Q3 2026 Earnings Call Transcript

Greetings, and welcome to the Coherent Third Quarter Fiscal Year 2026 Earnings Call. It is now my pleasure to introduce your host, Mr. 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 2026 and the business outlook for the fourth quarter of fiscal 2026. 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, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company.

These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, May 6, 2026, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements.

During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our earnings release and investor presentation 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. Coherent is a global leader in photonic technology, which is foundational to the performance and scalability of AI data centers and critical to many important industrial applications. We are at the center of an extraordinary expansion in optical networking infrastructure, driven by the rapid growth of AI and the increasing need for bandwidth and energy efficiency. As a result, we delivered another quarter of strong financial performance with accelerating growth, expanding margins and improving profitability.

Importantly, we are seeing continued strengthening in demand across our business. This quarter, we experienced another step function increase in our order book, driving our backlog to a record level. Customer demand remains exceptionally strong with no signs of attenuation, and our visibility continues to extend further into the future with orders now reaching into calendar 2028 and customer LTAs extending to the end of the decade. This demand is increasingly translating into near-term shipment and revenue opportunities as we continue to expand capacity.

Given both the near- and long-term demand strength, combined with our continued expansion of production capacity, we expect a period of sustained strong revenue growth over the coming quarters. We expect strong sequential revenue growth in our June quarter, and we continue to expect fiscal '27 growth rate to exceed our fiscal '26 growth rate. Turning to our Q3 operating results. Revenue increased 9% sequentially and 27% year-over-year on a pro forma basis, representing an acceleration in our year-over-year growth rate versus the prior quarter.

Non-GAAP gross margin expanded both sequentially and year-over-year and the combination of revenue growth, margin expansion and operating leverage drove non-GAAP EPS growth of 55% year-over-year. We continue to grow profitability significantly faster than revenue. We are pleased with the continued execution, but we also see significant opportunity ahead as we scale the business to meet the demand environment in front of us. Our Datacenter & Communications segment continues to be the primary driver of our growth and accounted for 75% of total company revenue in Q3. Growth in this segment accelerated again this quarter with revenue increasing more than 40% year-over-year.

Segment performance was driven by both accelerating demand and strong execution across our product portfolio. In our data center business, revenue increased 13% sequentially and 37% year-over-year, representing a second consecutive quarter of double-digit sequential growth. We expect data center growth to further accelerate in the current quarter, supported by exceptionally strong demand, improving supply and continued progress in our capacity ramp. Demand in our data center business remains exceptionally strong and broad-based across multiple customers and product categories.

We expect the accelerated growth in the current quarter to be driven by both transceivers and OCS systems. Within transceivers, we expect growth to be driven by both 800 gig and 1.6T. In particular, we expect 800 gig revenue to grow year-over-year in calendar '26, while 1.6T transceivers ramp rapidly through the balance of this calendar year and into next year as a broad range of customers adopt 1.6T. Given the exceptionally strong demand environment and the industry-wide constraints in indium phosphide, capacity expansion remains one of our highest priorities.

Importantly, we continue to make excellent progress on our 6-inch indium phosphide ramp, which is a key driver of our long-term capacity expansion and a meaningful differentiator for Coherent. We are now seeing the benefits of this ramp in both revenue and margin, and we expect those benefits to increase further over the coming quarters. We remain on track to achieve our goal of doubling internal indium phosphide output capacity by the end of this calendar year. And based on current execution, we now expect to reach that milestone 1 quarter earlier than originally planned.

We also expect to more than double our internal indium phosphide capacity again by the end of calendar 2027. Our 6-inch platform is producing EMLs, CW lasers and photodiodes and the yields for each of the 3 device categories continues to exceed those of our 3-inch production lines. During the quarter, we shipped our first transceivers containing components produced on our 6-inch lines, and those shipments contributed to both sequential revenue growth and gross margin improvement. The initial 6-inch production contribution came from our Sherman, Texas facility, which is the world's most advanced indium phosphide production site and will play an important role in ramping CW laser production for our CPO solutions, including those supporting our NVIDIA partnership.

Given the success of the 6-inch ramp to date, we have also announced plans to begin 6-inch indium phosphide production at a third site in Zurich. Overall, we are very pleased with the execution of our production teams. As we continue to ramp 6-inch output, we expect increasing benefits to both revenue and gross margin across our transceiver and CPO product lines over the coming quarters. We expect OCS revenue to grow this quarter as we ramp production capacity to meet demand.

We have increased our view of the OCS market opportunity to over $4 billion, reflecting expanding use cases across data center interconnect, scale-out and scale-up networks and continued broadening customer engagement. We believe OCS also expands our role into higher-value layers of AI networking infrastructure. We recently resolved the bottleneck in our production capacity and are now ramping output rapidly across 2 production facilities. As a result, we expect strong sequential revenue growth over the coming quarters as production improvements translate into higher shipments and backlog conversion.

We also continue to make strong progress in co-packaged optics, which we believe represents one of the most important long-term growth opportunities for Coherent. As we have discussed previously, CPO expands our role in AI data center architectures, particularly in the scale-up portion of the network, where optics is expected to increasingly complement and over time, displace copper. We believe CPO represents more than $15 billion of incremental addressable market opportunity. In March, we announced a strategic partnership with NVIDIA focused on multiple CPO-related products and solutions.

This partnership includes both NVIDIA's $2 billion equity investment in Coherent and a multiyear supply agreement extending through the end of the decade. The agreement covers multiple CPO-related products, including our high-power CW laser and provides meaningful long-term visibility into future demand. More broadly, our CPO opportunity is supported by the breadth and depth of Coherent's photonic technology platform. We believe our breadth of photonic technology and our manufacturing scale, position us very well to support a broad range of customer requirements across key optical components, subsystems and higher-level assemblies.

We expect initial scale-out CPO revenue to begin ramping in the second half of this calendar year with scale-up CPO revenue expected to begin ramping in the second half of calendar 2027. In addition to NVIDIA, we are also engaged with multiple other customers across a broad range of CPO and MPO opportunities. Overall, we believe CPO will become a significant contributor to Coherent's long-term revenue growth and margin expansion and will further strengthen our strategic position in AI data center infrastructure. Turning to our Communications business. Revenue growth accelerated significantly in Q3, with revenue increasing 16% sequentially and 60% year-over-year, driven by strong demand across data center interconnect, scale-across and traditional telecom applications.

We expect strong sequential growth again in the current quarter. Demand remains broad-based across customers, products and end applications. We are seeing strong momentum across our communications portfolio, which spans components, modules and systems, reflecting both favorable market conditions and Coherent's strong competitive position. In particular, we continue to see robust demand for our DCI solutions, including ZR and ZR+ transceivers as well as strong demand across our broader transport portfolio.

One additional growth driver that we are particularly excited about is multi-rail. These solutions address the increasing need for greater bandwidth and connectivity between AI data centers as workloads become more distributed across multiple locations. We believe multi-rail represents a significant expansion of our communications addressable market opportunity, and we expect initial revenue to begin ramping in the first half of calendar 2027. Overall, we believe our communications business is very well positioned for continued strong growth, supported by current demand strength, our expanding portfolio and the ramp of important new platforms over time.

Across our Datacenter & Communications segment, the breadth and depth of Coherent's Photonic technology portfolio, combined with our manufacturing scale, continue to resonate strongly with our customers. As a result, we have signed or are in the process of finalizing long-term supply agreements with multiple strategic customers that include both multiyear demand commitments and upfront investment to support capacity expansion. Turning to our Industrial segment. Revenue declined modestly both sequentially and year-over-year on a pro forma basis, reflecting continued softness in parts of the broader industrial market.

However, we are seeing encouraging signs of improvement, particularly in semiconductor capital equipment, where bookings have increased meaningfully. We expect that improving demand to begin contributing to revenue growth in the current quarter and to support further sequential improvement through the balance of the calendar year. Over the longer term, we see important incremental growth opportunities for our industrial technologies and AI data center applications. At OFC, we highlighted our data center XPU cooling solutions and thermoelectric generators, which address the growing thermal and power challenges created by larger AI data centers.

Our proprietary Thermadite material can improve thermal performance and help enable higher XPU efficiency, while our advanced materials for thermoelectric generation can improve data center power efficiency through waste heat recovery. We are engaged with multiple strategic customers on these technologies, and we believe they represent a meaningful expansion of our long-term market opportunity. We expect revenue from these products to begin ramping in the second half of calendar 2027. Overall, while industrial remains a smaller contributor to our current growth than data center and communications, we believe it is positioned to become an increasingly important source of incremental revenue and diversification over time.

In summary, we delivered another quarter of strong financial performance with accelerating revenue growth, expanding margins and increasing visibility into future demand. We are operating in a highly favorable demand environment driven by AI data center expansion, and we believe Coherent is uniquely well positioned to capitalize on this opportunity, given the breadth of our photonic technology portfolio, our manufacturing scale, our continued capacity expansion and the increasing conversion of demand into backlog and revenue. I want to thank the entire Coherent team for their strong execution and continued innovation.

I'll now turn the call over to Sherri.

Thank you, Jim. In our third quarter, we delivered accelerated double-digit year-over-year revenue growth and meaningful gross margin expansion, significantly improving profitability. We have strategically increased our capital investments to expand internal capacity in support of the rapidly growing demand in data center and communications. In addition, we also continued to strengthen our balance sheet, reducing our debt leverage ratio to below 1x.

I will now provide a summary of our Q3 results. Third quarter revenue was a record $1.8 billion, up 7% sequentially from the second quarter, and up 21% year-over-year, driven by growth in AI data center and communications demand. On a pro forma basis, revenue increased 9% sequentially and 27% year-over-year, excluding revenue from our Aerospace and Defense business and our Munich, Germany product division, which were sold in Q1 and Q3, respectively. Our Q3 non-GAAP gross margin was 39.6%, a 57 basis point improvement compared to the prior quarter and a 105 basis point improvement as compared to the year ago quarter.

We continue to execute on our gross margin expansion strategy, where we generated sequential and year-over-year increases in gross margin, primarily in the Datacenter & Communications segment. These improvements were driven by reductions in product input costs, yield improvements from 6-inch indium phosphide as well as significant benefits from pricing optimization. Third quarter non-GAAP operating expenses were $348 million compared to $321 million in the prior quarter and $297 million in the year ago quarter. R&D expense as a percentage of revenue increased to 9.9% in Q3 compared to 9.4% in both the prior quarter and the year ago quarter.

The sequential and year-over-year increases in R&D were primarily in the Datacenter & Communications segment product road maps. These investments are focused on multiple short- and long-term revenue growth drivers, namely in transceivers and CPO as well as new high-margin, high-value systems such as OCS and multi-rail. We continue to focus on investments with the highest ROI that drive the future growth of the company. SG&A expense as a percentage of revenue declined to 9.4% in Q3 compared to 9.6% in the prior quarter and 10.4% in the year ago quarter with continued progress on driving efficiencies and greater leverage in SG&A.

We are already seeing benefits from our low-cost regional shared services initiatives within the G&A functions as we streamline processes and gain better leverage and efficiency. In addition, our ERP consolidation project has made great progress where the majority of the company is now in a single ERP platform. We expect additional benefits from these initiatives in Q4 with more meaningful benefits into fiscal year 2027. Our third quarter non-GAAP operating margin increased to 20.3% compared to 19.9% in the prior quarter and 18.6% in the year ago quarter due to strong revenue growth and continued gross margin expansion.

Third quarter non-GAAP earnings per diluted share was $1.41, up 9% from the second quarter and up 55% from the year ago quarter. The acceleration in earnings outpaced revenue growth, driven by strong top line performance as well as gross margin expansion. Our cash balance increased to $3 billion from $1.5 billion in the prior quarter, primarily due to the $2 billion equity investment from NVIDIA that we announced on March 2, 2026. We focused our capital allocation priorities during the quarter on investments that drive long-term revenue growth and profitability, specifically investments in our data center and communications business and our R&D product road map as well as capacity expansion.

We also made $162 million in debt payments during the quarter, reducing our debt leverage ratio to 0.5x, down from 1.7x in Q2 and 2.1x in the year ago quarter. Our capital expenditures increased to $290 million compared to $154 million in the prior quarter and $112 million in the year ago quarter. These investments were focused on expanding our internal capacity to support the exceptional demand in data center and communications. Due to our strong bookings and the rapidly growing demand, we expect capital expenditures will increase sequentially in Q4. We continue to be on track with our capacity expansion plans.

With a strong balance sheet and continued focus on improving profitability, we are well positioned to support the unprecedented customer demand with investments to rapidly expand our production capacity. As a reminder, at the end of January, we closed the sale of our Munich, Germany product division. For reference, over the prior 4 quarters, this business contributed average quarterly revenue of $25 million with a gross margin well below Coherent's corporate gross margin. Our Q3 results included $8 million in revenue from this business.

I will now turn to our guidance for the fourth quarter of fiscal 2026. We expect revenue to be between $1.91 billion and $2.05 billion. We expect non-GAAP gross margin to be between 39% and 41%. We expect total operating expenses of between $360 million and $380 million on a non-GAAP basis. We expect the tax rate for the quarter to be between 18% and 20% on a non-GAAP basis.

We expect EPS of between $1.52 and $1.72 on a non-GAAP basis. With our strong backlog and excellent visibility, we are focused on rapidly expanding our internal capacity with investments that drive the long-term growth and profitability of the company. We will continue to allocate capital in a disciplined manner as we execute against our long-term financial target model and drive durable shareholder value. That concludes my formal comments.

Operator, please open the call for Q&A.

[Operator Instructions] We take the first question from the line of Samik Chatterjee from JPMorgan.

Congrats on the robust set of results, numbers here. Jim, maybe if I can start off with the guide for the June quarter. It is implying an acceleration from Q3, so the increases you had in Q3 from a revenue perspective. And particularly when I look back through the year, every quarter, you've managed to sort of accelerate the sequential revenue growth.

So maybe if you can sort of dive into, one, what's the driver on the demand side that's helping you lead to that acceleration? And maybe also contextualize it in terms of supply and how that's helping with the acceleration as well? And I have a follow-up after that.

Yes. Thanks, Samik, for the question. Yes, if you look at the midpoint in the June quarter guide, certainly, we expect acceleration in growth versus prior quarter and if you look at the year-over-year growth rate as well. We really believe the current June quarter kind of represents a new inflection point in our revenue growth rate moving forward, so faster growth this quarter.

And as we look forward into fiscal '27, which starts in July, we expect our fiscal '27 growth rate to be above fiscal '26. And on the demand side of the equation, I would say that just -- it looks exceptional right now, both in terms of the degree of demand, but also our visibility on demand. If we look at just bookings in the prior quarter, bookings in the prior quarter were up substantially from the previous quarter, record bookings, incredible amount of backlog, and we've now got orders that extend out into calendar '28. And so we have just tremendous demand ahead of us, but also great visibility on that demand.

And that demand is coming from places you'd expect, certainly data center and growth, both transceivers with some of the new growth vectors we're bringing on as well as communications. And then probably more importantly, on the supply side of the equation, that's probably really more than our focus. Demand looks great. What we're doing is ramping supply very, very quickly.

And both this quarter, but moving forward, we're bringing on substantially more capacity over the coming quarters. And probably the best single example of this is just the indium phosphide capacity that's coming online. Indium phosphide has kind of been the key constraint for us for a number of quarters. It's a constraint for the industry.

But our target this year is to double our indium phosphide capacity. And the great thing is we're -- it looks like based on the current execution, we'll achieve that goal next quarter, which is 1 quarter earlier than we thought. And when I look into next calendar year, we expect to more than double indium phosphide capacity again. So that's a quadrupling of capacity over a 2-year period.

And so that looks really good. And so I think that really unlocks an acceleration in our revenue growth moving forward. And that's kind of on all the existing business. Then you layer on top of that some of the new growth areas and new growth vectors that are coming online.

OCS is ramping. We expect that to contribute to growth this quarter and grow sequentially. CPO revenue kicks in, in the second half of this year. That's -- we view that as all incremental.

Our multi-rail systems will start contributing revenue in the first half of next calendar year. And then we think thermal solutions will start to generate revenue in the second half of calendar '27. So we sort of have these multiple growth vectors that are layering on top of the existing business growth. So we feel really good about the growth and the sort of accelerated growth ahead of us.

Got it. Got it. And then maybe just a follow-up on similar lines. You mentioned the acceleration on the indium phosphide capacity.

Given that you're tracking a bit ahead relative to your target for 2x in the first year? How should we think about potentially upside or accelerating the target for 2x sort of next year as well? And as investors, how should investors think about the impact of that on gross margin? How material is it?

When does it start to be material to your gross margin trajectory as well?

Thanks, Samik. Actually, on the second part of your question on gross margin, we already started to see the impact of 6-inch indium phosphide capacity, which has a much better cost structure. So 6-inch versus 3-inch is more than 4x as many devices at less than half the cost. We already started to see that contribute to gross margin expansion in our fiscal Q3. As Sherri said, I think in our prepared remarks, our guide in the current June quarter has gross margin going up sequentially.

Again, part of that, what's driving the gross margin expansion is the 6-inch indium phosphide capacity, which just gives us a much, much better cost structure. But overall, I'm really pleased with the execution on our 6-inch indium phosphide ramp. There's kind of 2 factors underneath there. There's just the raw capacity ramp, but also very important is the yields.

And so the team has executed ahead of plan on the raw capacity ramp, but also we're seeing very healthy yields. We're in production on 3 different types of devices, EML, CWs and PDs. And all 3 of those devices have yields on 6-inch that are higher than our 3-inch production yields. And Texas was the first facility we started ramping 6-inch on.

Super pleased with the progress there, because we saw such good yields out of the gate from Texas, which is the world's leading indium phosphide production facility. We started production in Sweden. And now we announced a third site that we're going to start production on 6-inch indium phosphide and that's Zurich, and we'll start to see production from that third site at the beginning of calendar '27. So this ramp of indium phosphide 6-inch is both -- it unlocks a lot of additional growth for us, but it's also definitely contributed to gross margin as it becomes a bigger portion of our indium phosphide overall production capacity.

We take the next question from the line of Simon Leopold from Raymond James.

The first thing I want to see if you could address is there's a perceived gap versus one of your primary competitors that stems from investors comparing their forecasts and your forecast in categories like the OCS and CPO. How do you explain the difference? And then I've got a quick follow-up.

Yes. I think, Simon, on both of those new growth areas, we feel really good about the growth that's ahead of us. On OCS, we recently, just over the last couple of months at OFC, we doubled our forecast of the market opportunity there. The revenue growth rate, the sequential growth that we're guiding in the current quarter, part of that growth, that sequential growth is OCS systems growth.

We feel great about the differentiation of our technology. It's a very differentiated technology that provides both higher reliability, but much, much better power efficiency. And so we feel really good about the long term, both the short- and the long-term growth prospects on that product line. And we've really been focused on just ramping capacity as fast as possible.

And as I mentioned in the prepared remarks, we did kind of have a breakthrough over the last couple of months on removing a bottleneck in the production capacity that's allowed us to ramp production at a much faster rate, and we're ramping in 2 sites in parallel. So we feel good about the OCS, both the long-term opportunity, but the ramp in the near term as well. And then look, CPO is -- I think it's a transformational growth opportunity for the company. We see that market size as over $15 billion, and that's probably a conservative estimate over the coming years.

We've -- CPO revenue for us will start in second half of this calendar year, and that will be initially scale-out CPO revenue. And then we expect to see the beginning of scale-up CPO revenue in the second half of calendar '27. And we're engaged with multiple customers. Obviously, we have a public announcement that we did with NVIDIA on our partnership with NVIDIA. That's all around CPO.

That's a multibillion-dollar agreement that extends out through the end of the decade. And importantly, is it's multiple different CPO solutions. So if you look at what can we provide in the CPO solution, it's not just the laser, right? We're certainly providing the high-power CW laser.

But beyond that, we're providing the external laser source module. We can provide the fiber attach unit, which includes micro-lens arrays. It includes polarization maintaining fiber. So we have our own fiber optics fiber that we'll provide in those solutions.

Within that external laser source, we provide all of the ingredients, not just the laser, but the isolators, the thermoelectric coolers. So there's a tremendous amount of content that we expect to provide in CPO. And I see this as a major new growth area for the company. And I think we're very, very well positioned in CPO.

And like I said, first revenue will start in sort of later this year, this calendar year.

Great. And just as a follow-up, I appreciate you don't want to get the -- micromanaging each product segment, but I'd like to see if you could confirm if the 1.6 terabit transceiver revenue exceeded, let's say, $100 million in the March quarter. And if not, when can we get to that milestone?

Yes, Simon, we don't break out individual data rate revenue for our transceiver business. But we expect 800 gig to grow this year. It will probably grow again next calendar year. And then on top of that, 1.6T is ramping at an incredibly rapid pace.

In fact, as I think we've shared in the past, that 1.6T ramp is actually faster than what we would have thought, say, a year ago, which we're really pleased with. And so if you look at our incremental or sequential growth in the current quarter, a good portion of that is driven by the 1.6T ramp. And we expect 1.6T to not just contribute to the current quarter sequential growth, but to continue to ramp very quickly over the coming quarters as well. And so I think really the growth drivers for our transceiver business are really 800 gig and 1.6T combined, not just this calendar year, but next calendar year as well.

We take the next question from the line of Thomas O'Malley from Barclays.

My first one is on gross margin. So if I look at gross margins in March at 39.6% and then I look at gross margins last year at 38.5%, the incremental on a year-over-year basis is around 44%. So since that time, I mean, you've increased 6-inch production, you've doubled indium phosphide almost, you exited some businesses. In fact, like your data center business, you kind of report -- well, you could assume some percentage of this comms business, but that's growing really nicely as well.

So why aren't you getting more incremental fall-through on the gross margin side? Is there any puts that you could highlight that are preventing you from kind of breaking out on that line item?

Yes. Thanks, Thomas. So the way -- a few things I'll just highlight from a gross margin perspective is that if you go back about to the end of Q4 of 2025, we've increased our gross margin sequentially in 7 out of the past 8 quarters. And if you include the 57 basis points improvement from our -- just our recent Q3 quarter, that's an increase of about 530 basis points.

And then if you tack on to the midpoint of our guide for Q4, that takes you to 570 basis points improvement. So I think that's pretty good progress. I mean we're not done, but I am pleased with the progress that we've made there. And the target that we put out at our Investor Day last year was greater than 42%, and we are super, super focused on making sure that we get to that target.

And when you look at the drivers of our gross margin expansion strategy that we've been executing on quarter over quarter over quarter, it's cost reductions, it's yield improvements and it's pricing optimization. And when you look at our Q3 quarter, each of those areas increased quite significantly from the prior quarter in each of those categories. And so we talked a little bit about some of those in my prepared remarks. But from a cost reduction perspective, we had improvements from 6-inch indium phosphide.

We've talked about the fact that it's half the cost, right, when you go from 3-inch to 6-inch. So we're already seeing the benefit of 6-inch. We also talked about yield improvements in Q2 that we saw in 6-inch. So we're continuing to see yield improvement as we continue to ramp.

And we talked about how we've got 2 sites going in parallel. We've got another site coming up. I expect to continue to see improvements on 6-inch as we bring the other site up and as we continue to ramp 6-inch. That's going to continue to add benefit to our gross margin.

And the other areas of cost reductions that we've seen, actually, that's been predominantly in our data center and communications business. So the majority of -- well, over the majority of our improvements in gross margin have really been in the data center and communications business. So I'm really pleased with that progress. We've also seen pricing optimization benefits.

That has significantly increased quarter-on-quarter and certainly year-over-year. And that's been not only in the industrial business, but that was actually quite sizable in our data center and communications business. So I'm really pleased with the progress we've made so far. We're going to continue to drive to get to our target and super focused on doing that, but I'm quite pleased with the progress so far.

And we're early stages is the way that I would look at it.

And then just as a follow-up, in the preamble, Jim, you mentioned some bottlenecks that were being relieved in the OCS business. What specifically are you referring to? And how much of an impact could that have on production?

Yes, there were some internal components or some components that we make internal to Coherent that we're pacing our production capacity expansion. And so we were able to sort of dramatically improve the amount of internal components that we were producing. And so that really unlocked an acceleration in our production capacity. And so the last month or 2, we've seen a really good ramp-up in our pace of production and expect that to continue.

So we're seeing a much faster ramp of production on OCS than, say, a few months ago, which is really good.

We take the next question from the line of Blayne Curtis from Jefferies.

Actually, I wanted to ask about scale-across just becoming a big talking point. You called it out in the comm business. Maybe you could just talk about kind of where that is today? And as you look to fiscal '27, how do you frame that ramp for scale-across?

Yes. Thanks, Blayne. Yes, we're seeing just tremendous growth in the scale-across part of the business. This falls within our Communications segment, which I mentioned in the prepared remarks.

So scale-across or DCI, also within that communications segment is traditional telecom. But the fastest growth that we're seeing is in that scale-across piece of the business. In the most recent quarter, we saw a 16% sequential growth and 60% year-over-year and here, again, similar to data center, just the demand is exceptional. The visibility is exceptional.

We have LTAs that are in place with customers in that segment. And we're seeing -- it's really broad-based across almost every product we have in that segment and broad across customers as well. And just to give you a sense of the products in that segment would cover components like pump lasers. It would cover modules like ZR/ZR+ transceivers, which would be the 100 gig, 400 gig and 800 gig ramping ZR/ZR+.

It covers line cards and amplifiers and then full systems as well. And so yes, this -- we expect this area, just given the demand we see in front of us and the visibility of this to be a very strong growth area for us moving forward. And then a new system that we think is going to continue to accelerate our growth rate here is multi-rail. And so our multi-rail technology, which we highlighted at OFC, this helps provide a huge capacity increase within the same power and physical area of the prior solution.

So it's a tremendous benefit to the customer. And we have a number of very differentiated component technology pieces that go into that system that really position us very well. And we're selling full systems, and we expect that revenue to start in the first half of calendar '27. And so just another growth vector layering on top. So very strong growth in this area, and we expect that to continue given the strong growth that we see ahead of us.

And then I just wanted to follow up on Tommy's gross margin question. I just want to better understand the tailwinds. You called out 6-inch as being the biggest driver. I'm assuming the 6-inch volumes that you mentioned you're shipping in your units are still fairly small.

So are there start-up costs that kind of roll off there, and that's what the savings are? And then as the -- is [indiscernible], is that a gross margin uplift as well?

Yes. So when I mentioned in the prior quarter, the 6-inch, I mentioned that as it was one of the contributing factors. There were actually a number of other contributing factors to gross margin expansion in the prior quarter. And in our guide for the current quarter, it's kind of similar. 6-inch is a contributor, but there's other factors as well.

There's pricing and other cost structure improvements that we made. And yes, I would say we're still pretty early in the 6-inch ramp. If you think about the 6-inch -- so we shipped our first transceivers last quarter that included devices from our 6-inch. And that was just the initial production that we started.

That will ramp significantly over the coming quarters. So I think there's much more of the 6-inch benefit is ahead of us. If you think about the total doubling of capacity and the fact that all of that doubling of capacity is 6-inch, by the end of this year, next quarter, half of our capacity will be 6-inch. So I think that benefit from 6-inch is more ahead of us.

And then on the 1.6T question, yes, we definitely see that as beneficial to gross margin. we expect -- just like we've always seen in prior transitions of speed of data rates at the beginning of the life cycle of a new data rate, generally, the gross margins are better than the prior data rate. So we would expect 1.6T to be beneficial to gross margin for the transceiver business.

We take the next question from the line of George Notter from Wolfe Research.

I was just curious about anything more you could tell us on the new LTAs that you're signing. Obviously, we learned a lot around the NVIDIA transaction. But you mentioned there's a number of other deals that you guys have brought in. Anything you can tell us in terms of how big those deals are?

What kind of duration are we talking about? Are they funding your capital expansions? Like anything you can tell us like financially just in the aggregate, more details would be interesting.

Yes. Thanks, George. Yes, there were a couple of additional LTAs that we signed in the prior quarter. And then I would say there's a number of other ongoing discussions.

We would expect to close some additional LTAs this quarter very soon. And those LTAs usually have 3 parts. You asked about kind of a CapEx commitment. Yes, there's usually an upfront investment from the customer. to help with the CapEx.

And that can come in a number of different forms, but there's usually some upfront investment, which kind of represents sort of skin in the game from the customer and which we view as really positive. And then there's -- of course, there's a supply commitment from us. But the third element is there's almost always some sort of demand minimal -- at least minimal demand commitment from the customer to make sure that, that capacity is going to get utilized. So those are kind of 3 parts of the LTA.

Almost every LTA has those 3 parts in it. And so yes, I would say good progress last quarter in additional LTAs, and we anticipate more LTAs to come and yes, significant in size.

Anything about the genre of customer here? Is this cloud providers? Is this systems manufacturers? Anything else you could say?

It's both, right? We would see -- we expect LTAs from both hyperscalers as well as other system customers. So I would expect both.

We take the next question from the line of Vivek Arya from Bank of America Securities.

This is Michael Mani on for Vivek Arya. I wanted to dive in deeper with some of the CPO LTAs or long-term agreements that you're dealing with, including NVIDIA, but maybe some of the other deals that you're kind of eyeing over the next couple of years. What's the mix of these agreements between lasers, ELS modules, which you highlighted OFC and the various other components that you could sell into a CPO solution like fiber attach units. How does that vary by customer?

Like what are the puts and takes there based on the deal?

Yes. It kind of -- it can depend by customer, but it's important to keep in mind that we have a very broad portfolio of CPO technology that we can bring to the customers. I think that's a real advantage for us. And we -- at OFC, we laid out all the different types of technology that we can bring to a CPO solution.

Lasers, the high-power CW lasers is certainly one important component, but it's not the only. We can also bring 200 gig and in the future, 400-gig VCSELs as well. There's some applications where VCSELs are sort of a better laser technology for like near package optics. But beyond that, if you look at the external laser source, we can provide that module.

But within that, almost all those key optical ingredients we have in-house as well, not just the laser, but the isolators, the thermoelectric coolers. So all of the ingredients that go in that, which customers view as a big strength because we're not dependent on others for those technologies. And then the actual fiber attach unit, so this is the -- what connects the switch chip or the XPU to the faceplate or to the external laser source module, we can provide that entire assembly as well because we have the lens arrays, we have the polarization maintaining fiber. So we have all the ingredients for the CPO solution.

And I would say most customers are leveraging, if not all of that portfolio, certainly a good portion of that portfolio.

Great. And for my follow-up, I just wanted to ask about the 2 incremental opportunities you highlighted for '27, right, with multi-rail and thermal management products. So you said revenue timing for first half, I think, for multi-rail and second half for the thermal products. But what are the milestones between now and then from a customer perspective?

Like when do we get a better sense of how large those ramps can be? And what does the competitive landscape look like in both of those areas? And how do you think you're especially differentiated, if you could articulate that?

Yes. Michael, on the -- let me start with the multi-rail, which is the near-term one. I would say the milestones are just the typical engineering milestones that we would walk through with the customers. There would be a qualification, a pilot run, very normal engineering milestones that we're moving through.

And again, we would expect revenue to start in the first half of '27. I think as we get closer to that revenue ramp, we can provide just some better idea of what the rate and pace of that revenue ramp is. But we see that as a substantial new product line with significant revenue opportunity. I mean, we sized the market for multi-rail at least $2 billion over the coming years, and it could be larger than that. And the technology that we have is very differentiated.

With multi-rail, it's really all about the underlying technology. And without going into a bunch of the technical details because we covered this at OFC, but there's a number of key components that go into that multi-rail that are unique to us or we have unique differentiation that position us really well. So we feel really good about the competitive positioning on multi-rail. And then the second part of your question, definitely, thanks for asking about the thermal solutions.

We're very excited about this. This is us taking our industrial technology, some of our materials technology that we apply to the industrial market and re-purposing this for data center. An example is our Thermadite technology. Thermadite is a material that it's a proprietary material that only Coherent provides.

And if you look at Thermadite applied to the cooling of, say, a switch chip or an XPU or an ASIC chip relative to the current thermal solutions, which are usually copper-based solutions, a Thermadite or other type of material that we could provide can provide heat transfer that's either 2x better than copper, sometimes up to 5x better than a copper solution. So this is a massive improvement for customers because what that means is if we use one of those thermal solutions that have 2 to 5x better thermal properties, it allows the say, the XPU, the GPU to run at a much higher frequency or utilization rate because it can be cooled much more effectively.

So it's almost like getting sort of more tokens out of the same CPU or GPU. And so it's a big win for our customers. We're really excited about that, very strong customer engagements there. And again, just kind of moving through the normal engineering milestones, but we would expect revenue in the second half of next year.

By the way, the other one that I would mention, which is really a great technology is our thermoelectric generators where we're harvesting waste heat from the -- again, the CPU or GPU, harvesting waste heat and converting that back into electrical energy, which is pumped back into the data center. So a great efficiency gain for power efficiency in the data center. So yes, we're excited about those new thermal solutions.

We take the next question from the line of Papa Sylla from Citi.

Congrats on the results. Maybe, Jim, my first question is around pricing in general from like a transceiver perspective. Obviously, you were, I guess, too, had one, as a seller of transceivers, but also a buyer of lasers and electrical component as well. And at least kind of yesterday or over the past couple of days, we have been hearing kind of some laser pricing increases, particularly for EML.

So I'm curious if you are seeing that on one front, but also are you able, if that's the case, at the transceiver level, pass through those costs? Are you -- do you have enough levers in general at the transceiver level to also increase pricing given the demand supply imbalance?

Yes. Let me start with the pricing and come back to the cost. On price, yes, I would call pricing very healthy, very healthy dynamics around pricing. Because of the supply versus demand, I think pricing has been very good, right?

And one of the things that always happens as we change data rates is the ASP goes up with the new data rate. So 1.6T pricing, higher than 800 gig, et cetera. And so I would say the pricing dynamics are very healthy. And then on the cost side, remember that most of the components that go into our transceivers are internally sourced.

And so that buffers us from any increases, provides some level of buffer against increases in pricing in externally sourced. Now we do use some externally sourced components. We do that for strategic reasons. But yes, we view it as we've been successful at either passing along those external component price -- higher prices or offsetting that with our own internal production as well.

So we've -- the combination of pricing and cost has been -- we've seen higher gross margins. I think Sherri shared in her prepared remarks, specifically in data center and communications, we've seen the gross margin improvement we've seen is primarily coming from that component of our business.

Got it. That's very helpful. And then in terms of my follow-up, it seems like it's very clear that the demand you are seeing for 1.6T is very strong, the early deployments at least. So I'm curious if you can touch a little bit on the mix you are seeing between EML, SiPho and perhaps even VCSEL.

And maybe a follow-up to that is kind of what would be, generally speaking, the margin implication of selling higher SiPho transceivers versus EML or vice versa?

Yes. On the second part of your question, we really don't see a significant margin difference between EML or SiPho-based transceivers. Both those transceivers are in the same ballpark of gross margin. And we're ramping both 1.6T, we are ramping both EML and cycle-based 1.6T.

Remember, even a SiPho-based transceiver requires a CW laser based on indium phosphide, right? So either way, they both require indium phosphide capacity, which is, again, ties back to why we're driving one of the reasons we're driving higher indium phosphide capacity ramp. But for us, the mix is really determined by -- between EML and SiPho is really determined by kind of the customer applications. So we work with the customer on which one of those 2 technologies just fits their application better.

And there can be pros and cons depending on the type of application. And then we do expect VCSELs to be used later on as well. Our 200-gig VCSEL development going very well. And beyond just 200-gig VCSELs that go into transceivers, we see 200 gig where we expect 200-gig VCSELs to be adopted in some CPO applications or NPO applications as well.

But yes, that initial 1.6T ramp is a combination of EML and SiPho-based 1.6T.

We take the next question from the line of Ruben Roy from Stifel.

Jim, the kind of the discussion around CPO has certainly seemingly accelerated since the beginning of the year through OFC and even over the past few weeks with some of your peers and yourselves talking about it. First question, just a clarification on the second half scale-out, '27 scale-up ramp. Are those ramps tied to NVIDIA specifically? Or are there other customers contributing to those initial scale-out CPO revenues for you?

And then the second part of the question is, as you think about CPO and new opportunities like multi-rail and the components that go into multi-rail, my understanding is some of those things have higher margin structures than maybe other indium phosphide or silicon photonics components. How are you thinking about allocating capacity across some of these sort of, let's call them, newer growth areas as you think about the next 12 to 18 months?

Yes. Thanks, Ruben. On the CPO, certainly, now that the NVIDIA partnership is public, yes, they're -- clearly, they're probably our lead customer on CPO -- and -- but we do expect other customers to follow as well. And we're engaged with multiple different customers.

It's actually a pretty wide set of customers, and we expect to have CPO solutions across multiple customers. But definitely, NVIDIA would be kind of the lead customer for us. And then on the second question on multi-rail, yes, definitely higher gross margin structure in that part of the business. You're absolutely right that there's some specific components that go into multi-rail solutions that are quite high margin that also rely on indium phosphide capacity.

In general, the way we look at capacity allocation is we allocate indium phosphide capacity to whatever drives the most -- the highest margin dollars. So whatever drives the maximum amount of margin dollars for the company, that's where we allocate the capacity.

We take the next question from the line of Sean O'Loughlin from TD Cowen.

Jim, congrats on a solid set of results, as always. One of the things, and I think this speaks a lot to maybe Blayne and Tom's questions earlier in the call is one of the things that investors are trying to get a better handle on is, as you ramp 6-inch indium phosphide and the capacity there, the delta between maybe shipping initial SKUs, initial transceivers revenue, as you mentioned, versus having that line fully qualified at some of your customers for volume production. And I'm going to ask the question in a way that I know is the wrong way to frame it. But if I think about we're going to double indium phosphide capacity next quarter, why hasn't that translated into doubling revenue?

And that's, I think, where I'm having conversations with a lot of folks, if you could just comment on that.

Yes. Remember that there is a latency from the indium phosphide devices to when we actually ship transceivers, right? So when the indium phosphide devices, whether that's an EML or CW laser come out of the production facility, it's really probably the next quarter, 2 to 3 months later before we see the transceivers then shipped based on those devices, right? And as an example, those transceivers that shipped in our March quarter, that was indium phosphide devices that were produced in either our September or the early part of our December quarter.

So there's usually a lag of a few months from when the devices are made to when we see those -- those show up in transceiver shipments.

And then just can you comment, Jim, on anything on the customer side? Or should we assume that there's a much tighter relationship between once the transceiver ships there, we've already been through the qualification process. Is that how we should think about it since it's...

Yes, there's nothing unique about the devices on 6-inch versus 3-inch in terms of qualification. There may, in some cases, need to be qualification, but that would have already happened ahead of production shipments, right? So when we're talking about production shipments, the qualification is already complete at that point.

Got it. That's helpful. And then maybe related to the CW EML question, and I know I just -- I wasn't not listening. I know you're going to say it's sort of agnostic and you go where the customer goes.

But if you could maybe comment on the 400-gig silicon photonics that you demonstrated at OFC and maybe some of the other industry commentary that maybe questioning the viability of silicon photonics and CW lasers at 3.2T, that would be helpful.

Yes. Thanks, Sean. Yes, as you mentioned at OFC, we demonstrated 400-gig silicon photonics that would enable 3.2T. That -- we demonstrated that, but it could be used in either transceiver or could be used in CPO.

So we demonstrated just the capability to do that. The form factor may be CPO or transceiver or both. But we would -- but we believe we have a path to 3.2T or 400 gig per lane silicon photonics based on that demonstration. And we're certainly -- we certainly expect to have both solutions based on 400-gig differential EMLs, which we already have but 400-gig silicon photonics as well.

And by the way, we're -- we have 200-gig VCSELs that we're working on, but we also have 400-gig VCSELs that are in development as well. Those are a little further out, but we're certainly working on that as well. So we think we've got a really robust road map of multiple different laser technologies to support the future road map for our customers.

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would now like to turn the floor back over to Coherent's CEO, Jim Anderson, for his closing comments.

All right. Thank you, operator, and thanks, everybody, for joining us today. In closing, we are certainly very pleased about the strong third quarter performance and the continued momentum across our business. Demand remains exceptionally strong, and we see accelerating growth ahead of us as we ramp capacity significantly over the coming quarters.

I want to thank our employees for the great execution and the continued innovation, and we look forward to updating you at our next call in another quarter. Thank you.

Thank you. Ladies and gentlemen, you may disconnect your lines at this time. Thank you for your participation.