Ttm Technologies Inc Q2 FY2021 Earnings Call

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the TTM Technologies Second Quarter 2021 Financial Results Conference Call. During today’s presentation, all parties will be in listen-only mode. Following the presentation, the conference will open for questions. As a reminder, this conference is being recorded today July 28, 2021. Sameer Desai, TTM’s Vice President of Corporate Development and Investor Relations will now review TTM’s disclosure statement. Please go ahead.

Thank you, Travis. Before we get started, I would like to remind everyone that today’s call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements related to TTM’s future business outlook. Actual results could differ materially from these forward-looking statements, due to one or more risks and uncertainties, including the factors explained in our most recent Annual Report on Form 10-K and other filings with the Securities and Exchange Commission. These forward-looking statements are based on management’s expectations and assumptions as of the date of this presentation. TTM does not undertake any obligation to publicly update or revise any of these statements whether as a result of new information, future events, or other circumstances except as required by law. Please refer to the disclosures regarding the risks that may affect TTM, which may be found in reports on Form 10-K, 10-Q, 8-K, the registration statement on Form S-4 and the company’s other SEC filings. We will also discuss on this call certain non-GAAP financial measures such as adjusted EBITDA. Such measures should not be considered as a substitute for the measures prepared and presented in accordance with GAAP and we direct you to the reconciliation of non-GAAP to GAAP measures included in the company’s press release, which was filed with the SEC and is available on TTM’s website at www.ttm.com. We’ve also posted on our website a slide deck, which we will refer to during our call. I will now turn the call over to Tom Edman, TTM’s Chief Executive Officer. Please go ahead, Tom.

Thank you, Sameer. Good afternoon, and thank you for joining us for our second quarter 2021 conference call. I'll begin with a review of our business strategy, followed by highlights from the quarter and a discussion of our second quarter results. Todd Schull, our CFO will follow with an overview of our Q2 2021 financial performance and our Q3 2021 guidance. We will then open the call to your questions. I am pleased to report that in the second quarter of 2021 TTM generated revenues and non-GAAP EPS above the high end of the guided range. All commercial end markets were better than guidance and year-on-year growth was led by strength in the automotive and data center computing markets. These results were achieved despite supply chain constraints, inflationary challenges, and foreign exchange headwinds. Last quarter, I discussed with you, the increasing prices and lead times of laminates, a key raw material for the manufacturing of printed circuit boards. We have been actively managing those supply constraints and higher raw material costs through measures like supplier diversification, ongoing operational efficiency efforts, and quotation adjustments to mitigate the impact on TTM. The magnitude of the impact on our cost of goods sold will be larger in Q3 and Q4, as higher laminate prices in Q1 and Q2 take some time to work through our suppliers and inventory. I am proud of how TTM employees have worked to deliver excellent performance despite the formidable challenges of this environment. Next, I would like to provide an update on our long-term strategy. TTM is on a journey to transform our business to be less cyclical and more differentiated. We believe that over time, investors will be rewarded with more stable growth, strong cash flow performance, and improving margins. As part of this strategic transition, we sold our mobility business last year. We are now able to generate more consistent cash flow with our strong set of technologies and broad exposure to longer cycle end markets. In the second quarter, we generated $56.9 million of cash from operations or 10% of revenue. A key part of our ongoing strategy will be to add capabilities and products that are complementary to our current offerings, both internally and through acquisitions. Looking forward, our balance sheet is in a strong position to pursue further acquisitions, as well as to support higher organic investment needs. Another benefit of our strategic shift is the seasonality of our business. The pattern has changed since the mobility divestiture. We now experience modest seasonal softness in the first and third quarters due to holidays and vacation periods in China and North America respectively, and stronger revenue levels in the second and fourth quarters. This seasonality combined with some pull forward of demand from Q3 into Q2 is resulting in a sequential decline in our revenue guidance. I would also like to update you on the COVID situation. The vaccine rollout in the United States has resulted in a decline in new COVID cases. And we have seen the same dynamic within our employee base. However, many parts of the world have much lower vaccination rates, and the rise of the delta variant has led to significantly increasing case counts in a number of countries with the potential for another round of lockdowns. We are watching these developments closely to monitor impacts on demand and supply. We are using a data-driven process, monitoring vaccination rates and local case counts to determine safety precautions at our facilities. As we welcome back visitors, begin traveling again and return several of our remote employees back to the workplace. Our global manufacturing facilities have been operating throughout the pandemic. Given the rapid reopening in the United States along with the summer holiday season, we are seeing more challenges in attracting and retaining labor, which is resulting in elevated costs and production inefficiencies in North America. Our employees are paramount to the success of TTM. And we actively endeavor to demonstrate their value to our company through a combination of financial and non-financial methods. We are also hopeful that the expiration of elevated unemployment benefits in the US and increased vaccination rates will encourage potential employees to join TTM as we work to support our customers. Now I'd like to review our end market. All historical end market disclosures exclude the mobility business unit and the two EMS plants, which halted production in December of 2020. For more details on end market disclosures, please refer to page 4 of our earnings presentation, which is posted on our website. The aerospace and defense end market represented 33% of total second quarter sales compared to 34% of Q2 2020 sales and 36% of sales in Q1 2021. We continue to experience a positive defense climate with our AMD program backlog at $671 million compared to $647 million a year ago. On a year-on-year basis, defense continues to outperform commercial aerospace which saw meaningful year-on-year declines in the quarter. The relative stability in the defense market is a result of our strong strategic program alignment and key bookings for ongoing franchise programs. We saw significant bookings in the quarter for Northrop's upgrade of F-15 fighter jets with scalable agile beam radar. We expect sales in Q3 from this end market to represent about 33% of our total sales. The medical industrial instrumentation end market contributed 19% of our total sales in the second quarter compared to 21% in the year-ago quarter and 17% in the first quarter of 2021. The MI&I market exceeded a $100 million quarterly run rate and performed much better than expectations, as instrumentation customers in the semiconductor capital equipment end market were stronger than expected and medical as well as industrial customers rebounded. For the third quarter we expect MI&I to be 18% of revenues. Automotive sales represented 18% of total sales during the second quarter of 2021. Compared to 11% in the year-ago quarter and 17% during the first quarter of 2021. Automotive grew almost 80% year over year and continues to grow sequentially above our expectations, exceeding a $100 million quarterly run rate, which is a level not seen since 2018. We are aware that the shortage of semiconductors is currently limiting automotive production, but this phenomenon has not directly affected our business since we do not purchase semiconductors. While we are monitoring the situation closely, to date it has had very limited indirect impact on our PCB demand. We expect automotive to contribute 19% of total sales in Q3. Networking communications accounted for 15% of revenue during the second quarter of 2021. This compares to 19% in the second quarter of 2020 and 15% of revenue in the first quarter of 2021. We saw relative strength on a year-on-year basis in networking compared to telecom as the 5G build-out in China faced difficult year-on-year comparisons. In Q3 we expect this end market to be 15% of revenue. Sales in the data center computing end market represented 14% of total sales in the second quarter, compared to 13% in Q2 of 2020 and 14% in the first quarter of 2021. This end market was up 15% year on year, primarily driven by the growth from our data center customers. We expect revenues in this end market to represent approximately 14% of third quarter sales as data center continues to drive year on year growth. Next, I'll cover some details from the second quarter. All of the following operations metrics exclude the mobility business unit and the two EMF plants that we closed. This information is also available on page 5 of our earnings presentation. During the quarter our advanced technology business, which includes HDI, rigid flex and RF subsystems and components accounted for approximately 31% of our revenue. This compares to approximately 28% in the year-ago quarter and 31% in Q1. We are continuing to pursue new business opportunities and increase customer design engagement activities that will leverage our advanced technology capabilities in new programs and new markets. Capacity utilization in Asia Pacific was 88% in Q2 compared to 70% in the year-ago quarter and 80% in Q1. Our overall capacity utilization in North America was 49% in Q2 compared to 63% in the year-ago quarter and 55% in Q1. As we added plating capacity in two of our North American sites for the first time in several years. Our top five customers contributed 29% of total sales in the second quarter of 2021 compared to 33% in the first quarter of 2021. We did not have any customers above 10% in the quarter. At the end of Q2, our 90-day backlog, which is subject to cancellations was $553.1 million, compared to $436.6 million at the end of the second quarter last year, and $540.5 million at the end of Q1. Our PCB book-to-bill ratio was 1.26 for the three months ending June 28. I'd like to conclude by again thanking our employees for continuing to contribute to TTM and our critical mission of inspiring innovation with our customers. Despite the raw materials and labor-related challenges we are facing, our business performed better than we expected as a direct result of our employees and our supply chain partners' concerted efforts to support TTM and our customers. Now, Todd will review our financial performance for the second quarter.

Thanks, Tom, and good afternoon, everyone. I'll be reviewing our financial results for the second quarter, which are also shown in the press release distributed today. As well as on page 7 of our earnings presentation which is posted on our website. For the second quarter, net sales are $567.4 million compared to $570.3 million from continuing operations in the second quarter of 2020. The year-over-year decrease in revenue was due to the closure of our two EMF facilities, which generated $21 million of revenues in Q2 of last year, and no revenues in this most recent quarter. Excluding that impact, revenues of the ongoing business grew 3.4% year-on-year, as growth in our automotive and data center computing end markets more than offset declines in other end markets. GAAP operating income for the second quarter of 2021 was $40.9 million compared to GAAP operating income from continuing operations of $23 million in the second quarter of 2020. On a GAAP basis, net income in the second quarter of 2021 was $28.3 million, or $0.26 per diluted share. This compares to net income from continuing operations of $9.3 million or $0.09 per diluted share in the second quarter of last year. The remainder of my comments will focus on our non-GAAP financial performance. Our non-GAAP performance excludes our divested mobility business units, non-routine tax items, M&A related costs, restructuring costs, certain non-cash expense items and other unusual and infrequent items. We present non-GAAP financial information to enable investors to see the company through the eyes of management and to facilitate comparison with expectations and prior periods. Gross Margin in the second quarter was 18%, compared to 18.4% in the second quarter of 2020. The year-on-year decline was largely due to the appreciation of the Chinese currency versus the US dollar in our China facilities and production inefficiencies in certain North American plants. Selling and marketing expense was $14.2 million in the second quarter, or 2.5% of net sales versus $15.7 million, or 2.7% of net sales a year ago. Second quarter G&A expense was $28.6 million or 5% of net sales, compared to $30.4 million, or 5.3% of net sales in the same quarter a year ago. In the second quarter, R&D was $4.1 million or 0.7% of revenues, compared to $5.2 million or 0.9% in the year-ago quarter. Our operating margin in the second quarter was 9.7%. This compared to 9.4% in the same quarter last year. Interest expense was $10.5 million in the second quarter, a decrease from the $15 million in the same quarter last year, due to lower levels of debt as we repaid $400 million of our term loan and our $250 million convertible bond as well as lower interest expense following our debt refinancing in the first quarter. During the quarter, there was a negative $1.8 million foreign exchange impact below the operating line. Government incentives and interest income reduced to a negative $0.7 million, or approximately $0.01 of EPS. This compares to a gain of $0.2 million in the second quarter a year ago. Our effective tax rate was 8.7% in the second quarter. Second quarter net income was $40 million, or $0.36 per diluted share. This compares to the second quarter 2020 net income of $33 million or $0.31 per diluted share. Adjusted EBITDA for the second quarter was $75.6 million or 13.3% of net sales, compared with second quarter 2020 adjusted EBITDA of $76.8 million, or 13.5% of net sales. Appreciation for the quarter was $21.2 million. Net capital spending for the quarter was $22.7 million. Our ongoing focus is cash flow from operations. During the second quarter, we continue to deliver consistently strong results, generating $56.9 million or 10% of revenue from operations. Our balance sheet and liquidity positions remain very strong. Cash and cash equivalents at the end of the second quarter of 2021 were $558.3 million and our net debt divided by last 12 months EBITDA was 1.4 times. We are using that strength to repurchase stock and to avoid issuing new shares related to our warrants. We previously announced a $100 million stock repurchase program, and during the second quarter we bought back 411,000 shares for $6.1 million. We also spent $3.1 million to cash settle 60% of the stock warrants that mature during the quarter, thus avoiding the issuance of approximately 210,000 shares. Now I'd like to turn to guidance for the third quarter. As Tom stated earlier, the nature and amount of seasonality we experience has changed since the divestiture of the mobility business. As a result of that change and the demand pull forward into Q2 that we witnessed, we expect sequentially lower revenue in Q3. In addition, we expect a larger inflationary impact in Q3, which will contribute to lower sequential operating margins. Given that, we expect total revenue for the third quarter of 2021 to be in the range of $530 million to $570 million. And we expect non-GAAP earnings to be in the range of $0.31 to $0.37 per diluted share. The EPS forecast is based on a diluted share count of approximately 109 million shares. Our share count guidance includes dilutive securities such as options and RSUs, but no shares associated with our warrants, as the current stock price is below the strike price of $14.26. We expect that SG&A expense will be about 8.2% of revenue in the third quarter, and R&D will be about 0.9% of revenue. We expect interest expense to total approximately $10 million. Finally, we estimate our effective tax rate to be 10%. To assist you in developing your financial models, we offer additional information. During the third quarter, we expect to record amortization of intangibles of about $9.7 million, stock-based compensation expense of about $5 million, non-cash interest expense of approximately $0.5 million and we estimate depreciation expense will be approximately $21 million. Finally, I’d like to announce that we’ll be participating virtually in the Jefferies Industrial Conference on August 3, the Needham Industrial Technology Conference on August 9; and the Jefferies IT Hardware Communications Infrastructure Conference on August 31. That concludes our prepared remarks and now I’d like to open the line for questions. Travis?

Our first question comes from William Stein, Truist Securities.

Great. Thanks for taking my question. Congrats on the good quarterly results. I think operating margin took a nice uptick to 9.7% in the quarter. I recall you have historically had a 12% to 14% target on this metric. But that was before the divestitures that you did. And I'm wondering, whether you still think 12% to 14% is a good target and whether you have a timeframe that you have in mind to achieve it?

I'll take that one. It's great to hear from you again, Will. In response to your question, we still believe in those targets. A key factor for us was getting our utilization levels up in Asia, and we're beginning to see progress on that front, which is a positive development. Additionally, we aim to continue growing our aerospace and defense business, especially our RF components and subassemblies, which have better than usual PCB fabrication margins. This is a crucial element that we need to advance. However, some of the positive news we expected from the improved utilization in Asia has been somewhat tempered by inflationary pressures related to raw materials, as Tom mentioned earlier, along with a tighter labor market that presents challenges in hiring. Consequently, this has led to some price or wage inflation in labor. These two factors are working against us, creating headwinds that are diminishing the benefits we would typically see from growth and improved utilization in Asia. Nonetheless, I believe these issues are temporary, and we will manage them through ongoing cost control and pricing actions. I see these as transitional challenges that we have been facing for a quarter or two and expect might persist for a few more quarters.

A follow-up to that, Todd, I appreciate it. But I just want to dig into that a little bit more. With regard to the inflationary input costs, labor is one aspect, but on the material side, we've observed a strong willingness and ability among suppliers, particularly in semiconductors and other components, to accept higher prices in this environment. Lead-times are extended, though they may not be as stretched for your parts. Input costs are rising, especially foundry and semiconductor costs. Semiconductors are increasing prices for their customers across the board, even in markets such as automotive, where you typically wouldn’t expect it, and customers are accepting these increases. I'm curious why we're not seeing this reflected in your business release and what it comes down to. Thank you.

Yes, so Will, this is Tom. Let me explain. First, in our printed circuit board business and also in our tire business, we have a set of businesses that vary by quarter. Approximately 40% to 50% of our commercial business consists of spot or non-contractual work. In our Aerospace and Defense business, about half is related to similar spot or non-contractual projects, or contracts with escalation provisions. The remaining 50% is based on contracts with our customers. As soon as we receive any increases or even forecasted increases, we can incorporate those into our quoting models for the commercial and A&D sectors I mentioned. The rest of the business involves negotiations, and the best time to negotiate is when contracts are up for renewal, which typically happens annually or even more frequently. That's when we negotiate pricing. In some instances, we’ve had to approach customers to discuss the current situation and ask for their understanding. Overall, we've managed to mitigate about 75% of the increases we've been facing, which I consider a strong outcome given the proportion of our business that is contractual. Additionally, we consistently focus on cost management and improving operational efficiencies. As we enter negotiations with our customers, we will address the pricing situation. This is how things operate in the printed circuit board sector, and we will keep working through this. As Todd mentioned, we are confident we can mitigate these challenges; it’s just a matter of time as we implement our strategies.

Thank you.

Sure.

Our next question comes from Jim Ricchiuti at Needham & Company.

Hi. Good afternoon. I may have missed it, but you're talking about Poland's. Can you just say or elaborate on where you were seeing the Poland's, in which market verticals? And maybe what was driving? And how unusual is that is to say?

Yes. Sure. Yes and predominantly where we saw that was in our, in the data center computing end-market and a little bit in the networking and the networking side as well. And not unusual Jim, if you look at the blending of Q2, Q3 and so I would consider that it sort of normal to think about it in terms of multiple quarters. And generally we were, because in Q2, as we highlighted, Q2 we have many more days of production in North America, coupled with the excellent utilization rates that we have in Asia Pacific. So we were able to push that product out and our customers were pulling that product as we go into the Q3, here in those two areas, we're expecting that we'll see a little bit of a more subdued demand. But really on the edges, if you will, feel very strong environment. And then, the other factor is just the ability with vacations in North America. Q3 is always going to be from a production output standpoint, a lower production output quarter for us versus Q2. So those are the sort of two factors that we're absorbing at this point in Q3.

And I don't know if you want to size it quantify a Tom. And the other question and the last question I had is just on the utilization rates, you guys alluded to the higher utilization rates in Asia Pacific. But I'm just wondering, are you at all concerned about your North American utilization rates?

Yes, I think the best way to assess the sizing is by examining the end-market forecast we provided. Comparing Q3 to Q2, the data center sector is down about 6%, and networking and telecom are down roughly 2%. This decline is largely related to inventory levels and fluctuations in demand from quarter to quarter. In the A&D sector, there is a decrease of about 3% from Q2 to Q3, along with a segment of MII that has dropped around 6%, primarily due to production constraints in North America. In terms of utilization, we are very excited about the situation. It may seem counterintuitive that North America’s utilization rates are down, but this actually reflects our investment in two new plating lines during the quarter, which are essential to our process. This expansion enhances our capacity to meet the strong demand we are experiencing in the market and allows us to handle rapid turnarounds in those facilities. We need to continue improving our staffing in North America, but having this added equipment capacity, especially where we had previously faced bottlenecks, is crucial. Furthermore, investing in plating lines signals to our customers that we are ready to meet their increased demand levels.

Got it. Thanks very much.

Thank you.

Our next question comes from Matt Sheerin, Stifel.

Hi, everyone. Just a question regarding the margin headwinds that you're seeing first on the labor side, and on the materials side. It sounds like and you're not the only one saying conditions have probably worsened today since a quarter or two ago. Do you have any visibility into when this stabilizes, and sounds like you're catching up a little bit on passing those costs along, but do you see any further progress in the December quarter?

To follow up on what Tom mentioned about our pricing process, we have observed steady increases over time. These costs have moved through our suppliers, impacted our inventory, and reached our customers. We are working to address these rising costs, which have been substantial over the past few quarters. We aim to stay ahead of this issue and collaborate with our customers on pricing. However, for the approximately 50% of our revenue that takes longer to adjust, we are making progress. Although Q3 presents some challenges, we performed well in Q2, successfully mitigating the effects of inflation for part of our business. As costs continue to climb in Q3 and into Q4, we recognize the difficulty in forecasting, especially as our suppliers are expected to raise prices again in August and September. Currently, we are implementing measures to address today's challenges, which should yield more favorable results in Q4 compared to Q3, as we have improved coverage. I liken this situation to climbing a mountain; we're about 75% of the way up in Q3. The team is diligently working to overcome the remaining challenges, though this quarter will be tougher. We feel more prepared for Q4 due to our extended efforts. However, this is contingent upon our suppliers' actions over the next few months, which remain unpredictable and have been rising steadily. We believe we have a plan in place and are actively working to close the gap. Currently, Q3 appears to be our most challenging quarter in this context, though it remains dependent on future supplier actions.

Yes. I would add that Todd's comments also reflect what we are observing and predicting from our vendors regarding their plans. These moments really highlight the importance of our partnership with vendors, especially those who can accurately forecast and strive to meet demand transparently. We have several partners who have really stepped up to this challenge. Our goal is to grasp where the market is headed and make sure our customers have that understanding as well.

Okay. Thanks for that. Could you remind us what percentage of the cost of goods is represented by the copper-clad laminate?

So it is probably our single largest material cost that goes into our overall cost of goods sold. In total, if you look at laminate as a percentage of our total cost of goods sold, it's about 14.5%. If you look at all of the copper-related stuff and precious metals that we use, it's maybe an aggregate about 20% of our total cost of goods sold is really what we're talking about here.

That's helpful. My second question is about M&A, which has been a key part of your growth strategy. You've had significant success in integrating acquisitions, and Anaren has broadened your product portfolio. What are your thoughts on potential opportunities? Your balance sheet has been improving, so what should we expect regarding M&A?

Yes. You emphasized that it has been central to our strategy and will remain a crucial aspect moving forward. We are still exploring revenue synergies on the Anaren side, particularly through our cross-selling initiatives. There is also a strong connection between our RF component design efforts and the support we provide for printed circuit boards. As we approach the three-year mark, this relationship has become optimal. We now have products available in the market, and we are expanding our catalogue beyond just couplers and resistors to include transceivers and other components. We are actively pursuing new markets beyond telecom where we have seen success, while also identifying opportunities in automotive and some areas of optical networking. I want to commend our team for their ongoing focus on business development, which is centered on differentiation and the direction we are taking as a company. Regarding M&A, we are definitely looking to enhance our RF component capabilities, leverage our aerospace and defense strengths, and ensure we have the right infrastructure to support our commercial customers. This is a long-term effort for us, and strategically, the first internal checkpoint is to establish a strong strategic framework. Moreover, we need to ensure that any acquisition meets our financial criteria. We are observing higher multiples in the market and increased expectations, but this typically changes over time. Adjustments will be necessary as we assess our financial metrics, which will help open up some of those strategic opportunities. We will continue to pursue this process, as it is a vital part of our strategy.

Okay. All right. Thanks a lot, Tom.

Thank you.

Our next question comes from Mike Crawford, B. Riley Securities.

Thank you. Regarding the automotive business, can you talk about design wins and conventional mix versus ED, which I think in the past have been around 77%. And also regarding design wins, I think in 2019 and 2020 combined, you had over $1 billion of design wins. And so where that stands today, as far as 2021 and outlook for the future?

Sure. Yes. Let me start with the design wins; we in this most recent quarter, won about 47 new automotive design wins with a lifetime program value of about $121 million. And a good decent portion of that was on the non-conventional side of the business. So that should give you a flavor of this most recent quarter. And what I would say in terms of the overall automotive product mix is relatively constant and what we reported last year about 26% of the overall business was non-conventional. So, advanced technology capability, so about 26% the balance would be conventional and clearly our focus continues to be on building that advanced technology content in that automotive business. And with that focus on new design wins. So good progress, solid progress, I would say in the quarter. And certainly strong prospects here. And finally, just a comment on the revenue. I think, we hitting again 2018 levels. Very, very nice to see in particular we saw demand growth in Europe, as a region. North America and Asia still remained at a high levels. But to see Europe come in, into the mix and grow was really the change quarter-to-quarter for us. So good, strong demand there.

Okay. Thank you. And then just further regarding advanced technology, what percent of revenue I know it seems quite small as a triple to i3. And given that you divested some capabilities with the mobility business, like how important are differentiated solutions you can provide with that i3 intellectual property and assets that you acquired a couple of years ago?

Yes, you're correct. In terms of total revenue, it's still quite small. We monitor the opportunities that arise from our Advanced Technology Centre, located in Chippewa Falls, Wisconsin, where we relocated the i3 assets. In this facility, we are developing substrate-like printed circuit board capabilities to meet our own demands, focusing on fine lines and spacing for very dense circuits. While we don't break down that revenue specifically, I can tell you that as we analyze our aerospace and defense customer roadmaps, our capabilities align well with their interests and technology plans moving forward. Currently, we support circuit lines and spacing down to around 25 microns, and we anticipate continuing to reduce this over the next five years. Our goal is to meet that demand. Overall, I can say that we're making solid progress from the UTC.

Okay, Thank you. And then final question will switch the gears but it looks like you guys are getting back into the absolute live trade show circuit in September with a defense show in London. But how does that affect business development going forward?

It's always better to meet in person. You're absolutely right, Mike. It has been challenging for our field application engineering team and our sales team, but they have done a great job interacting with our customers remotely. However, being face to face and participating in trade shows again is important. Our mission is to inspire innovation in our customers, and the best way to do that is by collaborating closely during the design process and ensuring we meet the specifications set out by our customers. Closer interaction is definitely a positive.

Excellent. Thank you.

Thank you.

Our next question comes from Christian Schwab, Craig Hallum.

Hi. This is Tyler on behalf of Christian. Thanks for letting us ask a couple questions. First, last quarter, you guys outlined the quantify the impact from these commodity prices and labor and FX impacts is 13 million, I believe. And I don't think I heard you quantify this quarter, if you could? And then it appears like your Q3 guidance at the midpoint implies gross margins are going to be up sequentially above 18%. I guess first, is that correct? And then what's kind of the driver there?

To address your question about the second quarter, we successfully managed the challenges posed by inflationary pressures, specifically in raw material costs, so these were not a significant issue for the quarter. However, we anticipate a tougher scenario in the third quarter as we face greater challenges and have not fully mitigated the cost pressures we are encountering. This will result in some shortfalls that will influence our guidance. When comparing our Q3 forecasts to Q2, the similar inflationary factors present a challenge. Our margins are stable, with gross margins likely remaining steady or slightly declining. However, operating margins will reflect these pressures, showing a similar trend. Consequently, our EPS guidance indicates a slight reduction, primarily due to the inflationary impacts. This highlights the gap between rising costs and our ability to counteract them. We intend to work towards narrowing this gap, but that is our current assessment.

Okay, great. Regarding my second question, you mentioned that your utilization rates in the United States were 49% this quarter, which is lower than in Asia. However, you are optimistic about the plate machinery you added to address the bottleneck. What is your target utilization rate in the United States for the future?

Yes, in North America, given the quick turn nature of the business, it's essential to have excess capacity available to meet demand. We also deal with fluctuating bottlenecks due to the high mix, low volume nature of our operations. Utilization isn’t a strong indicator of profitability in this context. However, ideally, we would like to see utilization around 60%. If we push toward 70%, it would require significant adjustments. As we utilize the newly installed equipment and bring in more labor—especially with improved labor availability anticipated in the fall—we hope to elevate the utilization rate above 50% and move toward that 60% target again.

That's great. That's all for me. Thanks, guys.

Thank you.

There are no further questions in the queue at this time. I would now like to turn the call back over to Tom.

Okay, great. Yes, thank you. And I wanted to first thank all of you for attending. Hopefully you understand. And I'll just highlight a few of the factors from the quarter. We delivered revenues and earnings at the high end of guidance. We did that despite COVID-19-related and supply chain challenges. And our end market diversification again really pulled through for us solid year-on-year growth of 3% for our ongoing business. And then thirdly, we generated strong and consistent cash flow, a nice demonstration of financial discipline on the part of our team. And finally, I'd just like to thank you again, thank our employees and customers and vendors as well for your continued support. Thank you very much.

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.