MKS Instruments - Q3 2021

Transcript

Operator (participant)

Thank you for standing by, and welcome to the MKS Instruments third quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference may be recorded. Should you require any further assistance, please press star zero. I would now like to hand the conference over to your host, David Ryzhik.

David Ryzhik (VP of Investor Relations)

Good morning, everyone. I am David Ryzhik, and I am joined this morning by John Lee, President and Chief Executive Officer, and Seth Bagshaw, Senior Vice President and Chief Financial Officer. Yesterday, after market close, we released our financial results for the third quarter of 2021, which are posted to our website, mksinst.com. As a reminder, various remarks today are about future expectations, plans, and prospects for MKS comprise forward-looking statements, and actual results may differ materially as a result of various important factors, including those discussed in yesterday's press release and in the most recent annual report on Form 10-K and any subsequent quarterly reports on Form 10-Q. These statements represent the company's expectations only as of today and should not be relied upon as representing the company's estimates or views as of any date subsequent to today, and the company disclaims any obligation to update these statements.

During the call, we will be discussing various financial measures. All forward-looking financial measures exclude any contribution from Atotech Limited, the acquisition of which we expect to close by the end of the year. Also, unless otherwise noted, all income statement-related financial measures will be non-GAAP, other than revenue. Please refer to our press release for information regarding our non-GAAP financial results and a reconciliation to our GAAP measures. Now, I'll turn the call over to John.

John Lee (President and CEO)

Thanks, David. Good morning, everyone, and thank you for joining us today. We delivered strong third quarter results with revenue of $742 million and net earnings per diluted share of $2.79. I'm very pleased with the strong execution of the entire MKS team as we worked tirelessly to address supply chain constraints while remaining focused on technology, innovation, and design win opportunities with our customers. Sales to our semiconductor market grew 36% year-over-year and 13% sequentially to another record, and was led by broad-based strength across our differentiated vacuum and photonics portfolios. We delivered another record quarter in our RF power solutions business, which benefited from robust demand from leading-edge 3D NAND applications.

As memory manufacturers scale 3D NAND to higher layer counts and greater density, we anticipate a continuing need for higher power and more precise RF generators for high aspect ratio etching. We are the market leader for these solutions and remain well-positioned to continue solving these challenges for our customers. In fact, following an outstanding 2020, where we delivered triple-digit growth and significant market share gains, revenue from our RF power solutions has grown more than 50% year to date, translating to another year of meaningful market share gains. We also saw continued momentum in our plasma and reactive gas solutions, with strength in our dissolved ozone products for wet clean applications. Given the increased need for water efficiency in semiconductor fabrication, we have designed a solution that recycles unused ozonated water.

I'm pleased to say, in the third quarter, we installed our first system in a leading-edge semiconductor fab and are seeing growing interest, interest from other customers. Sales of our photonic solutions to the semiconductor market grew notably in the third quarter, partly due to our acquisition of Photon Control early in the quarter, as well as continued growth in our optical solutions for lithography, metrology, and inspection applications. Our high-performance optical assemblies enable our customers to increase throughput while moving to shorter wavelengths and finer features. As we look out into the fourth quarter, demand in our semiconductor market remains strong, and we anticipate revenue to remain consistent to slightly up relative to third quarter levels. This does factor in the continued industry-wide supply chain constraints that we are all facing.

We continue to make good progress in our advanced markets, which grew 10% year-over-year, but declined 20% sequentially, primarily due to the seasonality in our flex PCB drilling business, which we mentioned in our second quarter call. Design win activity remains strong. We secured picosecond laser design wins for solar and PCB cutting applications and won a meaningful world-class optics design for a defense application. We added another beta customer for our HDI via drilling solution. I'm also very proud to announce that we received the Laser Focus World Magazine's Innovators Award for excellent innovation for our CapStone flexible PCB via drilling solution. For the fourth quarter, we expect revenue from our advanced markets to be consistent to slightly up, driven by steady demand across our end markets. I also wanted to provide an update on our pending acquisition of Atotech.

We are progressing as planned and continue to expect the transaction to close by the end of this year. The Atotech transaction is all about accelerating the next frontier in miniaturization and complexity for advanced electronics manufacturing, and we are looking forward to combining our highly complementary expertise and capabilities to optimize the interconnect. High-performance interconnects are the highways that carry the massive quantities of data between semiconductors, sensors, and other components in advanced electronic devices. We believe that optimizing the interconnect requires a cross-collaboration of laser-based processing and advanced chemistry applications to meet rapidly evolving customer requirements. Here is an example of how a high-density interconnect PCB in a mobile device has evolved in a short period of time.

Since 2007, the number of vias on an HDI PCB panel have increased more than four times, from 250,000 to more than 1 million. This has resulted in a more than 60% decrease in the size of the lines and spaces, as well as the diameters of the vias. These smaller geometries and greater density have been vital to enabling more functionality in our phones, such as more cameras, microphones, facial recognition, LiDAR front cameras, 5G antennas, and more. These changes have also made it possible for smartphone makers to build in larger batteries while delivering thinner form factors. Enabling this rapid scaling of PCBs is what we and Atotech do. We believe these trends will only continue over time, and we are excited to harness our combined capabilities to accelerate new designs and roadmaps for our customers.

We are also excited about Atotech's General Metal Finishing business or GMF. This is which is well positioned for a number of attractive secular trends, such as automobile premiumization, electrification, and lightweighting, as well as the industry transition to Chrome VI alternatives. This business also provides plating of new plastics for 5G antennas and chemistry for renewable energy applications, such as solar and wind turbines. Needless to say, we are eager to close the transaction, given our excitement about the opportunities that lie ahead for the combined company. With that, I'd like to turn the call over to Seth.

Seth Bagshaw (SVP and CFO)

Thank you, John. I'll cover our third quarter results and provide additional detail and guidance for the fourth quarter. Sales for the third quarter was $742 million, up 26% year-over-year and down 1% sequentially. While sales were negatively impacted by industry-wide supply chain constraints in the third quarter, our team continued to execute well in responding to our customer needs, which allowed us to exceed the midpoint of our guidance. Even with supply chain constraints, sales to the semiconductor market set another record at $488 million, up 36% year-over-year and up 13% sequentially, reflecting broad-based demand from our semiconductor capital equipment customers. In particular, we delivered record revenue from our RF power, pressure, and plasma and reactive gas solutions. We also delivered strong growth in photonics revenue from semiconductor customers.

This included continued momentum in our optical solutions business, as well as a $15 million contribution from the acquisition of Photon Control, the market leader in temperature measurement for the semiconductor market. This acquisition represents another seamless extension of our Surround the Chamber portfolio, and the integration is already well ahead of schedule. MKS's broad vacuum and photonics portfolio allows us to address the widest array of critical semiconductor manufacturing steps, spanning deposition, etch, wet clean, lithography, metrology, and inspection, which we believe is unique to the industry. Sales to our advanced markets grew 10% year-over-year to $254 million in the third quarter and declined 20% sequentially, primarily due to seasonality of demand for our flexible PCB via drilling solutions, which we discussed in our second quarter earnings call.

In addition, sales in industrial applications softened in the third quarter due to supply chain constraints impacting our vacuum portfolio. However, demand trends in these applications also remain healthy. For example, in synthetic diamond manufacturing, we've seen growing demand for our microwave, pressure, and flow products that are critical to the chemical vapor deposition process used in the manufacture of synthetic diamonds. For the third quarter, the revenue split between our semiconductor and advanced markets was 66% and 34%, respectively. Third quarter gross margin was 47%, a decrease of 40 basis points sequentially due to marginally higher input costs, but up 190 basis points year-over-year. Third quarter operating expenses were $148 million, up less than $1 million sequentially and within our expectations for the quarter.

Third quarter operating margin was over 27%, a decrease of 60 basis points sequentially, but up 400 basis points year-over-year, which reflects the strong operating leverage in our financial model. Adjusted EBITDA in the third quarter was $222 million, resulting in adjusted EBITDA margin of 30%. Net interest expense in the third quarter was $6 million, and our non-GAAP tax rate was approximately 20%, reflecting the geographical mix of our taxable income. Net earnings for the third quarter were $155 million, or $2.79 per diluted share. In terms of working capital, days sales outstanding were 54 days at the end of the third quarter, compared to 52 days at the end of the second quarter.

Inventory turns were two point nine times in the third quarter, compared to three times in the second quarter. We remained focused on improving our cash conversion cycle. In third quarter, operating cash flow was $153 million, and free cash flow was $133 million. We had increased our dividend in the second quarter by 10% and made a dividend payment in the third quarter of $12 million or $0.22 per share. Exiting the third quarter, maintained a strong balance sheet and liquidity position with cash and short-term investments of $880 million.

Our term loan principal balance was $827 million at the end of the third quarter, and we exited the quarter with a $53 million net cash balance, which included a net payment for the Photon Control acquisition of $268 million. As John mentioned, our pending acquisition of Atotech is proceeding as planned. Integration planning activities are progressing very well. We're also pleased to announce that we successfully syndicated our debt financing on October 22. Our term loan financing was two times oversubscribed, comprised of two tranches: a U.S. $4.7 billion dollar loan at 225 basis points over LIBOR, with a 50 basis point floor, and a euro tranche of EUR 500 million at 275 basis points above EURIBOR, with a 0 basis point floor.

Both tranches were priced at 99.75. Funding of the financing will coincide with the close of acquisition of Atotech and is subject to customary ticking fees. We believe this overwhelmingly strong interest from the lender community is a testament to strategic rationale of the acquisition, as well as our strong combined financial model and our track record of successful acquisition integrations and deleveraging. We look forward to closing the acquisition and excited to welcome the talented Atotech team to MKS. I'll now turn to our fourth quarter outlook, which excludes any contribution from Atotech. We estimate fourth quarter revenue of $760 million ±$30 million. This forecast includes the headwinds from industry-wide supply chain constraints, which we expect to persist through the fourth quarter. However, overall business levels are expected to remain strong.

Based on anticipated product mix, revenue levels, and elevated input costs, we estimate fourth quarter gross margin of 46% ±1 percentage point, and operating expenses of $151 million ±$4 million. For the fourth quarter, net interest expense is expected to be approximately $6 million, and our tax rate is expected to be 18%. Given these assumptions, we expect fourth quarter net earnings of $2.85 per diluted share ±26 cents. I'd like to now turn the call back to the operator for Q&A.

Operator (participant)

Thank you. As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Again, that's star one on your touchtone telephone to ask a question. Please limit yourself to one question and one follow-up. Please stand by while we compile the Q&A roster. Our first question comes from the line of Jim Ricchiuti of Needham. Your line is open.

Jim Ricchiuti (Analyst)

Hi, good morning. A couple of questions on the advanced markets business. I'm wondering if you can give us any sense as to how you see the equipment portion of that business in the current quarter. Is there any kind of disruption as it relates to some of the supply chain issues that we're seeing throughout the consumer electronics market?

John Lee (President and CEO)

Hi, Jim. Thanks for the question. It's John. Yeah, I think when we look at the advanced markets and the contributions from the various divisions, the expectations for Light & Motion and Equipment & Solutions were consistent with, with what we expected. And the constraint, the supply chain constraints manifested mostly in the V&A side of the business. As you know, we have supply chain constraints on the V&A side, and we've talked about the semi- equipment side of it. But obviously, those constraints also affect the portion of the advanced market business for V&A as well.

Jim Ricchiuti (Analyst)

John, are you satisfied with the progress you're seeing in HDI? Or is it you added another customer there, but I'm just wondering, the existing customers that you're working with, are you seeing the kind of scale up that you anticipated, or is this just because it's a new product, it's taking longer to scale it?

John Lee (President and CEO)

Yeah. No, we're really happy with the customers that we've previously announced that have placed volume orders. So you know, those tools have been running in production 24/7 for the past 6-8 months, and those tools have been performing well. And we also have these other design wins with other large volume PCBA manufacturers, and when they ramp

... we certainly expect that the orders will pick up. The interest on testing our tool remains very high, so we continue to do demos for various customers. And you know, our goal is to make sure that we continue to get these beta sites, get the design wins, and then when they ramp, then we should see the volumes pick up.

Jim Ricchiuti (Analyst)

Got it. I'll jump back in the queue. Thank you.

Operator (participant)

Thank you. Our next question comes from Patrick Ho of Stifel. Your line is open.

Patrick Ho (Managing Director)

Thank you very much, and congrats on a really nice quarter, given the circumstances. John, maybe following up, supply constraint issues, as you mentioned, continue to persist, but you guys did a really good job in both the September and the December quarter outlook on the semiconductor side of things. Can you just qualitatively provide a little more details? Are they the same components, the same issues that you experienced, in the September quarter? Or are things changing kind of, on a dynamic basis, where one thing may be resolved and something else pops up? Can you just give a little bit of color, of the issues you're dealing with?

John Lee (President and CEO)

Thanks for the question, Patrick. It's the latter. So when, you know, a particular part becomes constrained, we solve that issue, and then another one would pop up. And so this has been true for the last couple of quarters. So these supply chain constraints are still largely about electronic components, but not the same electronic components. So as we solve each one, then a new one pops up. I'd say the difference, you know, in this particular cycle with supply chain constraints is that we're partnering with our customers much more closely, and partnership has been great to see.

So working with them to resolve supply chain constraints, working with them to design, you know, substitute components, that's actually been a silver lining, a silver lining in the supply chain constraint issues, this stronger relationship with our partners and customers.

Patrick Ho (Managing Director)

Great. As my follow-up question, it looks like you continue to gain share on the RF power side of things. You talked about the 3D NAND applications. High aspect ratio is something that's also becoming a bigger application in DRAM. Do you see, you know, I guess, progress and gains continuing on the RF power front, particularly as DRAM has more and more of these high aspect ratio applications as well?

John Lee (President and CEO)

Yeah, Patrick, we're really excited about the industry trend towards vertical structures in general. That was started by, you know, even earlier than 3D NAND with FinFETs. 3D NAND certainly accelerated that, and we think that, as you pointed out, DRAM has become, you know, very vertical as well. And then, of course, when 3D DRAM becomes a reality, that's gonna continue that trend towards verticality in the semiconductor industry. And the experience that we've had over the last six or seven years in developing our power solutions for that really puts us in a pole position to offer those solutions and develop new solutions as these new challenges come up.

Patrick Ho (Managing Director)

Great. Thank you.

John Lee (President and CEO)

Thanks, Patrick.

Operator (participant)

Thank you. Our next question comes from Krish Sankar of Cowen and Company. Please go ahead.

Krish Sankar (Managing Director)

Hi, thanks for taking my question. I had two of them, too. John, I remember you said last quarter, September revenues would have been $750 million without supply constraints, and I'm assuming some of that got pushed into December. So if I look at it, without supply constraints, it looks like September to December quarter, the revenues are flat. Am I thinking about it right, or is there something else going on? And then I had a follow-up.

John Lee (President and CEO)

No, I mean, in our semi business, it's certainly going up, quarter-to-quarter. Supply constraints, you know, we certainly wanted to, you know, highlight that. But if you think about our Q2 to Q3, decrease in revenue, remember that E&S was, due to its natural cyclicality, gonna go down about $50 million. So we actually did better than that, with the rest of the business. So when you take that out, we're actually up quarter-over-quarter. And then, Q4 is also, you know, the, the cyclical downturn, down quarter for E&S. And so our guidance for Q4 is actually also up, quarter-over-quarter relative to Q3.

Krish Sankar (Managing Director)

Got it. Got it. That's super helpful. Then I just had a follow-up. I think Seth kind of mentioned about higher input costs impacting gross margins. You know, it looks like everyone in the supply chain is increasing prices, and I understand it's hard for you to increase prices. Your semi customers, maybe they pay for shipping, but not for product price increases. But are you doing any price increase on the advanced market side, where you have a longer tail of customers?

Seth Bagshaw (SVP and CFO)

Yeah, Krish, this is Seth. I'll take that question. Yeah, so we have higher input costs in Q3 and obviously through Q4, and we don't have a view on that will kind of abate. But you might recall, we have a like a pretty unique process at MKS, called a profit and cash recovery team. So we've had that in place for probably six, seven years. So what I would kind of say is, we meet on a monthly basis at the executive level and next couple of levels down in the organization. It's really global initiatives, and that's all designed to exactly do what you mentioned, kind of drive profitability improvements. And there's many levers there. It's obviously, we try to drive down, you know, product development costs, higher margins there, low-cost country migration.

There's always some level of pricing ability in that mix as well. So, you know, that's an ongoing cadence. We meet again on a monthly basis. We do offset inflation every year, you know, simple inflation, every pressure, and then also create opportunities to invest in other areas in the business. So I would say, you know, not to get into details about pricing, you know, dynamics, but that is part of the overall equation. It's again, a-

... embedded process we've had for a number of years has been very successful, and that's, you know, very much robust today.

Krish Sankar (Managing Director)

Got it. Thanks, John.

John Lee (President and CEO)

Yep, you're welcome.

Operator (participant)

Thank you. Our next question comes from Paretosh Misra of Berenberg. Your line is open.

Paretosh Misra (Analyst)

Thanks, guys. Good morning. So regarding Atotech, can you talk about the cyclicality in the PCB business? Does that industry need more capacity similar to what we are seeing in the SEMIs business or how are supply versus demand?

John Lee (President and CEO)

Yeah, Paretosh, you know, there's different aspects to the PCB industry. So, in terms of high density interconnect, it's less cyclical because that covers many, many more types of end devices. In terms of flexible PCB, that's a little more cyclical because the adoption today is strongly influenced by smartphones and those advanced devices, and that's also spreading across different types of advanced devices as well. So, you know, if that's a proxy for the electronics division of Atotech, there is certainly less cyclicality than the semi equipment type of business. But it's also growing very fast because the growth of semiconductors as well.

Paretosh Misra (Analyst)

Got it. And then, looking further ahead, what sort of opportunities do you think exist for Atotech to increase their content per device? Because I would think that as devices get smaller, they're probably likely to use more of these chemistries and materials per device.

John Lee (President and CEO)

Yeah, no, we are excited about, you know, once we close, the kinds of opportunities for us to work together with Atotech, with our, laser drilling group, to provide solutions to our customers faster. And I think there's a great amount of opportunity there to increase, you know, share for both the Atotech side and the MKS side. We've talked about that in the past. To your point, as features get smaller, it requires the ability to deliver, you know, advanced processes, and that requires investments in R&D. And as you know, Atotech invests more in R&D than any of their competitors. And it's also, you know, part of the MKS DNA. We like industries that continually evolve, continually require more difficult challenges, and require investments in R&D.

I think that's really a formula for success for MKS and also a formula for success for Atotech.

Paretosh Misra (Analyst)

Great. Thanks, John.

John Lee (President and CEO)

Thanks, Paretosh.

Operator (participant)

Thank you. Our next question comes from Tom Diffley of D.A. Davidson. Your question, please.

Tom Diffley (Managing Director and Senior Research Analyst)

Yeah, good morning. Thank you. John, I was wondering, you know, another Atotech question. Have you been able to collaborate with them over the last couple of quarters? Any kind of joint development work going on ahead of the potential close?

John Lee (President and CEO)

Well, we've, we've been, you know, working with them before, any announcement on the, acquisition as well. So that kind of work continues, Tom. And that's kind of normal business as we are still independent companies. But certainly, we are in the middle of integration planning, you know, and while we're keeping, you know, to the fact that we're both independent companies, we can start planning on what we might do together afterwards. But, the regular collaboration type of work that, the two independent companies work on, that, that has continued.

Tom Diffley (Managing Director and Senior Research Analyst)

Great. Okay. Seth, another supply question. Obviously, you know, it looks like issues continue into the fourth quarter. When you're talking to the suppliers, do you get any sense as to when either excess capacity comes on board or, or when they think the supply constraints might alleviate?

Seth Bagshaw (SVP and CFO)

Yeah, it's a good question, Tom, and I think John kind of answered this question a little earlier as well, because it's kind of a fluid situation. As John mentioned, we'll solve kind of one component shortage, and we'll pop up kind of next day. So it's been kind of our, you know, our approach the last couple of quarters. That's not too atypical in a big ramp environment. Obviously, we're much higher in record volumes. It's much more, you know, magnified, but it's really continued working through each of the suppliers, working closely with them. As one issue comes up, we solve it. Another one comes up, we solve that one. So it's kind of that type of process at this point, Tom. So it's hard to say when it'll be alleviated, but everybody's working on it.

A lot of smart people are kind of driving the right behavior. Our team, I said before, has done, I think, a great job because we did beat the up midpoint of our guidance for the quarter, and we're working very hard to keep our customers, you know, obviously, you know, product in their hands as well.

Tom Diffley (Managing Director and Senior Research Analyst)

Okay. And that 40 basis points input cost hit in the quarter. Do you expect that to stay roughly at the same levels for the next couple quarters?

Seth Bagshaw (SVP and CFO)

Yeah, it's probably—So you're right, in Q3, probably about 40 basis points is our estimate. In the fourth quarter, the guidance is probably a little bit marginally higher, and it's kind of hard to say when that'll, you know, kind of abate going forward. I did mention earlier, kind of answer to a question, we do have a profit and cash recovery process, which again is, you know, how we kind of mitigate any major increases on input cost, inflationary pressure. So we're gonna lean to that probably a little bit more, obviously, going forward, but it's probably a little bit north of 50 basis points in Q4, at this point, is our estimate.

Tom Diffley (Managing Director and Senior Research Analyst)

Okay, thanks for your time.

Seth Bagshaw (SVP and CFO)

Okay, thanks, Tom.

Operator (participant)

Thank you. Our next question comes from Joe Quatrochi of Wells Fargo. Please go ahead.

Joe Quatrochi (VP and Equity Research Analyst)

Yeah, thanks for taking the question. John, I was curious of your thoughts on the semi cycle. Typically, you know, MKS outperforms WFE when things are-

... and then when things slow, you know, you see it a little bit more just from an inventory correction standpoint. But clearly the supply chain dynamics are, you know, having inventory levels be much leaner. So, you know, I know it's hard to predict, but what happens, but I guess, how do you think about that in terms of maybe a softer landing for MKS, or maybe even to some extent, a bit of an inventory restocking?

John Lee (President and CEO)

Yeah, Joe, those are probable, you know, outcomes of the fact that we are in a supply-constrained environment. So things are pushing to the right for our customers, for us. And so, you know, logically, that extends any kind of cycle for sure. And then to your point, you know, if a downturn comes, then people are gonna, you know, need to replenish their inventory. There's not a lot of inventory just sitting out there, obviously. And then, you know, when you think about how MKS performs relative to WFE, our model is 200 basis points above, you know, long-term WFE. And, you know, we don't like to cherry pick.

We like to look at the long term, because, you know, if you take the last two years, 2020 and projected 2021, we will have outperformed WFE by 1,000 basis points, you know? But if you take it back, you know, five years, six years, that's the 200 basis points that we have modeled. And we still subscribe that that's the model that we should, that you should expect from us.

Seth Bagshaw (SVP and CFO)

I just wanna add one point to that, too, is we've got about a $1 billion run rate in our advanced markets business. So, just to emphasize the fact that we have worked really hard to be a broad-based revenue stream, and Atotech will add to that dynamic going forward as well. So even though majority of our sales now are seeing the semi market, we do have other areas that kind of balance that out throughout any cycle. And then the service business also has grown substantially as well. That's a pretty sticky business. So we've worked pretty hard over the years to make that operating model pretty robust and pretty, you know, rock solid in any type of cycles we see.

Joe Quatrochi (VP and Equity Research Analyst)

Got it. And then just, you know, on the advanced market side, you talked about, you know, the industrial application softness just from supply chain dynamics. Does your guide assume a similar level of impact in the fourth quarter, or does things get maybe a little bit worse before they get better?

John Lee (President and CEO)

You know, our guide is flat to slightly up in both markets, as we said. So, we're thinking that we could do a little better, even with the supply constraints coming up. So I don't think we're saying the supply constraints are getting better. In fact, they may be as bad or worse even, but I think our ability to deal with it is better, and our ability to partner with customers is certainly a lot better, as I mentioned earlier. So, that's why we're comfortable with our guide of, you know, flat to slightly up in both markets, Joe.

Joe Quatrochi (VP and Equity Research Analyst)

Got it. Thanks.

John Lee (President and CEO)

Thank you, Joe.

Operator (participant)

Thank you. Our next question comes from Sidney Ho of Deutsche Bank. Your line is open.

Sidney Ho (Equity Research Analyst)

Thanks for taking my questions. Maybe just to follow up to the supply constraint question, looking back third quarter, was the total revenue being constrained, roughly what you expected? And if you can look at Q4, see if you can quantify the, the impact of the supply constraints on both the revenue and gross margin line. And specifically related to gross margin, I understand you talk about higher input costs, but, being down quarter-over-quarter, excluding that impact, what would be the reason behind that?

John Lee (President and CEO)

Yeah, I think that impact is part of it, and then, you know, there's probably a little product mix. You know, there's also a little bit of inefficiency in our factories because as supply comes in, it's lumpy. But, you know, I think that's kind of in the noise, Sidney, so I wouldn't read too much. We're not trying to say that gross margins are changing, except for these kinds of inefficiencies brought on by supply constraints and the inefficiencies that they cause in our factories. So there's nothing more to the gross margin guidance than that. And then, you know, your other question about, you know, how much of the supply constraints we expect in Q3 materialize.

You know, it was, it was probably, you know, on that order that we talked about of, you know, the $30 million we talked about earlier, plus or minus, that was our range, and we did better. You know, we did better in Q3 than we guided. And in Q4, we maintained the range, plus or minus $30 million. Just as we talked about earlier, we don't see the supply chain constraints changing much. The challenges are still gonna be there. Our ability to deal with it as an industry and as MKS seems to be a little better. And we'll see how we end up at the end of the quarter.

Sidney Ho (Equity Research Analyst)

Okay. Maybe my follow-up question, on the operating expenses side, you guys have done a pretty good job in the past few quarters, staying in the $140-$150 range. And keeping incremental operating margin above your target of 40% for a number of quarters now. How should we think about OpEx trajectory beyond Q4, excluding the Atotech, obviously? Do you think there will be some catch up in spending, maybe some expenses coming back, maybe you need to hire more people, et cetera?

John Lee (President and CEO)

Yeah. Yeah, I'll take that, Sidney. So, what I kind of think about, if I take the Q4 guidance on OpEx and annualize that starting point, and then probably add in, you know, roughly the inflationary, you know, piece of on top of that, you know, 3% to 4%, that's probably a pretty good estimate for next year. We're still doing the budgeting process right now and the planning process, but I think it gives you kind of a pretty good sense of what we're thinking next year on OpEx. We are gonna lean into a number of areas. We do a number of, you know, investments in R&D.

... But again, I mentioned we were able to offset that through other cost initiatives as well. So even though it'll be up sort of inflationary amount, I believe next year, we're going to lean into other product development areas that we think are very compelling in the long term.

Sidney Ho (Equity Research Analyst)

Okay, thank you.

John Lee (President and CEO)

Yep, you're welcome.

Operator (participant)

Thank you. Our next question comes from Mark Miller from The Benchmark. Your line is open.

Mark Miller (Senior Equity Research Analyst)

Thank you for the question, and congrats on the quarter. I just wondering, any, any comments about what you're seeing in the bookings trend?

John Lee (President and CEO)

Yeah, Mark, we usually don't discuss the bookings, but I would comment that they remain very strong. Obviously stronger than we can ship, as we talked about all quarter. So, you know, one of the things we look at more in terms of the semi side is if things delivery request starts sliding to the right, you know, that might be indication of a downturn. We're seeing none of that. It's all the other way. We're also seeing booking windows open up, extend from our customers as they try to get, you know, in line further and further out into the future. So it remains very strong, very robust, and we really have no concerns about that. We're really all focused on, you know, getting the supply so we can deliver the products at this point.

Mark Miller (Senior Equity Research Analyst)

Okay. And as a follow-up, the several new fabs have been discussed coming up starting next year. When do you expect you'll start to be impacted, your bookings will start to be impacted by the ramp in these new fabs, second half of next year?

John Lee (President and CEO)

You know, if you think about some of the fabs that have been announced, you know, they're just literally digging the holes right now, kind of in Arizona. Austin, Texas, hasn't even started digging the hole. They got the land, though, right? So, these fabs will take, you know, at least a year and a half, two years to be ready to have equipment put in. Then, of course, those companies have to decide that the business, you know, justifies that. So I don't think it's a second half 2022 for those fabs. But there are a lot of empty shells or fabs with, you know, capacity to add. And so I think those new fabs, it's probably a two-year lead time.

Of course, I think you can ask the chip companies that, they may say similar things or, you know, or longer or shorter, but it's, it's at least in that timeframe.

Mark Miller (Senior Equity Research Analyst)

Thank you.

John Lee (President and CEO)

Thanks, Mark.

Operator (participant)

Thank you again, ladies and gentlemen. To ask a question, please press star one on your touchtone telephone. Again, that's star one on your touchtone telephone to ask a question. We have a follow-up question from Jim Ricchiuti of Needham. Your line is open.

Jim Ricchiuti (Analyst)

Yes, just a question on, again, going back to, the advanced markets, the way you're characterizing the business in, in Q4. What I'm wondering is, if we, if we pull out and look at the Light & Motion business, and perhaps pull out some of the, the semi-related portion of that business, I'm curious what kind of trends you're seeing in that business, just because it is, some of it is a proxy for the broader economy, and there have been some pockets where there's been some slowing. Are you seeing any change in, in order patterns in that Light & Motion business, excluding the semi area?

John Lee (President and CEO)

Yeah, that's a great question, Jim. We actually look at that very carefully. You know, we break out the semi part of light and motion, and then we look at the rest, the advanced markets. Certainly, the semi side is growing faster. You would expect that given the buildouts in WFE. But the advanced markets are also growing, you know, kind of double digits. So that's really a great sign. And as you know, it's different markets. You know, it's solar, it's display, it's advanced manufacturing, and defense even. So, but we're happy with the advanced markets growth of the light and motion division. That's actually been double digits right now.

Jim Ricchiuti (Analyst)

Okay. You're seeing that across geographies?

John Lee (President and CEO)

It's a good question. I think it's still strongly Asia focused, but that's because a lot of our business is Asia-focused. More of the GDP-type businesses like research, et cetera, that's probably, you know, not geographic. It's everywhere.

Jim Ricchiuti (Analyst)

Okay. Thanks a lot.

John Lee (President and CEO)

Thanks, Jim.

Operator (participant)

Thank you. At this time, I'd like to turn the call back over to David Ryzhik for closing remarks.