Q3 2025 Earnings Call Transcript

Greetings and welcome to the Coherent Fiscal Year 2025 Third Quarter Earnings Webcast. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Paul Silverstein, Senior Vice President of Investor Relations for Coherent.

Please go ahead.

Thank you, operator, and good afternoon everyone. With me today are Jim Anderson, Coherent’s CEO, and Sherri Luther, Coherent’s CFO. During today's call, we will provide a financial and business review of the third quarter of fiscal 2025 and the business outlook for the fourth quarter of fiscal 2025. Our earnings press release can be found in the Investor Relations section of our company website at coherent.com. I would like to remind everyone that during our conference call today, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company.

We wish to caution you that such statements or predictions based on information that is currently available and that actual results may differ materially. We refer you to the documents that the company files with the SEC, including our 10-Ks, 10-Qs, and 8-Ks. These documents contain and identify important risk factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements. This call includes and constitutes the company's official guidance for the fourth quarter of fiscal 2025. If, at any time after this call, we communicate any material changes to this guidance, we intend that such updates will be done using a public forum, such as a press release or publicly announced conference call.

Additionally, we will refer to both GAAP and non-GAAP financial measures during this call. By disclosing certain non-GAAP information, management intends to provide investors with additional information to permit further analysis of the company's performance and underlying trends. For historical periods, we provided reconciliations of these non-GAAP financial measures to GAAP financial measures in our earnings release, in investor presentations, that can be found on the Investor Relations section of our website at coherent.com. Let me now turn the call over to our CEO, Jim Anderson.

Thank you, Paul and thank you everyone, for joining today's call. I'd like to start by thanking my Coherent teammates for another quarter of strong execution and their continued focus on accelerating our pace of innovation as we introduced a number of outstanding new products over the past quarter that will help drive long-term growth for the company. Our fiscal third quarter revenue increased by approximately 4% sequentially and 24% year-over-year to a record $1.5 billion. This was primarily driven by ongoing strong AI data center related revenue growth and a third quarter of growth in our telecom revenue.

We also continued to make solid progress towards achieving our gross margin target of operating above 40% on a non-GAAP basis. In fiscal Q3, our non-GAAP gross margin improved on both a sequential and year-over-year basis to 38.5%. Our revenue growth and gross margin expansion drove a 2.4x increase year-over-year in our non-GAAP EPS. While I'm pleased with the progress to date, we have much more work and opportunity ahead of us.

I'd now like to share some updates on our products and markets. Starting with our data center and communications end market, Q3 revenue increased by 9% sequentially and by 46% year-over-year with growth in both our AI data center and telecom end markets. In the data center end market we achieved record Q3 revenue which grew 11% sequentially and 54% year-over-year due to ongoing strong AI data center demand. We have the broadest and deepest portfolio of photonic technologies required for high-speed optical data transmission.

Our customers value both the breadth and depth of our technology portfolio as well as our supply chain flexibility and resiliency, especially in the current environment. At the Optical Fiber Communications Conference in March, we introduced many new optical networking products and technologies. For example, six of our products received awards reflecting innovations at the component, module and system level. At OFC, we showcased three different 1.6T transceiver designs based on three different types of lasers, design based on our EML technology, a design based on our new 200 gig per lane VCSEL technology, and a third design based on our silicon photonics technology.

The three different 1.6T demonstrations illustrate the wide breadth of technology options that we bring to our customers as we partner with them over multiple generations of data rate and architectural transitions. We continue to expect 1.6T to begin ramping during this calendar year. We're making good progress with our lead customers and we continue to execute well through the typical stages of engineering milestones and customer qualifications. We are also pleased to see continued expansion of our 1.6T customer engagements.

While we approach the 1.6T ramp, our engineering team is also focused on the development of our portfolio of 3.2T transceiver products and technologies, which will support a range of optical data transmission form factors. For example, at OFC, we reached a key technical milestone for the industry when we demonstrated our 400 gig per lane differential EML, which is the foundation of 3.2T transceivers and paves the path for future industry adoption of 3.2T transceivers. We also expect to see adoption of our 400 gig EMLs in 1.6T transceivers, where they can provide meaningful benefit to our customers.

We also showcased a wide range of co-packaged optical solutions over the past quarter. We announced our collaboration with NVIDIA on co-packaged optics and networking switches for AI infrastructure and at OFC we showcased a comprehensive portfolio of optical networking components for CPO applications in both the scale out and scale up domain. Indium phosphide is the key technology behind our internally produced EML and CW lasers, with the latter being used in our silicon photonics and CPO solutions. We've had in-house indium phosphide capability for over 20 years.

Indium phosphide based EML transceivers already account for the majority of our data center transceiver revenue and a majority of our EML based transceivers utilize our internally manufactured lasers. To meet rising demand for optical networking solutions that use either EML or CW lasers, we continue to expand our indium phosphide capacity. In Q3 we once again expanded our capacity both sequentially and year-over-year with the year-over-year capacity growing by over 3x. We remain on track to introduce our 6-inch indium phosphide platform, which will provide significant advantages in terms of both lower cost and higher volume production.

We expect to begin ramping 6-inch volume production next quarter. We also continue to make good progress with our new data center Optical Circuit Switch or OCS platform, which drives a significant expansion in our data center addressable market opportunity. The underlying technology in our OCS switch is based on field proven digital liquid crystal technology that has been deployed for many years in demanding telecom applications. Our technology has tremendous benefits versus the mechanical MEMS based solutions offered by others and our customer engagement and enthusiasm around our OCS platform continues to grow.

As I noted last quarter, we've already received our first customer order for this key new differentiated platform and we continue to expect initial OCS revenue in calendar 2025. In telecom, our Q3 revenue increased 2% sequentially and 21% year-over-year. Q3 was the third consecutive quarter of sequential growth. Revenue growth in Q3 was driven primarily by data center interconnect along with further improvement in traditional transport market. We saw continued growth in the ramp of our new products including our 100 gig, 400 gig and 800 gig ZR, ZR+ Coherent transceivers and expect these products to continue to ramp over the coming quarters.

We also continued to expand our product portfolio and announced new products at OFC to address increasing demand for high-speed, efficient and scalable metro regional and DCI applications. We expect this to continue to be a key growth area for us over the long-term. In our remaining markets which are primarily industrial related applications, aggregate revenue was relatively stable with a decrease of 2% sequentially and an increase of 1% year-over-year. In Q3 we saw a healthy year-over-year growth in the semi-cap equipment and display capital equipment end markets that was offset by soft demand in broad based industrial end markets such as precision manufacturing.

Growth in our semi-cap equipment revenue was driven by increased demand for advanced packaging tools where our lasers, optics and advanced materials are being increasingly adopted. In our display capital equipment market year-over-year growth is driven by ongoing demand for our differentiated excimer laser annealing systems which support both Gen 6 OLED fab expansions and new Gen 8 fabs, as OLED screen adoption continues to grow. We expect the total surface area of OLED screen production to double over the coming years as OLED screens are adopted across a broader range of devices. In support to the OLED expansion, we continue to ramp shipments of our laser systems for new Gen 8 OLED fabs.

Shifting now to our investment strategy, I'd like to provide an update on our strategic portfolio optimization. We continue to drive a series of actions stemming from the portfolio assessment that we completed last year with several parallel initiatives in motion. One area of focus to optimize our portfolio is to exit or divest non-core product lines. For example, during the March quarter we shut down development of silicon carbide devices and modules and eliminated the related headcount and operational expenses.

We have refocused our silicon carbide business on substrate and EPI production where we have differentiated technology and healthy customer demand. We also discontinued several other unprofitable product lines. Another area of focus is to continue to streamline our asset base and divest underutilized assets. For example, we recently announced our intent to sell our underutilized production facility in Champaign, Illinois.

We are also pursuing several other asset optimization actions. As we reduce investment in non-core product lines and streamline our asset base, we continue to concentrate and grow investment in our core growth and profit engines to accelerate shareholder value creation for the long-term. We'll provide additional details and examples regarding our strategic portfolio realignment at our upcoming Investor Day. Regarding the current tariff policy environment, the impact of tariffs to our business in the current quarter is not expected to be significant.

One of our strengths, which is valued by our customers, is supply chain resiliency and flexibility. We have a global manufacturing footprint that spans roughly 60 different locations across 14 countries, with roughly half of our manufacturing sites located in the U.S. Our geographically diverse supply chain, combined with the internal production many of our most critical technology infeeds, provides adaptability and optionality that benefits our customers. To the extent there are changes in the landscape, we will adapt as necessary to support our customers.

In summary, I'm pleased with the additional progress we made in our fiscal third quarter and especially proud of the large number of new products and technologies that we introduced. With a high level of uncertainty in the current macroeconomic environment, we're taking a more cautious near-term view of our end market demand. However, we continue to expect fiscal 2025 to be a strong growth year for the company and we believe we are well positioned for continued long-term growth. I look forward to sharing more details about our long-term plans for the company at our upcoming Investor Day.

I'll now turn the call over to our CFO, Sherri Luther.

Thank you, Jim. In the third quarter we drove continued sequential improvement in our financial results with strong revenue growth and gross margin expansion driving strong profitability. In addition, we strengthened the balance sheet by paying down $136 million in debt. Third quarter revenue was a record $1.5 billion, an increase of approximately 4% sequentially and 24% year-over-year.

From a segment perspective, networking revenue increased 10% sequentially and 45% year-over-year driven by strong AI data center demand. Laser segment revenue decreased 3% sequentially and increased 4% year-over-year. The year-over-year growth was driven primarily by demand for our excimer annealing lasers in our display capital equipment business as well as higher demand in semi-cap equipment. Materials segment revenue decreased 3% sequentially and decreased 1% year-over-year.

Both the sequential and year-over-year declines were due to softness in the consumer electronics end market. Our third quarter non-GAAP gross margin was 38.5%, an increase of 30 basis points compared to the prior quarter and an increase of 490 basis points compared to the year ago quarter. The sequential and year-over-year improvements in non-GAAP gross margin were driven by higher revenue volume as well as benefits from our gross margin expansion strategy, where we saw improvements in both pricing optimization as well as cost reductions offset somewhat by unfavorable mix. Cost reductions included lower manufacturing costs as well as yield improvements.

Third quarter non-GAAP operating expenses were $297 million compared to $283 million in the prior quarter and $254 million in the year ago quarter. The R&D increases were primarily driven by increased investments in our product portfolio. The SG&A increases include debt repricing fees incurred in Q3 to reduce the interest rate on our term loan B by 50 basis points. As a result of our strategic portfolio optimization, the company incurred restructuring cost of $74 million on a GAAP basis in Q3 related to a number of restructuring actions including the elimination of certain nonstrategic product lines, site closures and consolidations, workforce reductions, contract terminations and other associated cost reductions as well as initiatives to drive greater efficiency and lower costs.

From an R&D perspective, we continue to focus on investing our R&D in those projects with the highest ROI while driving efficiency and greater leverage in SG&A. Our third quarter non-GAAP operating margin was 18.6% compared to 18.5% in the prior quarter and 12.6% in the year ago quarter. Third quarter non-GAAP tax rate was 25% compared to 17.4% in the prior quarter due to the restructuring charges that I mentioned which were primarily in higher tax rate jurisdictions. Third quarter non-GAAP earnings per diluted share was $0.91 compared to $0.95 in the prior quarter and $0.38 in the year ago quarter.

We paid down $136 million in debt during the quarter using cash from operations. This brings our fiscal year-to-date total debt payments to $386 million, reducing our debt leverage to 2.1 times as defined in the credit agreement. I will now turn to our guidance for the fourth quarter of fiscal 2025. We expect revenue to be between $1.425 billion and $1.575 billion. We expect non-GAAP gross margin to be between 37% and 39%.

We expect total operating expenses of between $290 million and $310 million on a non-GAAP basis. We expect the tax rate for the quarter to be between 21% and 24% on a non-GAAP basis. We expect EPS of between $0.81 and $1.01 on a non-GAAP basis. Our guidance comprehends the impact of tariffs based on the current policy environment.

The current impact is not expected to be significant. In summary, I am very pleased with the progress we have made in Q3. We will continue to focus on improving profitability through gross margin expansion as well as operational efficiency. It's important that we make investments for the long-term growth of the company while driving operating leverage and efficiency. Cash and capital allocation will continue to be key focused areas to further strengthen and deleverage our balance sheet.

As a reminder, we will host an Investor Day in New York on May 28, at the New York Stock Exchange. At that event, we will outline our overall strategy, including our end market growth opportunities, product and technology roadmap and long-term financial model. That concludes my formal comments. Operator, please open the call for Q&A.

Thank you. [Operator Instructions] Now the first question we have comes from Samik Chatterjee of JPMorgan. Please go ahead.

Hi, thanks for taking my questions and congrats on the robust results. Maybe Jim, if I can start you off on the, you in your prepared remarks did mention the pace of innovation and we're seeing that across the industry and from Coherent as well. You had a bunch of announcements, product announcements at OFC. Can you just help us think about the significance and the impact, as well as somewhat in relation to timing of when investors should expect those to become more material in terms of revenue and impact the P&L?

And then I have a follow-up. Thank you.

Yes, thanks Samik. Yes, I appreciate that. I'm always happy to talk about products, so thanks for asking. You know, so we did have quite an outstanding month in March in terms of new product announcements and technology demonstrations most of that happening at OFC.

And I think it really showcased the great innovation that happens every day within Coherent. But I could go on and on about the product announcements, but maybe I'll just highlight two or three is one of the ones I was most proud about of what the team accomplished was, we showed three different versions of a 1.6T transceiver. So obviously for the industry, for the data center, the next big transition in terms of data rate is 1.6T. And we showed three different versions.

One that was based on our 200 gig EML technology, one that was based on our 200 gig VCSEL, and then another one based on our silicon photonics. And I thought that was a great way to showcase the breadth and the depth of technology that Coherent brings to our partners when we partner on a multi-generational basis. And then my other one that I really liked was we demonstrated 400 gig differential EML. And the reason that one's important is because that's really the foundation laser technology for 3.2T transceivers.

So we're deep into development of our portfolio of 3.2T transceivers and demonstrating that key laser capability of 400 gig EML is a really important milestone. So really proud of the innovation the team demonstrated there. So we're really pleased with the progress on that. And then you asked about kind of timing of impact.

All of what I just mentioned we view as significant to the company. And then timing of impact would be on 1.6T, we continue to view the 1.6T ramp as we've said in past quarters, we expect 1.6T revenue to start in this current calendar year and we're making good progress through kind of the normal, what I would call the normal engineering milestones and qualification milestones with the customers across multiple customers. So continuing to see that beginning as a ramp in this calendar year and then obviously continuing into the following calendar year.

Got it. Thanks for those insights and maybe for my follow-up. Clearly there's a lot of concern both with investors as well as the broader industry in relation to the macro as well as tariffs right now. And you outlined that you're not really seeing tariff as a headwind.

But still, maybe if you can flesh out the strength of your U.S. Manufacturing footprint, how that gives you some level of flexibility with your overall manufacturing plans. And at the same time, how are you incorporating any second order demand impact in your guidance for the fourth quarter in relation to any demand hiccups to expect because of the macro where we stand today. Thank you.

Got it. Thanks. On the first part of your question on the kind of flexibility of our manufacturing footprint, as we mentioned in the prepared remarks, when we look at the current tariff policy environment, we don't expect any significant impact to our financials this quarter. And with respect to the manufacturing footprint, I think the company has really done a great job over the past years of building a very resilient and adaptable supply chain.

And just a couple of data points around that, I mentioned in the prepared remarks, if you look at the global footprint of the company, we have over 60 different production facilities worldwide and those are across 14 different countries. And so from a geographic diversification perspective, we have really great geodiversity in our production footprint. Now those 60 plus production sites, actually roughly half are within the U.S. so we're very proud of our strong U.S. manufacturing presence and we view that as a key capability. But the second point I would make in terms of supply chain resiliency is around vertical integration.

And this applies to not just our data center business, but also to our industrial business. For instance, our laser business is if you look at a lot of the very key technology in-feeds for whether it's a data center transceiver or an industrial laser, we make ourselves manufacture ourselves a lot of the very key components that go into our transceivers or laser systems or other products. And so that's an important part of our supply chain resiliency and flexibility. So to the extent that there are changes in the landscape, the tariff landscape, and to the extent we need to adapt manufacturing, move manufacturing to different places for the benefit of our customers, we certainly feel like we've got a very good, resilient, adaptable supply chain to leverage for that.

And then I think the second part of your question was on demand impact. With respect to tariffs, I would say the one place where we're taking a more cautious view on the end market demand, I would say is more in the industrial part of our business. You know, the current tariff environment I think is creating just a higher level of uncertainty across the environment. And so we're taking a bit of a more cautious near-term view on our industrial business.

But other than that, I'd say on the other part of our business, our data center and communications business, we see that as continuing to grow and be strong.

Got it, thank you, very helpful, thanks.

Thank you. The next question we have comes from Simon Leopold of Raymond James. Please go ahead.

Thanks for taking the questions. I wanted to first ask you about what you're seeing in the trends for the 800 gig, which I guess is more of a foundational element today of your data center business? We've been getting a lot of questions or hearing about debate about excess inventory. So if you could help level set us of where are we and where are we going in that category of equipment.

And then I've got a quick follow-up, which I'll ask after this one.

Okay, thanks, Simon. So on 800 gig, I would say first, if I look at 800 gig shipments last quarter, I would say the demand was strong and as expected. I mean if you look at, as I mentioned in the prepared remarks, our data center business, so these are primarily datacon transceivers that grew 11% sequentially and grew about 54% year-over-year. So we continue to see strong demand in 800 gig, but also I would say 400 gig and below we also saw strong demand.

So good, strong demand. And then if I think with respect to inventory, I think you're asking about customer inventory.

Yes.

You know, clearly we don't have perfect visibility into our end customer inventory. But I will say that from our experience and from our interactions with customers, when as we're shipping them, for instance transceivers, they are using those or deploying those very quickly after we ship them. So we're not seeing any obvious pockets of inventory because we're seeing customers deploy those transceivers very quickly after shipment.

Thanks, that's helpful. And then my other question is regarding the mix of technologies in the data center. I think it's great in terms of the new products you've talked about having offerings in VCSELs, in silicon photonics and with EMLs. I want to get a better understanding of how does that mix line up with your revenue?

And the reason I'm asking is, I feel like there's a perception that you're overly dependent on VCSELs for revenue and so you've got all the tools in the tool chest and it's just trying to understand what's the mix and how does that evolve over time? Thank you.

Yes, thanks Simon. So yes, definitely if there is a perception that we're over indexed on VCSELs, that's certainly not the case. As I mentioned in the prepared remarks, if we look at our transceiver revenue, actually over half the revenue is based on EML. So over half of our transceiver revenue comes from EML based transceivers.

And then if I look at that portion of EML transceivers, actually the majority of that EML transceivers actually ship with our own internally designed and manufactured EML. Now we do utilize external EML sources as well, but as I said, over half of our EML transceivers are from our own EML factories. So hopefully that addresses a little bit of the mix. You know, VCSELis still, we view an important part of our tool chest.

But as I said, majority of transceivers are EML based now. Although I'll also say that, a growing portion of the transceiver is now silicon photonics too. So we do have silicon photonics transceivers. And as I mentioned earlier, in terms of 1.6T transceivers, we have all three solutions.

Right. We were intending to offer our customers 1.6T transceivers based on EML, VCSEL and silicon photonics so we can deploy the best technology for whatever particular application the customers are trying to address.

Thank you.

Thank you. The next question we have comes from Blayne Curtis of Jefferies. Please go ahead.

Hi, Ezra Weener, I'm for Blayne. Thanks for taking my question. Two I guess, the first one kind of following up on the last question in 800 gig and some of the technological changes there as you moved to EML, can you talk a little bit about the traction of your own EML and what that means in terms of your supply, demand and capacity growth there and how it looks when you move from 400 gig to 800 gig? And then second question would be, can you talk a little bit about your guidance from a segment basis?

Yes. And the first part of your question on 800 gig, that would say the traction is on our own EML is quite good considering, as I mentioned, the majority of our total transceiver revenue ships on our own EMLs. Right? And look, I think our strategy of using both external and internally produced EMLs is a good way to provide greater supply chain resiliency again to our customers.

We're able to offer very resilient, adaptable supply chain because we're using, we're able to shift and adapt our own internal capacity as well as our externally supplied EML capacity. So we view that as a key tool of our supply chain resiliency. But certainly internally produced EMLs is an important part of our strategy. I'll also mention that just reiterate that remember we've shared that our indium phosphide capacity has tripled on a year-over-year basis.

And our intention is to continue to expand our indium phosphide capacity. Our 6-inch indium phosphide line will go into will start production next quarter. And that 6-inch line moving from 3-inch to 6-inch provides significant increase in capacity, but it also provides a significant step function improvement in cost structure as well. So we see that as a big benefit.

And one of the reasons we're ramping indium phosphide capacity beyond just the immediate need for transceivers is also for CW lasers for instance, CPO applications. So indium phosphide capacity is used for both EML as well as CW lasers. And so we're ramping that capacity in preparation for that as well. And so we see again, we see indium phosphide as a key capability in the company, something we've had in house for over 20 years and something we expect to continue to invest in.

On the second part of your question around guidance, yeah, if you look at the midpoint of the guidance that Sherri provided on revenue, roughly flat at the midpoint sequentially. But within that, what I would say is we're expecting data center and communications to be sequentially up in the current quarter and then our industrial related end markets to be sequentially down. And with the industrial related markets, as I mentioned earlier, I think just given the kind of more uncertainty in the environment, we're taking a bit of more of a cautious view on the end market outlook around industrial, but in data center and communications, we expect to continue to see growth.

Awesome. I appreciate it.

Thank you. The next question we have comes from Thomas O'Malley of Barclays. Please go ahead.

Hey, thanks for taking my question. Tactically first off, on the silicon carbide business you're exiting there, there's obviously some costs associated with those people, but there's also some revenue associated with that business unit as well. In your June guidance, what are you assuming from a revenue perspective from silicon carbide and maybe walk through what numbers would have been if you would have included it, that would be helpful just to compare?

Yes. On the devices and modules portion of our silicon carbide business that we discontinued, that was largely pre revenue. So there is no revenue that comes out of the forecast because those were largely pre-revenues. So our revenue today is on the substrates in EPI and that's the place that we continue to invest.

And so what we did is we shut down investment for devices and modules and we're just focusing on substrate in EPI. And that's really where we think that we have a significant differentiation in the manufacturing capability and the technology behind that. That's where we have a long history and that's also where we have strong customer relationships and we see improving demand in terms of the size of that silicon carbide revenue. We don't break that out, but it's a, I would say it's a small percentage of our overall revenue, certainly in the probably low single digits.

Helpful. And then just something I noticed, obviously going into the June quarter, you're getting a bit of revenue uplift, obviously a little – flattish, but gross margins are pressured a bit. Should we be thinking about mix differential that gets you to lower gross margins or are there any other factors that we should be weighing as to why you're seeing the sequential step down?

Yes, Thomas, I'll take that question. So, first of all, the gross margin guide, it is a range, but within that range at the midpoint, to your question about what could impact that could cause it to be a little bit less downward from, sequentially and that would. Mix would be the biggest driver there, frankly, because mix can always be a headwind. Mix within our market segments, amongst our market segments and within our market segments can be a headwind.

But the other thing I will take the opportunity to point out is that, the sequential improvement that we did see in Q3, very pleased with that. 30 basis points sequentially in 490 basis points year-over-year. And the great thing about what we've been doing is our gross margin optimization strategy is where we've been focused on product cost reductions as well as pricing optimization. And what I can tell you for Q3 is that we've seen that frankly, we saw benefits across all of our market segments within the company in the product cost reductions. We saw it on market segments.

We saw examples of that, we saw yield improvement, we saw overall cost reduction. So I was really pleased with that. And then from a pricing optimization perspective, we did see benefits in, in our lasers business and in our datacom business, examples of where we were, executing on pricing improvements there. So I'm really pleased with the progress that the team has made so far.

We are definitely in the early stages. We're continuing to focus on that. But those levers for pricing optimization and cost reduction, they really help when we do have mixed headwinds. And so the other thing I would mention is that the timing of these initiatives can kick in some near term, some longer term, and the rate and pace can differ.

So that's just a few other little specifics that I can share with you in terms of that gross margin optimization strategy. But we are focused on the target of over 40%, and I look forward to giving more color on that at our Investor Day in May.

Thank you. The next question we have comes from Vivek Arya of Bank of America. Please go ahead.

Hi, this is Michael Mani on Vivek Arya, thanks so much for taking our questions. Just first on the 1.6T ramp at this stage, your visibility, do you have any insight into what your relative share could be for the upcoming ramp? Maybe relative to 800 gig? And then further on that, could you give us a sense of what the pattern adoption is across your customer base?

Is it just starting with a few customers and, kind of like 800 gig, maybe later in the ramp there'll be a longer tail of customers that then eventually catch up. Just how should we think about that progression? Thank you.

Yes, thanks, Michael. On the first part of the question, it's probably too early for us to talk about share of 1.6T ramp. But as we said, we still continue to expect revenue to start this calendar year and then ramp through the course of the following year and beyond. And then one of the things that we're seeing in the industry, which has changed versus say a number of years ago, is we're seeing these faster adoption cycles of new data rates.

And so we're seeing overlapping cycles. And so we expect 800 gig to continue to ramp as the 1.6T adoption starts. So we still expect 800 gig demand to remain strong, I would say, into next year as well, with 1.6 kind of ramping on top of that. And we'll actually give a picture of what we expect the industry adoption rate of 1.6T to be at our Investor Day at the end of May.

We'll map out what we think is kind of the 800 gig to 1.6T transition. And we would view our revenue profile will kind of match the industry adoption rate. On the second part of your question, in terms of pattern of customer adoption. Yes, I think what you, the way you described it is accurate is we would see probably a smaller number of early adopters of 1.6T and that expanding out over time.

That's what we saw in 800 gig is a small number of initial adopters of 800 gig. And although that did expand pretty rapidly over the course of about a year. And so we would expect the same to happen on 1.6T.

Great, thank you. And then just one on gross margins. So just to confirm, I know you said no significant impact from tariffs, but is there any cost headwind contemplated in your gross margin guide for the next quarter and then from here through the end of the year, could you give us a sense of where most of the expansion opportunity could come from? From whether it's, cost reductions, yield, product mix, further pricing optimization just among those big buckets, what would be the biggest contributors for the next, for maybe like the medium term and then just finally on, on the pricing optimizations.

So I know you said you've already begun to do that. How early are we in that process? How much of, I guess, how much of a benefit will that be over the next couple quarters? And what are some areas where you can, you still see great opportunity to maybe optimize price.

Thank you.

Sure. Thank you for the question. Number of questions there. So I got to make sure I cover them all.

But in terms of the. I think the first one had to do with, sort of cost impact and tariffs and gross margin. I think that was what your sort of your first question was. And what I can tell you is that, in addition to what I've already said, I mean, right.

The gross margin guide is based upon the best information that we have for Q4. It incorporates, all the best information that we have. The current environment related to tariffs, which as we have said, Jim has said, both of us have said in our prepared remarks, is not significant. And, we're going to continue focusing our gross margin expansion strategy, for pricing optimization and cost reductions. And sort of the unfavorable component that could occur is mix.

And that's that I responded to in the earlier question. So all of those earlier comments apply to your question. And then in terms of the rest of the year, where are the opportunities for improvements in gross margin? How can we get it up?

We don't guide beyond the current quarter, but we are focused on the product cost reductions and the pricing optimization. The way to think about that, and of course we'll give more color to Investor Day. But the way to think about that is when we think of product cost reductions, that's the entire company, right? We're looking everywhere in the company, every segment, no stone unturned, product costs, manufacturing costs, fixed costs, all elements of cost, as well as yield improvements.

And so every part of the company, every part of each business is participating in that and really driving toward those improvements. When you think about pricing optimization, that is primarily in the industrial and other part of our business. It doesn't mean datacom won't have benefits there. In fact, we did have benefits from pricing in Q3 from datacom.

But most of that benefit, if you think about where most of the opportunity is coming from in the company for pricing will be in the industrial and other part of our business. Because for datacom, we're focused on growing revenue growth, market share, all of that. And so that's kind of the way you can think about in terms of where in the company we would be generating these benefits that are part of this optimization strategy. And then in terms of the relative magnitude of each of these elements that I'll give you more color on at our Investor Day where I think we've got some good information that we'll share with you that will help give you that better perspective at that time.

Hopefully I covered them all. I don't know if I missed any part of your question.

No, that was super helpful. Thank you.

Thank you. The next question we have comes from Papa Sylla of Citigroup. Please go ahead.

Thank you for taking my question and congrats on the strong results. I guess for my first question, Jim, I was wondering if you can just provide more color on the telecom sub-segment. I guess if last quarter the sentiment was for traditional telco, cautiously positive. Has the sentiment improved incrementally since then, despite maybe more macro uncertainty?

And in terms of mix, how should we think about the mix between traditional telco versus DCI at this point?

Thanks, Papa. Yes, I think we're in the traditional telecom. We're still in that cautiously positive mode that I mentioned last quarter. Yes, we're still seeing incremental improvement on a kind of quarter by quarter basis.

So we're certainly happy to see that. Now where we're seeing bigger growth is of course in DCI. Kind of the second part of your question, that's still a smaller portion of our telecom revenue, but no doubt the bigger growth driver in that segment. When we look at our telecom revenue grew over 20% year-over-year, some of that was improvement in traditional telecom, but the majority of that growth was driven by DCI.

And we expect that DCI component to continue to grow over the coming quarters.

Got it. That's helpful. And my follow-up is kind of on margin and kind of alongside prior questions. And here obviously you have been quite successful in your efforts to improve margin through kind of manufacturing, reducing manufacturing costs, improving yield and price increases.

I guess for this quarter in particular, what would you maybe attribute primarily your margin outperformance between those three? And maybe the second part of this question is how far along in terms of the yield improvement efforts, how far along are you. There's still a lot of room there or are you getting really close to your internal targets?

Yes, sure, Papa. So I think your question, it cut out a little bit, but I think your question was where is most of the, where did most of the benefit in Q3 come from? In terms of pricing and cost, I think is what you're asking. And so really, cost reductions tend to be a little bit higher in terms of the contributor versus pricing, but again, that can fluctuate on a quarterly basis.

And that's not necessarily always the rule, but that's generally what we saw for Q3 cost reductions, a little bit higher than the pricing improvement. And then in terms of where we are on the yield improvement, I mean, as you can imagine for a manufacturing company, there's manufacturing a number of different products, there's lots of opportunity for yield improvements all throughout the manufacturing processes in many of our businesses. And so it's not the situation that you sort of make a yield improvement and you're done. It's always ongoing, there's always opportunity for improving yield.

And also as new products come out there additional opportunities that present themselves to create yield improvement. So that is going to be an ongoing part of our strategy.

Got it. Thank you.

Thank you. The next question we have comes from Chris Rolland of Susquehanna. Please go ahead.

Hey guys, thanks for the question. So perhaps first to follow-up on your manufacturing footprint, specifically for transceivers, I guess, I think you're in China and Malaysia with that manufacturing. Do you have the capacity to serve American customers via Malaysia or how is China involved in that? And then perhaps if you could give us some color as to what percent of your business might actually end up in America.

So yes, can you fully serve America out of Malaysia and what percent goes to the U.S.? Thank you.

Yes. On the first part of the question, the answer is yes. In fact, today if you look at our U.S. based, for instance, customers, like hyperscaler customers, those transceivers come from Malaysia. So yes, today we're supporting our U.S. customers almost entirely from Malaysia.

And then on the second part of the question, I think you were asking about like total revenue by geography, how much is North America based? I don't have.

For transceivers, yes.

Well, for transceivers, boy, I don't have. Chris, I don't have that in front of me, but it certainly is a very significant percentage. Right, but I don't have that right in front of me.

Yes, [indiscernible] on EML, I think today our strategy is actually to use a mix of both external and internal produced EMLs for our transceivers and I would expect to continue to use a mix. We have a number of external EML vendors that are great partners and have been very reliable suppliers and we view it as a nice way to have just even more supply chain resiliency. So as I shared the majority of our EML based transceivers ship with our own internally produced EMLs. But I would, expect to continue to utilize external suppliers as well.

On CW lasers, maybe for us, maybe just to maybe clarify that on CW lasers we have produced, CW lasers for our telecom products for many years. So remember we've had indium phosphide capability for over 20 years. And so we've been doing CW lasers for a long time for telecom. And moving forward with the adoption of silicon photonics in some transceiver applications and potentially in CPO applications as well.

We believe there's certainly opportunity for increased usage of CW lasers in data centers. And so part of the capacity ramp that we're doing is in support of making sure that we have the right capacity in place to support our customers with respect to CW laser needs over the long term as well. And definitely that 6-inch line actually will be introducing 6-inch capacity at two sites, two separate physical sites. So in that 6-inch capacity is yes, definitely a key enabler of our capacity expansion.

And then again, I'll just reiterate a significant cost structure advantage as well.

Thanks, Jim.

Thank you. The next question we have comes from Karl Ackerman of BNP Paribas. Please go ahead.

Yes, I have two if I may. Sherri, could you quantify the gross margin impact on your March quarter and June quarter outlook from these portfolio optimization actions taken in the quarter? And I have a follow up.

Yes, thanks Karl. So I think you're referring to some of the restructuring that we've taken the portfolio actions associated with it. And so what I would say is that the actions that were taken in terms of underutilized assets or underutilized businesses that benefit is certainly will contribute to our financials from a gross margin and OpEx perspective depending on the nature of the actual divestiture. So for example, the Devices & Modules business that Jim talked about from our silicon devices business, I mean that didn't affect our revenue, because that was pre-revenue as he described.

And so it really affected more from an OpEx perspective going forward and not really from a revenue or gross margin perspective. So it depends on the nature of the businesses in terms of where it will impact in the P&L. When you go forward in terms of going to the future in terms of our long term model, we'll give you more color on how to think about our gross margin at our Investors Day as well as our complete operating model from an OpEx perspective and revenue growth. And I think it's really all of those elements that come into play longer term that is more will be more useful for you to see at our Investor Day.

And from a -- looking at our overall model perspective versus the actions that we took during the quarter, having a significant impact in the quarter, I think it's more long term impact I think is really the short answer to the question where you would think the benefit. So the results that we had for Q3, I wouldn't say, that there were significant impacts related to the portfolio analysis directly in the P&L, but what you have been seeing even prior to Q3 is the shift in R&D spend. I mean that was a big part of what we talked about in looking at the portfolio review analysis was really making sure that we pull R&D out of those non-strategic or underperforming assets and really focus it towards the profit and growth engines.

And so those are the things that you already see that we're doing. We're seeing that in Q3 and prior quarters and so you'll continue to see that going forward, but otherwise I would say, it's more longer-term that you'll see the benefits of some of our restructuring actions that we took.

Yep. Thank you. Jim, I was hoping you could address how you see a demand outlook for datacom transceivers, particularly 800 gig in the June quarter and throughout the calendar year. And the reason why I ask is, some investors have been concerned about this inventory build and heightened competition, pressuring margins.

That doesn't seem to be the case for you, but perhaps you could highlight how you see second half relative to first half in the context of your datacom transceiver business? Thank you.

Yes, we don't guide beyond the current quarter, but what I would say is, in datacom we continue to see strong demand signals from our customers, both kind of shorter-term demand signals which would be purchase orders and backlog, but also longer term demand signals like the forecast that they'll give us a 12-month or 18-month forecast. And so we continue to see strong demand from the data center customers who are expecting that business to continue to grow. And certainly we're not just maybe to clarify, we're not just focused on matching the market growth. We're also focused on share gain.

We believe we gained share over the last two to three quarters and certainly we're very focused on continuing to gain share of wallet at our customers and overall share in the market.

Thank you.

Thank you. The next question we have comes from Meta Marshall of Morgan Stanley. Please go ahead.

Great, thanks. A couple questions for me. Maybe first, just kind of on the commentary about industrials and the second half potentially, being a little bit weaker. Just wanted to get a sense, is there any pull forward that you observed in the first half that makes you more cautious or is that just kind of macro caution, just given the uncertainty in the environment?

And then maybe second question from me, I'll just get in now. You do have a sizable military kind of business. Any impact from what we're seeing with the federal government just in terms of timing or approval processes? Thanks.

Thanks, Meta. On industrial, we haven't seen any signs of pull forward. The customer ordering patterns have been very normal. And our caution, our sort of more cautious outlook around the industrial end market demand is really related to the second thing that you mentioned, just macroeconomic uncertainty that's causing us to just take a more cautious outlook on that market in the near term.

But we still believe that that is a long term growth area for the company and certainly an area we'll highlight as long term growth in our Investor Day later in May. The second part of your question around the Aerospace and Defense business, I would say, that business, it's a smaller part of our revenue, but that business has been doing quite well recently. We saw good sequential growth. If I take our most recent quarter, we saw good sequential growth in the most recent quarter and year-over-year growth as well.

Great, thank you.

Thank you. The next question we have comes from Ryan Koontz of Needham & Company. Please go ahead.

Great. Thanks for getting me in here. With regards to DCI, which is hot, we're hearing everywhere and the ZR designs for the pluggable transceivers there, if you pull out the DSP, what is your addressable kind of wallet share there in terms of the bill of materials that you can sell your products into a ZR module?

Well, we do two things with respect to DCI and ZR modules. We make our own modules and sell our own modules, but then we also sell components into other suppliers of those modules. So we kind of address the market from both perspectives. I think your question was about the second piece of it…

That’s right.

Yes, I don't know how to really break down the bomb opportunity, but I would say, it's a significant opportunity for us and it's a very good part of our business. We see good demand there and also I would say, it's a reasonably good gross margin as well. I think we could probably give you a better picture when we meet at our investor day this month, DCI and our products in the DCI space is one of the topics we'll hit at the Investor Day. So, I would say probably stay tuned and we can provide a little bit more color at the Investor Day.

Sounds great, Jim. And then on your new OCS product, can you remind us where you are in terms of launch, introduction, trials, customer wins, and remind us of the use case there for the OCS?

Yes, happy to. Really great product. I'm really excited about it. So first of all, in the use case, the OCS replaces an electrical switch.

So the reason a customer would want to switch or change from an electrical switch to an optical switch is because then the data transfer transmission stays in the optical domain, which has performance and power efficiency advantages. Our OCS solution is very differentiated versus what else is out there in the market. The other solutions are mechanical MEMS based solutions. Ours is based on digital liquid crystal technology from our telecom business, which has much higher reliability and other benefits as well.

We continue to expect revenue to begin to generate revenue from that product line this calendar year. And we do have existing customer orders in place. So it's something that we're -- it's a product line we're really excited about in terms of TAM expansion and future revenue growth.

Got it. Is that playing to the AI clusters typically or are you kind of maybe in the front end of the network typically or where you deploy that?

Yes, good question. It can go into multiple parts of the market or the data center deployment. So you would find it in potentially multiple different parts of the data center.

Got it. Thanks so much.

Thanks.

Thank you. Ladies and gentlemen, that is all the time we have for questions. I would now like to turn the floor back over to CEO, Jim Anderson for closing comments. Please go ahead, sir.

Thank you, operator. And thanks everybody for joining us on the call today. I do want to take the opportunity to once again thank my Coherent teammates for all their hard work and dedication and their fantastic innovation. And then thanks again for joining us, and we're looking forward to sharing more details of the long term plans for the company at our Investor Day on May 28th. Thank you.

Thank you, sir. Ladies and gentlemen, that then concludes today's conference. Thank you for joining us. You may now disconnect your lines.