Q1 2026 Earnings Call Transcript

Good day, everyone, and welcome to the Lumentum Holdings First Quarter Fiscal Year 2026 Earnings Call. [Operator Instructions] Please also note today's event is being recorded for replay purposes. [Operator Instructions] At this time I would like to turn the conference call over to Kathy Ta, Vice President of Investor Relations. Ms. Ta, please go ahead.

Thank you, and welcome to Lumentum's First Quarter of Fiscal Year 2026 Earnings Call. This is Kathryn Ta, Lumentum's Vice President of Investor Relations. Joining me today are Michael Hurlston, President and Chief Executive Officer; Wajid Ali, Executive Vice President and Chief Financial Officer; and Wupen Yuen, President, Global Business Units. Today's call will include forward-looking statements, including, without limitation, statements regarding our future operating results, strategies, trends and expectations for our products and technologies that are being made under the safe harbor of the Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our current expectations, particularly the risks set forth in our SEC filings under Risk Factors and elsewhere.

We encourage you to review our most recent filings with the SEC, particularly the risk factors described in our 10-K for the fiscal year ended June 28, 2025, and in our most recent 10-Q to be filed by Lumentum with the SEC. The forward-looking statements provided during this call are based on Lumentum's reasonable beliefs and expectations as of today. Lumentum undertakes no obligation to update or revise these statements, except as required by applicable law. Please also note that unless otherwise stated, all financial results and projections discussed in this call are non-GAAP.

Non-GAAP financials have inherent limitations and are not to be considered in isolation from or as a substitute for or superior to financials prepared in accordance with GAAP. You can find a reconciliation between non-GAAP and GAAP measures and information about our use of non-GAAP measures and factors that could impact our financial results in our press release and our filings with the SEC. Lumentum's press release with the fiscal first quarter results and accompanying supplemental slides are available on our website at www.lumentum.com under the Investors section. We encourage you to review these materials carefully.

With that, I'll turn the call over to Michael.

Thank you, Kathy, and good afternoon, everyone. In Q1, revenue surged more than 58% year-over-year, while operating margins expanded by over 1,500 basis points. $533 million represents the highest revenue achieved in a single quarter in the company's 10-year history by significant margin. Our growth is powered by AI demand spanning our laser chips and optical transceivers inside data centers as well as the interconnect and long-haul networks that link them. In fact, we estimate that over 60% of our total company revenue now comes from cloud and AI infrastructure, driven both directly by hyperscale customers and indirectly through network equipment and optical transceiver manufacturers that embed Lumentum components in their solutions.

There is a growing convergence between telecom infrastructure and AI data center-driven networking as our customers align traditional network equipment with the needs of intensive inferencing workloads. Having built the company on telecommunication subsystems, Lumentum has evolved into a leading provider of optics for scaling AI compute. On our last earnings call, we projected crossing $600 million in quarterly revenue by the June 2026 quarter or earlier. Today, our Q2 outlook shows that we expect to surpass this milestone well ahead of schedule, with the guidance calling for a revenue midpoint of approximately $650 million, 2 quarters earlier than we previously targeted.

As a reminder, we have identified 3 major drivers of future growth: cloud transceivers, optical circuit switches and co-packaged optics. Of these, within our Q2 outlook, we are not yet expecting meaningful contributions from optical circuit switches and co-packaged optics. In cloud transceivers, we are set to resume sustained growth in fiscal Q2, and this upward trajectory should accelerate over the next 4 to 5 quarters. Before discussing our first quarter results in more detail, I want to address an important change in how we report our financial results.

We will now discuss our financials as a single reportable segment, aligning with our current organizational structure. After several months with the company, I decided to reorganize in order to react more quickly to market and technology changes and move resources to the highest value opportunities. In that context, Wupen Yuen, who many of you know, is now the Head of Global Business Units, owning all product road map decisions. While this shift simplifies our reporting framework, it also gives investors more insight into our numbers by breaking the cloud and networking business down a bit.

In that vein, we will provide revenue breakouts in our quarterly reports and commentary for 2 product types, components and systems. We define components as the individual building blocks that enable larger solutions such as laser chips, laser subassemblies, line subsystems and wavelength management subsystems. Systems in contrast are complete stand-alone products that deliver full functionality to the end customer, including optical transceivers, optical circuit switches and industrial lasers. We provide historical views of those 2 product types in our earnings deck that can be found on our Investor Relations website.

Using this breakout, components revenue in the quarter was $379 million, which was up over 18% sequentially and up 64% from the same quarter last year. Our components products delivered strong broad-based growth across our laser chip, laser assembly and line subsystem product lines, driven by robust demand inside the data center and from data center interconnects and long-haul applications. We achieved another record in EML laser shipments, driven primarily by 100-gig line speeds and supported by an increase in 200-gig shipments. We also initiated CW laser deliveries for 800-gig transceiver manufacturers, marking an important milestone in our product road map.

As we've shared before, our indium phosphide-based wafer fab has been fully allocated due to robust customer demand. However, I'm pleased to report that we have made better-than-expected progress on yields and throughput and now see line of sight to add approximately 40% more unit capacity over the next few quarters, setting the stage for calendar 2026 to be another breakout year for laser chip shipments and solidifying our leadership in indium phosphide-based light sources for the data center. Although still small in absolute terms, we saw sequential growth in our ultra-high power laser shipments as we continue the initial phase of our production ramp. we still expect a significant increase in shipment volumes in the second half of calendar 2026 as adoption continues to accelerate, and we are seeing opportunities to expand our customer base.

We are seeing strong sustained momentum in our data center interconnect or DCI components, which support not only optical links within campuses, but also connections spanning up to 100 kilometers in scale across architectures. Shipments of our narrow line width laser assemblies for DCI transmission grew for the seventh consecutive quarter, rising over 70% year-over-year, demonstrating both robust market demand and our continued success in scaling manufacturing capacity. Shipments of our line subsystems for data transport also delivered strong sequential and year-over-year growth, benefiting from the same macro trend.

We also saw sequential and year-over-year growth in coherent components for long-haul data transmission and achieved a record quarter for pump lasers supporting subsea and terrestrial networks. Finally, we saw a sequential rise in 3D sensing products, consistent with the seasonality of a new smartphone launch. Even in our Q1 historically peak shipment quarter, these products contribute less than 5% of total company revenue, underscoring that the broad strength of our components portfolio is driven almost entirely by the accelerating global build-out of cloud infrastructure and highlighting Lumentum's essential role in powering that expansion.

In Systems, revenue was $155 million, down 4% sequentially, but up 47% year-over-year. Cloud transceiver revenue was roughly flat to the prior quarter as we used the quarter to increase manufacturing capability in Thailand to meet increasing customer demand. From this point forward, we expect to see the end of the fits and starts in production capability we have experienced in this product area, and we now forecast a period of sustained revenue growth. Our guidance into Q2 provides our first proof point that as new 800 gig and 1.6T products ramp in future quarters, we expect to see the revenue layering benefits that our larger transceiver competitors have experienced.

Our initial ramp of optical circuit switches from Thailand is progressing well, and we remain on track for a rapid acceleration in manufacturing expansion over the coming quarters. As expected, we saw a sequential decline in industrial laser shipments, reflecting the continued softness in the broader industrial market. Looking ahead to the fiscal second quarter, we expect approximately half of our sequential revenue growth in absolute dollars to come from our components products, driven by broad-based strength across product lines serving cloud applications. The other half is expected from our systems products serving cloud customers, primarily reflecting the ramp of high-speed optical transceivers for data center applications and to a lesser extent, the early phase of our optical circuit switch ramp.

As I highlighted at the start of my remarks, we are only at the beginning of our growth journey in cloud and AI infrastructure. Lumentum story has many chapters ahead, and we are entering a period of sustained expansion, fueled by the accelerating adoption of AI and the optical technologies that enable it. Our components products will remain the cornerstone of both revenue growth and profitability, while our systems products are scaling rapidly with cloud transceivers, optical circuit switches and other high-performance solutions. With expanded manufacturing capacity and the ramp of new products, we are confident in our ability to drive continued top line growth, margin expansion and long-term shareholder value.

Now I'll hand the call over to Wajid.

Thank you, Michael. First quarter revenue of $533.8 million and non-GAAP EPS of $1.10 were at the high end of our guidance ranges. GAAP gross margin for the first quarter was 34%, GAAP operating margin was 1.3%. GAAP net income was $4.2 million and GAAP net income per share was $0.05. Turning to our non-GAAP results.

First quarter non-GAAP gross margin was 39.4%, which was up 160 basis points sequentially and up 660 basis points year-on-year due to better manufacturing utilization and favorable product mix as a result of increased data center laser chip shipments. First quarter non-GAAP operating margin was 18.7%, which was up 370 basis points sequentially and up 1,570 basis points year-on-year, primarily driven by revenue growth in components products. First quarter non-GAAP operating profit was $99.8 million and adjusted EBITDA was $127.6 million. First quarter non-GAAP operating expenses totaled $110.5 million or 20.7% of revenue, an increase of $1.2 million from the fourth quarter and an increase of $10.1 million from the same quarter last year.

This year-over-year growth reflects annual employee cash incentives tied to company performance, along with ongoing investments to scale our operations in support of expanding cloud opportunities. Q1 non-GAAP SG&A expense was $41.5 million. Non-GAAP R&D expense was $69 million. Interest and other income was $3.7 million on a non-GAAP basis.

First quarter non-GAAP net income was $86.4 million and non-GAAP net income per share was $1.10. Our fully diluted share count for the first quarter was 78.3 million shares on a non-GAAP basis. During the first quarter, our cash and short-term investments increased by $245 million to $1.12 billion. Our cash position benefited from a convertible notes transaction completed during the quarter, which contributed $306 million in net proceeds. Our inventory levels increased sequentially to support the expected growth in our cloud and AI revenue.

In Q1, we invested $76 million in CapEx, primarily focused on manufacturing capacity to support cloud and AI customers. Turning to revenue details. First quarter components revenue at $379.2 million increased 18% sequentially and 64% year-on-year. Our first quarter systems revenue at $154.6 million was down 4% sequentially and up 47% year-on-year.

Now let me move to our guidance for the second quarter of fiscal year '26, which is on a non-GAAP basis and is based on our assumptions as of today. We anticipate net revenue for the second quarter of fiscal year '26 to be in the range of $630 million to $670 million. The midpoint of this range would represent a new all-time quarterly revenue record for Lumentum. Our Q2 revenue forecast reflects the following expectations: Components expected to be up sequentially with strong growth across our portfolio of products addressing cloud and AI applications and systems to also be up sequentially with strong growth from cloud transceivers and progress in the early phases of our optical circuit switch ramp.

We project second quarter non-GAAP operating margin to be in the range of 20% to 22% and diluted net income per share to be in the range of $1.30 to $1.50. Our non-GAAP EPS guidance is based on a non-GAAP annual effective tax rate of 16.5%. These projections also assume an approximate share count of 83.5 million shares. With that, I'll turn the call back to Kathy to start the Q&A session. Kathy?

Thank you, Wajid. [Operator Instructions] Now Kevin, let's begin the Q&A session.

[Operator Instructions] Your first question comes from the line of Samik Chatterjee with JPMorgan.

Just making sure. Can you hear me?

Yes, we can hear you.

Sorry, getting used to the new system. So thank you, strong results. Congrats on the outlook as well. Maybe on the transceiver side, high confidence in relation to sustaining that growth going forward, and you're calling for a pretty sizable growth into the next quarter as well.

Maybe just talk a bit about what's driving that confidence, maybe more in addition to the capacity ramp that you talked about? Is there more diversification on the customer front as well. That's giving you visibility into that consistent growth? And what's in particular driving the strong increase of about $60 million or so, I think that's what you're guiding to for the quarter-over-quarter sort of into the next December quarter?

And I have a follow-up.

Yes, this is Michael. I think we've highlighted this for the last couple of quarters. Our improvements in execution is beginning to bear fruit. If you remember, we said that we've been really missing the front part of customer ramps due to some execution challenges.

And that seems to have corrected off where we now are participating in the very early part of customer ramps. We have expectation to be shipping 1.6T transceivers sometime middle-ish of next year. and those will be at the early part of the customer ramp as well. So for the first time, we're getting this layering effect where we're not seeing a dip in revenue as we sort of see one cycle ramp down and the next one ramp up. We're getting this layering effect that I talked to in the call.

That's predominantly with our largest customer, but we are seeing revenue from the 2 customers that we've talked about previously as well. But pretty much the majority of all of this is coming from our largest customer.

Got it. Got it. And for my follow-up, Michael, you talked about the 40% increase in capacity for datacom chips. Wondering if you can just help me think through what that means on a revenue basis?

I would assume the mix would tilt more towards 200-gig EMLs, but what is generally the plan in terms of usage of that capacity? And how should we translate that maybe into terms of what it means for revenue increases?

Yes. I think you have 2 effects, and those 2 effects will ultimately layer on top of each other. One is just the raw output, and we'd expect to see this 40% increase over the next couple of quarters. But then to your question, we also see a second effect, and that is that the 200 gig lasers will start to layer in.

We talked about shipping 200 gig lasers in the last quarter. There's more in the guide. We'd expect to see about 10% of our mix in the early part of 2026, calendar 2026 be from 200 gig lasers. So you're going to get those 2 effects now sort of adding to one another, the fact that our capacity is increasing.

And then the second issue is the fact that we would expect to see 200-gig lasers become a much more meaningful part of our mix in calendar 2026.

Kevin, I think we'll take our next question.

Your next question comes from the line of Ryan Koontz with Needham & Co.

I wanted to ask about the continuous laser output, how -- that's a new product for you, how you think about that market opportunity. Is that something you're targeting for your own optical transceivers and what sort of customers lined up for that?

Yes, Ryan. I mean, we've talked about the CW lasers for a bit here. We have a 70-millowatt CW laser that really started meaning shipping in this quarter will be a reasonable part of our mix next quarter. We've characterized that as sort of a pipe cleaner, shipping to other customers in an effort to eventually bring CW lasers into our own transceivers.

So we have a 100-millowatt CW laser that we'd expect. We're actually sampling it this month. We'd expect to be in full production in the middle of the year of 2026. That 100-millowatt CW laser is what we're going to use really in our internal transceivers. So as we've stated in previous discussions, we'd expect to be manufacturing the CW laser specifically to use it in our own transceivers, and that should happen sometime second quarter-ish of calendar 2026.

That's great. Exactly what I was hoping to hear. So -- and then shifting gears maybe to narrow line width lasers for the DCI element. Is that a different set of competitors? Obviously, a different set of customers, but can you kind of educate us a little bit on the competitive environment for the narrow linewidth lasers for Coherent?

Yes. I'll maybe give some comments and then throw it to Wupen. We are -- we have very strong market share here, right? I think our competitive landscape is more limited perhaps in this area than many of those we participate in.

To your point, Ryan, the customer base is different. These are more of the traditional telecom guys that now have shifted and pivoted their business toward the hyperscalers. And so we're providing solutions to all of those guys in our narrow linewidth offering. But we have, Wupen correct me if I'm wrong, very, very high market share there and a strong competitive position.

Yes. Thank you, Michael. I think that's definitely true. I think that's a business we've had for the last 10, 15 years as a company.

And then the challenge that laser capacity is not easy. And we have actually mastered that over the last 10 years or so. And you can see our continued progress in our revenue quarter-over-quarter. We're strongly positioned there.

We do see some competition there, but again, the technology is going to be difficult. So we expect we're going to continue the strong market share position going forward.

Your next question comes from the line of Mike Genovese with Rosenblatt Securities. Mike, your line is open. Please go ahead. You may have to unmute yourself.

So as you increase indium phosphide capacity, the output of that, how should we think about the split between that going into components or that going into systems? Like what's the framework there?

Yes. No, the vast majority of our output will be sold into the external market. We are shifting our mix toward 200-gig EMLs. Wupen has been in the middle of that.

And as I said, about 10% of our mix in the first quarter of calendar 2026, the March quarter, we'd expect to see at 200 gig. We will continue to sell the majority of our capacity out to external customers. The small amount of capacity that we've allocated to CW lasers just to prove that we can do it and as I say, pipe clean a little bit, we will probably end up reallocating that to internal consumption. And that percentage, again, is relatively modest, right?

We'll sell most of our capacity into the external market.

So I guess given that, and I realize this is a tough question to answer, but $1.40 outlook for EPS at the midpoint, it's a really impressive number. But it also -- could it even be higher I mean if we've got a really high-margin product leading to growth?

Yes. Look, I mean, we feel like we have a very dominant position here. I think in our last call, we talked about being sold out. That is absolutely the case.

The demand far exceeds even as we continue to add laser capacity, demand is far outstripping our ability to supply. And so our challenge right now is making these allocation decisions. We're trying to allocate the capacity to the highest dollar value components we have and the highest margin components we have to your point, Mike. And that in order is 200-gig EMLs, 100-gig EMLs and then CW lasers for internal consumption.

And we're going to mix as much as we can to 200 gig. The demand is certainly there. 100-gig EMLs. We're going to continue to allocate as much as we can to that. And then to the extent we can cleave a little bit off to improve our transceiver business, we'll do that as well.

And Mike, just -- it's Wajid here. Just to add a little bit to that. So that 40% increase in indium phosphide capacity is focused on laser chips, which has, as you know, higher gross margins than many more of our other product lines. So as that flows through in the coming quarters, that will have a positive effect on our earnings per share.

What you're seeing this quarter is without that increased capacity and increase gross margin contribution from the indium phosphide capacity we talked about in our prepared remarks.

Your next question comes from Christopher Rolland with Susquehanna.

So congratulations, particularly on the guide, that was -- that's pretty incredible. And congratulations to Wupen couldn't have happened to a smarter guy. But in terms of the transceivers and that market, it's my understanding that 102 switches are not really ramping until next year. In fact, they won't have like qualified ASICs in a box until early next year.

That's the precursor to qualifying 1.6T transceivers. So perhaps for Michael, as you see this playing out, I guess my first question is, are you going to strategically use your -- what seems like market-limited EML supply to drive new customers and new qualifications on the transceiver side. It sounds like maybe yes. And secondly, on the EML side, as in the first half of the year, would you expect customers to stockpile these ahead of these qualifications?

Is this something that you see in the first half even before 1.6 starts ramping?

Yes, Chris, first, thanks for the kind words, and I fully agree. Wupen is the smartest guy in the industry. We're very lucky to have them. Look, a couple of remarks.

Maybe first on the last piece of it, which is the stockpiling for right now, what we're seeing happen is demand, as we said on the last call, is far outstripping supply. Even as we add this extra capacity, we're in a situation where we are making allocation decisions almost on a daily basis. And it's really putting a lot of strain both on the business unit and on Wupen as we try to make those calls. In that regard, honestly, Chris, we're actually probably shedding customers rather than adding.

We're trying to make our bets on the folks that we think are going to be good partners. We've gone out and worked a series of long-term agreements and the folks that are willing to step up and help us, we really want to help them. And so what we've actually tried to do is maybe counter to your question a bit, and that's consolidate supply and consolidate our customer base around a couple of folks that we think are going to be long-term winners. Those customers in return have given us multiyear commitments that give us a lot of confidence that our business is going to be sustainable even as we continue to ramp capacity through the next probably 6 or 8 quarters.

So that's kind of the dynamic. Do you want to speak a little bit about 200 gig and the dynamic there because not all of it is 1.6T.

Correct. Thank you, Michael. Again, thanks for the comments. I really appreciate your kind words as well.

So on the 1.6T front, right, you're correct, 102.4 switch until really, I would say, late Q2 next year calendar. And today, applications are actually mostly to the customers or through the customers who do not rely on that switch to take place. And there are 2 customers today can use the 200-gig EMLs optics in their systems today. And certainly, I think you have a good point there that are we going to leverage our laser supply position to increase our 1.6 module opportunities.

We will say that the customer already know that we have such a laser in our portfolio. And therefore, I believe that they will have thought about it when they engage us on the module side. But again, like Michael said earlier, we will allocate our laser capacity based on the profitability metric more than to try to broaden our transceiver opportunities in 1.6T using our laser.

Very helpful, Wupen. And back to you, Michael, at OFC, I remember you were somewhat reticent to put on more indium phosphide capacity. And so as I think about the industry more largely, ,competitors are ramping 6-inch indium phosphide kind of as we speak. And it does seem like the early market is going to be for EMLs here, which are a large die because you put the modulators on there.

But as we move to CW, it's a smaller die. And I'm just wondering do you think we might end up in an overcapacity situation, particularly when we -- competitors ramp and eventually we move to SiPho and CW. And what do you think the timing might be around that? And just putting all of this together into your decision to put more capacity on, what made you change your mind?

Yes. I mean, look, I think there's a couple of things, Chris. One, we're actually been able to squeeze more out of the capacity we have and the remarks that we had in the prepared remarks, we talked a lot about improvements in throughput and improvements in yield. And that's really what's helped us.

We are still transitioning between our 3-inch and 4-inch. We made a decision to really focus on 4-inch as a sweet spot here at least in the near term. And that's what's led to most of the improvements you can see here. So we've not put a lot of additional capital into our fabs to expand output, that's number one.

Number two, I think on the battle between CW and EML, it appears to us that CW is going to ramp with 1.6T but so will EML. And so the slope of the 2 ramps was hard for us to call but it looks like no matter how you slice it, the numbers will increase. So even if the mix shifts away from EML-based transceivers at 1.6T, the absolute numbers seem to be stratospherically high. And at least in the near term, we see no end in sight.

We watch it every day, Chris, just like you're sort of cautioning but I think for the next 6 quarters, we're completely sold out, and we have long-term agreements, as I said, that we've worked out with our customers to ensure that they're going to take any capacity -- that the additional capacity we've got online. So we obviously think about it every single day, but I'd have to say, right now, our concern is not when will this roll over. It's how do we get and service the customer base that we have and the demand profile we're looking at.

And just one last comment in addition to what Michael said, right? The capacity we have in place are interchangeable between lasers and EMLs. No matter how the market share of these lasers change over time, we're able to serve the overall market. So that's also part of our investment decision in fab and kind of implementation decision along the way.

Yes. understood. Thank you guys, good strategy and congrats.

Thanks, Chris.

Your next question comes from the line of Simon Leopold with Raymond James.

I wanted to first ask about the OCS opportunity. I know you said that it's currently a fairly small market. But coming out of the ECOC show, it certainly sounded like the industry as a community was more upbeat. And I've heard second or third hand that you've suggested that this could be $100 million by your December '26 quarter.

Now I don't know that, that's true. So I wanted to hear directly from you how you see this market evolving? And then I've got a quick follow-up.

Yes, Simon. Look, I would say, if anything, our confidence has increased that we will ramp through the calendar year to that $100 million a quarter target in December of 2026. Our engagement level with customers on this product is super high. Wupen and I are spending probably more time in this product category than any other. The number of use cases we're seeing coming from customers and potential customers is growing.

And the virtues that you and I have talked about on a number of different occasions are really playing forward. So we are -- make no mistake, we are more confident in this market than we were probably last quarter at this time, and that confidence is building every single day.

And then just as a follow-up, in the prepared remarks, you described the outlook for the December quarter as broad-based improvement. I would like to see if you could rank order, what does the biggest dollar increase come from sequentially in December versus September relative -- thinking about the datacom transceivers, the telecom devices, the datacom chipsets, where is the biggest dollar contribution coming from in your forecast?

Yes. Look, this is broad-based. I mean I think the thing that probably caught us flat-footed is the width of the customer demand. It's touching everything.

We talked about pump lasers. We talked about narrow linewidth. We talked about the transceivers. We talked about even coherent components.

So it is very, very broad-based. And every single one of our segments is up. Every single one of our segments is contributing to the growth that you see. If I was to specifically answer the question, Simon, I would say it is the transceivers.

The transceivers are coming off the mat. We had, as we characterized, I think in the prepared remarks, fits and starts of the transceiver business. We finally see that turning a corner. I think last reported quarter, we got back to the level that we had when we bought Cloud Light in the guide, that number is up significantly.

But the thing that we expected people to ask is just given not only exceeding $600 million, but doing so by a pretty wide margin in the guide, we had expected more questions on, hey, what happened here? Why are you guys so surprised? And what really did happen was just the width of the demand that we saw -- and our ability to service it, quite frankly, our execution has improved. I think Wupen's team has done a really, really good job getting in there and figuring out how to deliver these products.

As we think about the forward look, that's going to be a challenge. Supply chain will be a big challenge. But it is -- has been a surprisingly, surprisingly broad-based demand signal.

Next question comes from the line of Papa Sylla with Citi.

Congrats on the very strong results. I just wanted to kind of -- it was asked differently, but I just wanted to double check on the supply-demand imbalance for EML specifically. I think it's very clear kind of demand is running ahead of supply. But I guess, how would you characterize the supply-demand this quarter versus last quarter, for instance?

I understand you kind of increased investment and yield improve. But on the other side as well, it seems like CapEx is going up across the board. Just if you could help us understand kind of how has that balance changed from last quarter to now?

Yes. I mean I'll have Wupen give some color, pop-up. But I would say the following. I mean, in our -- in the guide our supply is going up more than 10%.

So we definitely have some pretty good additive supply even into the guide. What I'd say, though, is the demand signal has -- the demand supply imbalance has increased. Last quarter, I think we characterized it as roughly a 20% shortfall relative to total customer demand even with this add, even with the add in supply, I would say that number has increased to 25% to 30%. We are quite a bit short right now relative to the customer demand.

And again, we'll kind of have you talk to it a bit, right? You're making bets on who you think is winning and trying to consolidate through LTAs and other vehicles who our customer base will be as we look out in the next 6, 7 quarters.

Yes. Thank you, Michael. Absolutely true. I would echo that the demand and supply mismatch has increased in the last 3 to 4 months.

It's getting worse. And we're seeing that all these newly announced projects that you see throughout the last several weeks, that results in extended horizon of the supply-demand mismatch as we can see. And that's the reason why we're able to sign up the long-term agreements with our leading customers. And we're also trying to be very careful in making sure that our devices are supporting the key hyperscaler customers, too.

So those are the key kind of thoughts going into the allocation process. And we realize that we cannot make everybody happy, but we try to make sure that we strategically maximize our shipment to the most important customers.

Got it. No, that's very clear. And just for my follow-up on margins. obviously, this quarter kind of very strong improvement. But I guess going into the December quarter, and if my math is right, given the sales guidance you provided and the operating margin you provided, you could be very close to what you gave out previously in terms of your longer-term target.

I guess, is that kind of the right way to think about it going into the December quarter? And just for kind of a quick follow-up to the supply-demand imbalance, we've now kind of demand further outstripping supply, kind of what's your approach in terms of pricing at this point? Do you have now more levered to even increase further pricing on EML and further expense margin as well?

Yes. Let me have Wajid talk to the gross margins. I mean, in short, you're right. I think we're moving the margin line up.

Pricing, obviously, is a lever. And when you look at that very, very carefully. I think what you see in the guide is sub-pricing, very targeted price increases happening. I think as you look out next year in 2026, our agreements with customers will include more pricing, more broad-based price increases, just given the supply-demand imbalance.

We're still obviously trying to do we can to work with customers and make sure that they are happy with us as a supplier. But we are using this demand, supply imbalance to impact of the pricing. Wajid, do you want to talk a little bit about the margin?

Yes. So I mean, our margins are certainly benefiting from the improved manufacturing utilization that comes with the increased revenue base. As we move into Calendar '26, we're expecting margins to continue to nudge up in line with the OFC model that we had provided, not just the pricing impact, but also what Michael talked about earlier with 200G EMLs becoming a larger proportion of our overall unit mix as our capacity improves on indium phosphide. And then as our growth drivers come into play in Calendar 2026, 1.6T, OCS and CPO, all of those product lines will contribute to improving our gross margins once again.

So we're set up very nicely as revenues are expected to improve next year with these new product lines and increase capacity to further improve our gross margins and our non-GAAP operating margins.

Your next question comes from the line of George Notter with Wolfe Research.

This is [indiscernible] on for George. I just wanted to double click on CPO. What do you guys see in terms of the demand outlook there? I mean, compared to the last few quarters? And then how is -- how or if -- how is that customer and market expanding, if at all?

Yes. Let me take it and again, I'll have Wupen add a little color. What -- I think between our last discussion and this one, 2 things are true. One, I think demand is stronger than we initially forecast.

So we feel pretty good about the numbers in the second half of Calendar 2026. Remember, the ramp that we basically talked about is early stages Q3 of the calendar quarter -- calendar year. And then a more meaningful contribution in the fourth quarter of the calendar year. So the demand, the forecast seems to be getting better, timing is same, so no real change in the timing, but the forecast is better. The second thing that I'd say is that our customer conversations have magnified and multiplied.

So we're getting engaged now not only with the priority customer, right, that's launching our Switch product, really taking advantage of CPO, but other customers as well. So we feel really good about the demand signal, no change in timing signal and the number of customer engagements has gone up since we last talked. Wupen, just overall on the technology, how are you seeing things?

Yes. Thank you, Michael. Definitely, we feel that the demand and interest has really increase in last quarter. Most recently in the OCP, that's a couple of weeks ago, that was a major topic of conversation during that conference.

And to facilitate our engagement with our customers, we've been using this pluggable module or tunable SFP module, to conveniently engage also different applications or different customer sets across the supply chain to kind of broaden our visibility and engagement into that portfolio. And we're seeing now much heightened interest in that area, which we believe that later will translate into even more demand for our ultra-high power laser chips going forward. And we are more optimistic than last quarter on the general or industry-wide adoption of the CPO solution, including our lasers.

Your next question comes from the line of Meta Marshall with Morgan Stanley.

Maybe following up on Simon's question. Just as you guys ramp the OCS business to kind of that $100 million. Just trying to get a sense of kind of what are some of the milestones you're looking for. Or the -- is it kind of getting through their labs? Is it testing the hardware? Is it the software? Just kind of what are some of the key milestones we should be looking at over the next year?

Meta, let me just give you restate sort of how we see the revenue and then talk technically a little bit about the milestones. We've outlined sort of a revenue ramp of kind of mid-single-digit millions here in the December quarter, getting to double digit -- very, very low double digits in the March quarter and then accelerating to kind of mid $50 million, $60 million in the middle of the year and then getting all the way to that $100 million mark in the December quarter. As I said to Simon, we feel increasingly confident just given the level of customer engagement that, that revenue ramp will be there and perhaps there's even upside to it.

What's going on right now? I mean the hardware is generally qualified. We've got -- we talked about 3 different customers with our OCS products. In all 3, that product is in their labs.

We feel very good about the hardware piece of it and being through all the major gates relative to hardware qualification. Software is more difficult, right? There's a lot more software with this product than there is with anything that we've done in the past. We are on multiple, multiple calls with our customers working side by side to get the software in.

But I would say that's the thing that keeps me up at night more than anything else is just getting our software right and getting that software qualified by the customer. We would expect to be qualified probably fully by both of our major customers in the first quarter, in the March quarter and then the third customer probably in the middle of the year. So we've got some more work to do on software, but that shouldn't [indiscernible] the revenue ramp that I just laid out.

Got it. And then -- just in terms of the transceiver business, understanding kind of the ramp of that is primarily going to the first and major customer. But just is the expectation that kind of the vast majority of this ramp going forward will only include that kind of primary customer? Or just how should we think about any of the ramps of the additional customers of Cloud line at this point?

Yes. Look, I think we're still ramping the second and third customers as we've talked about. We're engaged with more customers now. But what we're really trying to do is bound this business.

And when we talk about this, again, we've sort of said, hey, we see this being a $250 million a quarter opportunity for us -- and we think we can do that with reasonable margin by being somewhat selective. So Wupen's team is out talking to a good handful of customers looking for the most margin-rich opportunities that might be TRO type where the technical challenge is higher. 1.6T, obviously, the technical challenge is higher. And we think we can build on the success that we've had with our primary customer, add on here and there where we need to. But to sort of get to $250 million a quarter, we have line of sight to that.

And we think we can do that more profitably than we have in the past simply by choosing the most margin-rich opportunities to go after.

Yes. Meta, 1.6T margins are going to be significantly better than 800G margins. That's our expectation. And so a lot of that $250 million a quarter that Michael is talking about is going to come from the ramp of 1.6T products, which will have a materially better margin profile than our 800G products. So that will help us from both ends.

Kevin, I think we have time for just 1 more analyst question.

Okay. Your last question comes from the line of Karl Ackerman of BNP Paribas.

Michael or Wajid, you noted that your growth of transceivers should accelerate over the next 4 to 5 quarters. Is that comment sequential or year-over-year? And then is there a way to frame the quarterly opportunity of transceivers among your 3 hyperscaler providers versus your initial expectations of $250 million a quarter? And how does your fab capacity build out in Thailand support that?

Yes. I mean we obviously have line of sight to the opportunities in front of us are -- certainly lead to the $250 million a quarter. So we can see that. And what we're trying to do, as I said, is really balance it out now among the customer opportunities, which one to choose such that we can really get the highest margin profile out of the business.

There's no question that the leading customer today will be the leading customer tomorrow and into the future. They really partnered up with us well. We're better understanding that working cadence and understanding the road map and really trying to gear our road map to that. But that doesn't preclude us from continuing to look and engage customers 2 and 3 and actually beyond customers 2 and 3. But Karl and you and I have had this chat a couple of times, I don't expect this business to run away, right?

We don't expect this thing to grow unbounded. We want to grow in a margin-rich profitable fashion, and we have enough other growth drivers and the confidence in our co-packaged optics and our optical circuit switch is increasing at this point. So yes, we want to grow our transceivers. We think there's a great opportunity to do that.

We think we can do that profitably as why you just said to the last questioner. But we're not -- we could take on a lot more of this business than we have if we went after it in an unbridled fashion. You asked in the last part of your remarks on sort of our fab capacity. The transceivers, as you know, is really manufacturing capacity.

And we've added manufacturing capacity in Thailand to support that kind of sort of bounded number. We could add a lot more, as I said, the customer opportunity we're seeing is not dissimilar to the lasers is very, very strong. But our general view is let's limit it for now and let these other major growth drivers play out. And that -- the 3 growth drivers are on top of this broad-based growth you're seeing in all facets of our business.

I mean everything seems to be firing right now. And I think we're not being given credit for the additional growth drivers that will layer into just the fact that the broad-based business is doing so very, very well.

And this concludes the Q&A session. I will now turn the call back to Kathy Ta for closing remarks.

Thanks, Kevin. Thank you. That is all the time we have for questions. We look forward to connecting with you at upcoming investor conferences and at meetings this quarter. With that, I would like to thank you for joining us today.

This concludes today's call. Thank you for attending. You may now disconnect.