&A session.

[Daniel Wang, executive]

[Operator Instructions] The first one is Charlie from Morgan Stanley please.

[Charlie Chan, analyst]

Thanks, Daniel. Johnny. First of all, congratulations for your great execution even during this very geopolitical environment. So I do have a few questions around this issue. So first of all, you mentioned that the new BIS rule is very specific, which you consider as a kind of good news in the long term. But I'm wondering, first of all, how do you ensure the KYC, know your customer, that their products wouldn't be for military usage maybe after several layers of integration and redistribution. That's the first question.

And also the second question to Johnny. How are you going to manage your China business in the long term, right? Meaning, for example, if some China projects, margins is a super attractive, whether you would prioritize those China projects? That's my first question.

[Johnny Shen, executive]

Danny, do you want to go or...

[Daniel Wang, executive]

Yes, for the KYC, I think we work with other suppliers. We have -- we define a kind of a genre -- so first of all, before we sign up, for example, the project getting started during the NDA stage, this a lot of document for our customer to sign. We need to understand their market segment. We need to understand their application and also their end customer as well is in which category. So both, us and also major suppliers were reviewed. Once we feel comfortable, we will prepare all the document for our end customers to sign before we signed a 3-way NDA.

And this document will be signed twice by the staff and project [indiscernible] during the project take out. So that takes care of the KYC portion. Yes, for our end customer, same thing, they need to sign a KYC with their potential end customer. And on [indiscernible] the shipment, we will review that as well. So that's again, rule we define. And for all the compute -- high compute power-related project, we will apply for the classification, make sure from the third-party, they won't validate the 3A900 category. So before tape-out, all the classification needs to be done, KYC-related document need to be signed. So I don't know, Charlie, does that answer your first part of the question?

[Charlie Chan, analyst]

Sure, sure. Yes. I'm sure that your vendors, partners want to ensure the KYC just on to no more details. But my second question also about your that China strategy.

[Johnny Shen, executive]

Yes, like I mentioned before, I will not make a normal operation, business as usual. Yes, so as all the customer and us complying with the regulation and we will take -- we are continuously taking the business. By natural, to be honestly, we will more focus on non-China business more -- the China business will be selective. I give us -- we consider has a great potential, reasonable profit, and we will continuously to support, but internally, we have this kind of a rule. We need to make sure every single account contribution will be limited. For example, we will not allow any account contribute more than 10% of the total revenue. Yes, if it's over that, and we can easily change the ASIC back to COTO royalty model in order to prevent the big impact, so to answer your question, we will continue to support China business selectively and focus on non-China business more.

[Charlie Chan, analyst]

I see, and my second question is associated that actually. Since now you want to focus more on China business and U.S. is kind of a big growing market. Whether you are hearing some customers demand that they don't rely want their design is down by your China operation or even they don't want their chip to be produced in either Taiwan or China. How are we going to -- if that is the case, how are you going to manage those requests?

[Johnny Shen, executive]

Okay. So let me try to answer your question. Yes, to be honestly, 3 months ago, when we have investor company meeting for Q2, I do some calculation, only 20% of our customers has a sound requirement or you mentioned about, do not use China resources in China. But recently, you are right. I think I get more and more of this kind of a request, precise how much? I don't know, still insignificant, but looking forward, I think this number will increase. So that's why we have a more aggressive hiring plan in other regions, in Japan, in Taiwan and also the Southeast Asia.

And also similar to other U.S. company, we do have a plan to ship, to send our engineer working in different regions. Now to be honestly, I do some -- internally, I do some inquiry asking a senior engineer, do you -- are you willing to work in Japan or in Singapore and Malaysia? And I think the feedback is positive. All of them -- I think most of them are not against working in other regions for like 2 to 3 years. So that's the work we're on. We will continuously hire, more aggressive hiring in other regions, yet, in the meantime, we can send our existing China resource to other regions to welcome a design.

[Charlie Chan, analyst]

Got it. Yes, I just want to make sure, does request or requirement doesn't limit your ability to win the future projects. For example, we know that Marvell, Broadcom, they are super aggressive to compete with your future projects. But thanks for your explanation. I will be back to the queue and resent some follow-up questions later. Thank you.

[Haas Liu, analyst]

First question relating to your question similar to Charlie asked earlier. What percentage of the engineer right now are based in China? And how do you think their percentage change in the next 2, 3 years?

[Johnny Shen, executive]

Okay. Right now, about 70% of our engineering resources are located in China. And the other region, we have 2 teams in Japan, which accounts for about 30%. And in Taiwan, we have 1 team, which contributes about share our design resources.

[Daniel Wang, executive]

Looking forward, by next year, we will increase more aggressively. Near the 2024, I have a plan to have about 50-50 kind of weight between China and non-China.

[Haas Liu, analyst]

All right. I see. But would the company's cost structure change in Italy as a result of this kind of engineered reallocation?

[Johnny Shen, executive]

We do some calculation. I think the increase will be very, very insignificant. Yes, as you know, right now, China itself, the cost is not so low. Yes, we all know that. And also Japan, based on current inflation, everything in Japan cost is very attractive. Yes, we're thinking about other area like Malaysia. Yes, Malaysia cost, I think, is much lower than China, but Singapore is a little bit higher. So combined with these 3 regions, I think the cost after some calculation, I think, it's pretty much the same. Yes, I don't expect the cost structure will increase.

[Haas Liu, analyst]

Got it. Yes. And then regarding the automotive business you mentioned earlier, are we doing the HPC kind of chips or the companion chips inside the car?

[Johnny Shen, executive]

I guess, the automotive area, we are focused to area. You're right, automotive HPC from Level 2 to Level 5, when we have a chance, we will try our best to win. That's on the [ HV ] side. And each of car makers also have a plan to build out their data center, so that's the server side. I think both of them will have an opportunity to win.

[Haas Liu, analyst]

Okay. All right. So basically, we have really won the project, right, but do you stand a good chance to reendorse the project?

[Johnny Shen, executive]

We -- in fact, we already won a couple, and we -- So, so many customers -- excuse me, a big man Carminko approaching us recently.

[Daniel Wang, executive]

Next, [indiscernible].

[Unknown Analyst]

Thanks, Daniel. Congrats on the good results. I have a couple of questions if I can start. My first 1 would be on the total addressable market, right? So the 38090 and 48090 have obviously restricted a certain percentage of the market, China time or beyond that in treasury more. But I'm just wondering in terms of localization, demand for chips below that threshold, you see that as sizable. Is there just a lot of demand there as well?

[Daniel Wang, executive]

Okay. [indiscernible] let me answer you this question. Actually, we don't have too much good relations for the 48090. 48090 mainly defines the supercomputer system. Our job is doing the IC turnkey service. So the class, the new classes -- the class has more relationship with us is the 38090. For 38090, the most important spec in this class is the 600 gigabits per second I/O speed. From these spec, you can see the main purpose of this new class is targeting GPU and AI GPU and maybe service accelerator, so-called -- for CPU, CPU usually don't need to have such high I/O speed. So most of the CPU will not go into this class -- and for GPU, to be honestly 38090, the stats this class defined is not low. The benchmark is the NVIDIA A100, which is a pretty advanced chip. So -- and the lastly, the reason why right now, we don't see a significant impact to our ongoing project.

[Johnny Shen, executive]

Yes. Yes, let me add to that. Daniel is right. We have a very, very limited impact on current projects. But looking for the draw back side, I think when our GPU customers stepping into 5-nanometer or 3-nanometer, I think that will be easy violates 600 gigabyte requirement. So I think they have to have a few work around seeing continuously, I think, future GPU project using most leading-edge technology, this kind of opportunity, I think, will -- our customers need to change their direction. I think that area I think will be slow down for CPU and other applications. I think now will be not much impact. Sure.

[Unknown Analyst]

Sure. So just to clarify, so what you're saying is that a large -- so a decent -- a chunk of the market is being affected by these restrictions, at least going forward, because you can't get grow in that space, but you're saying like, for example, the CPU market and even GPUs, you can repurpose to be below that threshold. So this China market is still quite sizable over the longer term. Is that how you view it?

[Daniel Wang, executive]

Maybe Shyang can add some color later. That to us, as I mentioned, for the stacks right now, the stack is not low. Actually, the state, as I mentioned, the NVIDIA A100 is pretty advanced GPU, so we don't see right now for this -- in the near term, we don't see it block a very big chunk of the market. But in the future, maybe, but according to the document the IS released, they will dynamically to -- adjust the specs in the 38090.

[Johnny Shen, executive]

Okay. So yes, let me add more. From our customer point of view, I think they are -- honestly, they are a little bit over some of the next generation. But thinking about the bright side, yes, since NVIDIA cannot offer their -- any advance ship to China, they already have a chip into production. So they consider the lifetime cycle for their existing chip will be longer, and volume will be bigger. And for those kind of companies, GPU has a spec near the limitation, I think most of them are our customers. So I think the near term, I don't expect too much revenue impact from these China CPU makers.

[Unknown Analyst]

Sure, understand. One more follow-up question. As you strict focus and strategy to focus more on non-China projects, is this pivot away from China, something very easy to execute because I really assume you -- I mean it's actually a 70% revenue in other markets, right? So it's very easy just to focus sales and marketing efforts on other countries. There won't be a lag time for you to sort of pick up marketing efforts in other countries, right? Because I would assume the demand is very strong, is that case, okay?

[Daniel Wang, executive]

Okay. When you look at the whole market, the design demand is, as I mentioned, very, very strong and the less supply for the advanced technology node, the vacant supply, the biggest design supply is really, really limited. Maybe Alcip, [indiscernible] or maybe 1 or 2 others can provide us kind of services in leading-edge technology nodes. So we don't see taking projects from non-China region will be a problem, but it takes time, but it is not that difficult to do.

[Johnny Shen, executive]

Okay. Yes. Let me try to add to that. Yes, obviously, our U.S. revenue increased quite a bit recently and also all the opportunities. I'm thinking about this way because, unfortunately, right now, the entire IC market is not so good. Right now, it's a market a little bit towards the recession portion, that's not good for our end customer. But thinking about the bright side, when the customer doing the cost down, the first thing they are thinking about is outsource. Yes, to be honestly, most of our customers and potential customers already issued the hiring freeze or even layoff. So they -- I consider, they need us much, much more than before. So in fact, I think the outsource to save the cost and we are the proven one. I think, during this situation, we expect we have more opportunity, yes, especially in the North American regions.

[Daniel Wang, executive]

Okay. So let me move to the next one. [indiscernible]?

[Unknown Analyst]

I'll ask some simple questions. Just I think everybody was pretty concerned as by the end of second quarter, we see on your financials that China exposure account for 39% of total revenues. And with the BIS American sanctions, share prices went down a lot. And then thank you for clarifying that. But going forward, let's say, we're concerned about the future, right? Do you see the China exposure of 26% currently to meaningfully go down in the foreseeable future next year, let's say, first 2 quarters of 2023, perhaps. Or is it going to stay the same?

And second question is, we keep hearing from various sources that the company is in talk with some customers about autonomous driving, projects related to that. And so if that's true, when do you see this revenue contribution to kick in next year perhaps? And if that's true, maybe the NRE project would go on for several quarters, maybe, I don't know. And when do you reasonably expect that to commence production if everything goes smoothly.

[Johnny Shen, executive]

Okay. Yes, let me go first, and maybe you can add on later. In terms of China business, yes, like I mentioned before, before we taking some China business, especially the high compute-related business, we need to be more conservative sign off all related document, KYC-related document and working with the suppliers to do some DD before we take it. Yes, after, we're thinking about this low risk and no risk, especially no military usage, those kind of stuff, customer already and also signed a related document back to us, then we will take. So I don't -- I try not to manage it for the total percentage. But I also mentioned about for every single account, we need to control them under 10 percentage like less than 10% or so. Yes, with any specific account, one account, you see this invitation, we can change the model back to COT or back to the royalty model. So total percentage as long as we combine compared to the Gen rule, I don't intentionally to further reduce the China concentration. Yes, that's your first question.

The second question is autonomous driving contribution starting from Q4 and next year, we -- I expect to have some certain [indiscernible], but the actual mass production contribution based on current calculation, I'm thinking about by the end of -- near the end of 2024, we expect to see a significant revenue booming during that time. But prior to that, I see pretty much all the NRE, as you know, the automotive are different compared to other applications. We need to engage much earlier other projects, which is doing purely back-end implementation because most of IC maker or system house, they already have a team to do their front-end architectural-related design. But for car maker, they need more support effort from us and also from our partner. So that's why I think the -- from the design stuff to production in this longer period, and based on our calculation, the real contribution will be by the end of 2024.

[Daniel Wang, executive]

Okay. Let me say it this way. For the percentage part, I would say for last year, because the U.S. contribution will grow a lot very significantly next year. So the percentage from -- the revenue contribution percentage from China will go down, but the absolute amount, the value revenue, absolute amount, we don't expect it to go down because the demand there is still strong and the generation migration is still ongoing. I think that is my best guess for the next year. Charlie, please.

[Charlie Chan, analyst]

Follow-up questions. My question is more about the competition again. I mean, your U.S. peers like Marvell, Broadcom, I think they can piece that they have a lower wafer price, right, versus your [indiscernible], and they can support them from in design, and there could be some China cuts requirements, right? Because China's side just at a very, very young, young stage. So how are you going to address also kind of competition from the U.S. competitors in those perspective? And also speaking about the competition, whether you can resecure or sustain your largest U.S. customers' revenue into 2024 and 2025.

[Johnny Shen, executive]

Okay. Let me try to answer that first. Yes. First of all, specifically, you mentioned about the Marvell, Broadcom and GOC, I think all of them are very respectful competitor. I think -- and I think each group of us has some advantages but also disadvantages. Yes, I don't want to mention too much. I think we carefully to do the competitor analysis. We know where is our advantage. And we know what's the disadvantage for other suppliers. We have good attacking point, try to penetrate in. In fact, we are winning a few of them already. The most important thing is, the price is the price from our supplier. I think that's -- before that's the biggest drawback from our side because the size compared to us to the U.S. provider are much less.

And when I talk to the major supplier, I think we can -- I can say I already get the consensus agreement if our current business is supporting by us when we try to approach their next generation and supplier will be fairly provide more competitive pricing to us in order to get a fair competition to other competitors.

Yes, I'm looking forward to see that happen. I think I already get some agreement from the major supplier. Hopefully, that will happen. And local support, I think that's very important and also a neutral position. I always mention about the neutral position. And both us and a major supplier doesn't believe you're making a product still compete with your customer. I think some other -- most of our competitors, I think they're making their own product. And in the meantime, they also make ASIC. I think it will be competencies are out there. I think that's one of our advantage. We are always maintaining mutual position, never compete with any customer.

[Charlie Chan, analyst]

So on this U.S. major accounts projects, do you have additional kind of advantage that you can secure the project. I think investors are all very curious with the next-generation projects is already secured. Can you give us some color?

[Johnny Shen, executive]

Daniel, do you want to cover this?

[Daniel Wang, executive]

Okay, sure. For the next generation, I won't say we were waiting, you never know. It didn't have -- it never has the result yet. Of course, when we do generation by generation project, we have certain advantage from the design perspectives. And yes, we -- I can just say, we try our best to win and we have advantage to win. But -- you never know honestly.

[Johnny Shen, executive]

Yes. So the good news is, this customer keep prolonging their design. I think the -- when we talk to them, originally, thinking about the current design maybe till the middle of 2024. But right now, they have a plan to expand, to extend their production period. So I can say next generation, of course, we will try our best to win. But since we are the incumbent, I think we are holding a good -- biggest advantage to win the next generation even though we can sacrifice a little bit about the current generation market in order to secure the next generation. I think this is something we were thinking about.

[Charlie Chan, analyst]

Actually, that is going to my next question. So Daniel, can you give us some kind of assumption for the future gross margin because probably you also need to be more flexible about the Turnkey price, right, to secure mix generation. So can you give us some guidance for 2023 gross margin level and also operating margin level?

[Daniel Wang, executive]

Okay. Firstly, I have to say, I'm really -- I haven't done the number forecast for next year. And -- but I can offer you the best guess for next year because the production revenue will go up significantly. The gross margin will go down for sure because the gross margin for our production and the gross margin for our design, there is a relatively a large gap between these 2 kind of -- 2 types of revenue. So my best guess is, the gross margin will be at about maybe high 20s, but that's just my best guess. I didn't -- I haven't done the number forecast right now for next year.

[Johnny Shen, executive]

Yes, overall, I think Daniel is right, gross margin will go down a bit. But if we think about the top line and NAM margin, we have confidence to have a significant growth in the next year.

[Daniel Wang, executive]

I have to emphasize here that I knew some -- I know some investors watching our gross margin. I'll offer you my view. For the production revenue, any gross margin better for us because we don't need extra human resources or necessary expense to process this revenue. So any gross margin from the production revenue will go directly down to the operating level. So no matter how low the gross margin is for the production. It is a plus to our company. And when you look back into our financial performance in the past 6 to 8 or even 12 quarters, you may see our gross margin may go up and down. But as long as production revenue goes up or they say, the whole revenue scale goes up, the operating margin goes up. So I think that's my perspective to our business structure.

[Charlie Chan, analyst]

So my very last question is about your 5-nanometer opportunities. So Shyang, so how many 5-nanometer project you're going to see NRE contribution next year? And can you give us some hints about the end application? And on the strategy-wise, right? I know you guys just focus on back-end design place and route, and that has been a great winning strategy. But do you kind of rethink this strategy, meaning, for example, you have a future automotive for China customers needing some more front-end design support. Would you consider to increase that part of service as well?

[Johnny Shen, executive]

Okay Yes. To answer your question, 5 nanometer, we already win one. We already win couple, not one. This morning, we just had a board meeting. I think the -- ourselves report, we have a recent win, 3, 5-nanometer design. So we have a plenty -- 5-nanometer in our portfolio right now in the pipeline. And to answer your question for the application, I think most applications stay out the same, HPC and AI related in Europe, in U.S., in North America, in Europe and also in China.

[Charlie Chan, analyst]

Does that include the automotive HPC?

[Johnny Shen, executive]

No. No that particular 1 is not 5-nanometer Okay. Yes. To answer your second question, yes, in order to win the automotive application, we need some front-end support. So other stuff HPC related, if ready want us to do -- to involve the front-end support, to be honestly, our plan to reject, yes, because myself and Chairman always are thinking about when you're making the system, you need to have a certain differentiation. You need to have some capability. You cannot just 100% rely on partners to do the -- to define your spec and architecture. But automotive is a totally different thing. The market already exists. They just transition from a conventional one to the autonomous driving. So they need many, many hands. So in that area, I think we already have a few partners already located in [indiscernible]. We are even thinking about to invest some of them. But in order to maintain our neutral position I will not own the [indiscernible] team, but I try to control and drive from end partners, help each other for us to win. So we already have a couple of net, in fact, they already get involved during our presale stage.

[Daniel Wang, executive]

Okay. Next one is [indiscernible] from HSBC.

[Unknown Analyst]

Just question was really going back to last year. We had this China speaking for that time. Just wanted to update. I think there was time you were talking about, there are about 3, 7 nano quarter going forward. What happened to that? Then how -- Okay. I'll just ask this first and then will follow up with.

[Daniel Wang, executive]

Okay, for [indiscernible], it is pretty simple right now. Everything is really, really clear right now that [indiscernible] putting the full note for entities list, which means for the new regulation in the same time, BIS has a list of 28 companies. And for [indiscernible], right now, their only choice for land is looking for license from BIS and they will do so.

[Johnny Shen, executive]

That's a full note for. So that's why [indiscernible] along with the other 27 companies, they need to follow the tightest regulation applying for license -- just for your information, right now, fortunately, I think before October 7, we already ship out all the [indiscernible] related, there will be 0 inventory in our hand. So I think the -- we will not suffer any APA issue from this account. And we encourage this customer to apply for license to continuously produce their next generation.

[Unknown Analyst]

My second question is, you actually think very much for clarification about this BIS impact on your revenue line. I just want to know on the second order, right? Because in the past, we did a lot this papers test chip for our Chinese companies resume specs. There was -- I think when we do test chip or NRE project, you do have certain expectations about in the future when they come in for the mass production that number may be reflecting your future's revenue forecast. Will you be able to quantify that if that project is not going to go ahead for production anytime soon?

[Daniel Wang, executive]

Okay. Okay, for your question. That I would suggest you can imagine if you were the customer and you are doing a project and the specs may fall into the class of 38090, what will you do? You may scale down our spec, right? So I -- from our perspective, we follow the regulation and when customers trying to do the high computing power project, we will extend to do the ECCN classification first to make sure that their project is not subject to yes.

[Johnny Shen, executive]

Okay. So let me add to that. For China customer, like I mentioned before, Daniel also mentioned, only 1 customer -- one product line of one customer may [indiscernible] 38909.

[Daniel Wang, executive]

No, no 38090.

[Johnny Shen, executive]

Sorry about that. And most of -- our other customer is not even closer to that spec. So whatever the preparation, whatever the math will already take out we can continuously to do the production. Yes, you mentioned about the test chip. I think we rarely make any test chip for China customer. I think most of the test chip 3-nanometer, 5-nanometer to proven IAP, to prove some I/O speeds for Europe and also for the North American customer. Yes, I think almost 100% of the China customers go for the [indiscernible] directly.

[Unknown Analyst]

My last part is about -- you're talking about the progress in the auto side, I remember, in the past, you were a bit hesitant going to the auto business. We just build a project message to [indiscernible] and also were taking up too much engineering resources, right? But now, we said going in -- those [indiscernible] are still valid. And if they are still well there, what will be the impact on the margin, the auto become a big part of our business?

[Johnny Shen, executive]

So let me try to answer your question. Before we are little bit hesitated to take automotive IC-related business, you are right because IC maker if they try to compete with the existing service provider like NVIDIA and AMD, we consider it's very difficult, and also risk is much higher. And also, we always mention about provide the ASIC service to chip provider. This business will not be sustain too long because they are making the chip. We're helping them to the back end. We're helping them to source. We are most of their cost of a good source. But right now, season company and car maker approaching us, that will be a different story. Yes, that's a pure ASIC. We're helping the system company, we're helping the carmaker to do the ASIC. That's our focus of business. Yes, the ASIC by definition, is helping the system company to do the chip. So recently, the reason we opened the door and start to do more investment because so many carmakers make the plan to do the ASIC. That's our business.

[Daniel Wang, executive]

Because of the time constraint, we take the last participants for the questions. Brian, [indiscernible].

[Unknown Analyst]

My question is really on hearing reports that next year to be USD 800 million here for you. So I just wanted, first of all, confirm that's the sort of number you're thinking of -- and secondly, could you just break down a bit where -- how do we get from where we are today to next year? And to the extent that we need some of the China business to grow to get there?

[Daniel Wang, executive]

Okay. Okay. First thing first, that we have never said $800 million and the Taiwan Stock exchange did not -- does not allow a company to give guidance, the revenue guidance to the outsiders. I can just say that, for this year -- actually, to us, internally is kind of disappointing because of the insufficient substrate supply. For next year, we don't see the substrate supply as a bottleneck anymore. So because of that, we expect the production revenue to our U.S. customer to grow maybe 3x, 4x by comparing with the revenue contribution this year. So that's the reason why I told the investors that last year, the revenue growth will be quite significant. This project will be a major growth driver for our revenue next year. but how high, how big the revenue can be, I would say, the number is really huge, but I really don't want to mention it in our earnings conference meeting.

[Johnny Shen, executive]

So I guess, that's it. And thank you for your participation. And hope you can support us as always. Thank you.

[Daniel Wang, executive]

Thank you very much. Thank you.