Coherent (COHR) Q2 2026 Earnings Call Transcript

Image source: The Motley Fool.

DATE

Wednesday, February 4, 2026 at 4:30 p.m. ET

CALL PARTICIPANTS

• Chief Executive Officer — James Anderson
• Chief Financial Officer — Sherri Luther
• Vice President, Investor Relations — Paul Silverstein

Need a quote from a Motley Fool analyst? Email [email protected]

TAKEAWAYS

• Revenue -- $1.69 billion, up 7% sequentially and 17% year over year; on a pro forma basis, up 9% sequentially and 22% year over year after excluding the divested aerospace and defense business.
• Non-GAAP Gross Margin -- 39%, increasing by 24 basis points sequentially and by 77 basis points year over year.
• Non-GAAP Operating Margin -- 19.9%, up from 19.5% in the prior quarter and 18.5% in the year-ago quarter.
• Non-GAAP Operating Expenses -- $321 million, or 19% of revenue; down from 19.2% in the prior quarter and 19.7% in the year-ago quarter.
• SG&A as a Percentage of Revenue -- 9.6% in Q2, down from 9.8% in the prior quarter and 10.2% in the year-ago quarter.
• Non-GAAP Earnings Per Share (EPS) -- $1.29, up from $1.16 in the prior quarter and $0.95 in the year-ago quarter.
• Debt Leverage Ratio -- 1.7 times, improved from 2.3 times in the year-ago quarter.
• Record Data Center and Communications Segment Growth -- Over 70% of revenue; segment revenue rose 11% sequentially and 34% year over year; data center alone grew 14% sequentially and 36% year over year.
• Book-to-Bill Ratio in Data Center Business -- Exceeded 4x in Q2, with bookings now extending into calendar 2027.
• Indium Phosphide Six-Inch Wafer Ramp -- Achieved 80% of target to double internal capacity by year-end, with wafer starts more than quadrupling QOQ from September to December.
• OCS (Optical Circuit Switch) Backlog -- Backlog increased sequentially; now over 10 customer engagements with a majority toward 320x320 system size; revenue expected to ramp through this year and next.
• 1.6T and 800G Transceiver Demand -- Both product lines grew in Q2 and are expected to drive continued double-digit sequential and year-over-year growth, with 1.6T ramping substantially in upcoming quarters.
• Capital Expenditures (CapEx) -- $154 million in Q2, up from $104 million in the prior quarter and $106 million a year ago, supporting capacity expansion in response to customer demand.
• Portfolio Optimization -- Completed sale of Munich-based materials processing product division; expected to be immediately accretive to gross margin and EPS; reduction of headcount by approximately 425 employees; 10 sites exited this quarter and 33 total in six quarters.
• Q3 2026 Guidance -- Revenue between $1.7 billion and $1.84 billion; non-GAAP gross margin of 38.5%-40.5%; operating expenses of $320 million-$340 million; non-GAAP tax rate at 18%-20%; non-GAAP EPS of $1.28-$1.48.

SUMMARY

Coherent (NYSE:COHR) reported steep growth in both revenue and profitability, driven by sustained demand for data center and communications products, supported by visibility into bookings now extending into 2028 for some customers. Management highlighted unprecedented demand with a book-to-bill ratio above 4x in the data center segment and confirmed accelerated expansion in production through six-inch indium phosphide wafer ramping, already reaching 80% of target capacity. The company’s industrial segment is positioned for sequential growth starting in June, primarily from increased semi-cap equipment orders, and recent portfolio streamlining, notably the Munich product division sale, is expected to immediately boost margins and earnings. Strategic customer engagements and multi-year supply agreements, combined with capital investments across global manufacturing, reinforce management's message of continued operating leverage and above-revenue EPS growth in the foreseeable future.

• Management indicated most of calendar 2026 bookings are completed with calendar 2027 "filling very, very quickly," and some customer forecasts extend into calendar 2028.
• James Anderson stated, "visibility of the business is the best it's ever been," referencing detailed multi-year forecasts and recently signed long-term supply agreements that include financial commitments from customers.
• The six-inch indium phosphide ramp, underway in both Sherman, Texas, and Yarfala, Sweden, supports the production of key transceiver components (EMLs, CW lasers, photodiodes) with yields exceeding three-inch wafer lines.
• Sherri Luther detailed that pricing optimization, improved manufacturing yields, and reduced product input costs accounted for 470 basis points of gross margin improvement versus FY2024, and gross margin is guided to continue rising toward a long-term target above 42%.
• Coherent’s CPO and OCS products are entering revenue ramps, including a "large purchase order from a market-leading AI data center customer" for a CPO solution based on a six-inch indium phosphide line, with initial revenue expected late this year.
• CEO Anderson expects internal indium phosphide sourcing to increase as a proportion of total supply, though external partnerships will remain important for supply resilience and customer requirements.
• SG&A and R&D as a percentage of revenue are targeted to trend toward 8% and 10%, respectively, as operational efficiency initiatives progress and investments scale to growth opportunities.

INDUSTRY GLOSSARY

• Indium Phosphide (InP): A compound semiconductor material used for high-speed, high-efficiency photonic devices, essential for advanced optical communications and transceivers.
• OCS (Optical Circuit Switch): A device enabling dynamic, high-capacity optical connectivity within data center and network environments without electrical conversion, enhancing bandwidth and energy efficiency.
• CPO (Co-Packaged Optics): Technology integrating optics and electronics within the same package, reducing latency and power consumption for high-throughput network infrastructure.
• EML (Electro-absorption Modulated Laser): A laser device combining a laser source with an integrated modulator, used for high-speed optical data transmission.
• VCSEL (Vertical-Cavity Surface-Emitting Laser): A type of semiconductor laser with light emission perpendicular to the chip surface, used in 3D sensing and high-speed data communication.
• ZR/ZR+: Pluggable coherent optical modules designed for high-speed data center interconnect and metro/regional optical transport applications.
• DCI (Data Center Interconnect): Technology and equipment used to connect data centers, enabling high-capacity data transfer between sites.
• Multi-rail Technology: An optical transmission platform allowing multiple parallel optical transport channels, facilitating increased network traffic within existing infrastructure.
• BOM (Bill of Materials): The comprehensive list of raw materials, components, and assemblies required to build a product.
• SG&A (Selling, General, and Administrative): A category of operating expenses that includes costs related to selling, general business operations, and administrative functions.
• Semi-cap: Semiconductor capital equipment manufacturers; segment refers to companies providing manufacturing tools used in semiconductor fabrication.

Full Conference Call Transcript

Paul Silverstein: Thank you, operator, and good afternoon, everyone. With me today are James Anderson, Coherent's CEO, and Sherri Luther, Coherent's CFO. During today's call, we will provide a financial and business review of 2026 and the business outlook for 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 and the future financial performance of the company. We caution you that such statements or predictions are based on information that is currently available and that actual results may differ materially.

We refer you to the documents that the company files with the SEC, including our 10-Ks, 10-Qs, and 8-Ks. These documents contain and identify important risk factors that could cause the actual results to differ materially from those contained in the projections or forward-looking statements. This call includes and constitutes the company's official guidance for 2026. If at any time after this call, we communicate any material changes to this guidance, we intend that such updates will be done using a public forum such as a press release or publicly announced conference call. Additionally, we will refer to both GAAP and non-GAAP financial measures during this call.

By disclosing certain non-GAAP information, management intends to provide investors with additional information to permit further analysis of the company's performance and underlying trends. For historical periods, we provided 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, James Anderson.

James Anderson: Thank you, Paul, and thank you, everyone, for attending today's call. As the world's leading innovator and provider of photonic technology and solutions, Coherent is at the center of an extraordinary expansion of optical networking infrastructure that's enabling tremendous growth in data traffic in the scale across, scale out, and scale up networks of AI data centers. As a result of the AI build-out, we saw strong revenue and profit growth in our December. We also experienced another step function increase in our bookings, which we expect to increase again in our current quarter.

Given the extraordinary strength and visibility of demand from our customers, combined with our continued rapid expansion in production capacity, we expect a period of sustained strong revenue growth over the coming quarters. In particular, we expect continued strong sequential revenue growth in both our March and June quarters, and we expect our fiscal 2027 revenue growth rate to exceed our fiscal 2026 growth rate. The key growth drivers that we see over the coming quarters are growth in both 800 gig and 1.6 T transceivers, growth from the ramps of new products such as OCS and CPO solutions, and ongoing exceptionally strong demand in our product for DCI and scale across.

In addition, we are now seeing demand signals that indicate a pickup in the growth of our industrial business over the course of this calendar year, led by strong orders from our semi-cap equipment customers. Overall, we're excited about the growth outlook over the coming quarters. We're also focused on driving meaningful operating leverage and expect to continue to deliver EPS growth at a significantly faster rate than our expected revenue growth rate. With that overview, let me provide some additional details on our recent quarter and what we expect moving forward.

Turning to our Q2 operating results, revenue increased by 9% sequentially and 22% year over year on a pro forma basis, which excludes revenue from our recently divested aerospace and defense business. Non-GAAP gross margin expanded by 24 basis points sequentially and 77 basis points year over year. The combination of revenue growth and gross margin expansion drove non-GAAP EPS growth of 11% sequentially and 35% year over year. I'll now provide some highlights from our two operating segments.

In our data center and communications segment, which now accounts for over 70% of our revenue, we saw an acceleration of our sequential growth rate with Q2 revenue growing by 11% sequentially and by 34% year over year, driven by strong growth in both the data center and communications markets. In our data center business, we drove a substantial acceleration in our sequential growth rate, with Q2 revenue growing 14% sequentially and 36% year over year. The acceleration of sequential growth in Q2 was driven by very strong execution from our production teams. Given the exceptional demand and our rapidly expanding capacity, we expect double-digit sequential growth in data center again in both our March and June quarters.

Given that this is our largest and fastest-growing business, I'd like to provide some additional details on both the demand and supply picture within our data center business. Q2 data center revenue growth was driven by growth in both 800 gig and 1.6 gig transceivers. In Q2, we experienced another step function increase in our data center bookings with a book-to-bill ratio that exceeded 4x as customer demand continues to increase and customers place orders further out in time, which provides us with strong visibility for the coming quarters. The strength of our product portfolio combined with our vertical integration and our expanding US manufacturing footprint provide a clear competitive advantage with our customers.

We expect revenue growth in the current quarter to be driven by a combination of growth in both 1.6 T and 800 gig transceivers as well as growth in our OCS systems. We see strong demand for our 1.6 T transceivers across multiple customers and continue to expect both 800 gig and 1.6 T to grow significantly in calendar '26. We expect 1.6 T to ramp significantly over the coming quarters, with the early phase of the ramp driven by our EML and silicon photonics-based transceivers, followed by our 200 gig VCSEL-based 1.6 T ramping in the second half of this calendar year.

On the supply side, to address the extraordinary growth in demand, we are investing in the rapid expansion of our production capacity.

Paul Silverstein: For example, we significantly increased our indium phosphide production.

James Anderson: In Q2, and we are executing on track to our plan to double our internal indium phosphide production by the fourth quarter of this calendar year. As a reminder, our indium phosphide capacity expansion is driven by our ramp of six-inch wafer production. A six-inch wafer compared to a three-inch wafer will produce more than four times as many chips at less than half the cost. Our production team is doing an outstanding job ramping our six-inch indium phosphide production, and I'd like to take the opportunity to thank our team for executing ahead of our plan in Q2. We are ramping production in parallel at two sites, Sherman, Texas, and Yarfala, Sweden.

We are in production with three different types of key transceiver components on six-inch indium phosphide, EMLs, CW lasers, and photodiodes. Our six-inch yields continue to exceed the yields of our three-inch production lines. In addition, we have multiple six-inch indium phosphide substrate suppliers, and we have secured committed substrate supply that supports our expected doubling of capacity by our December. In short, we are very pleased with our ramp of the world's first six-inch indium phosphide production lines and expect this production ramp to support significant revenue growth and margin expansion of our transceiver products over the coming quarters. We also expect to continue to supplement our internal indium phosphide capacity with continued sourcing from external suppliers.

For example, EML supply from our external suppliers increased sequentially in Q2, and we expect it to increase again in the current quarter and during this calendar year through continued long-term partnership with our key external suppliers. We also continue to invest in the expansion of our transceiver module assembly capacity. We are expanding our production capacity in Malaysia, Vietnam, and other locations. Overall, I'm very pleased with the continued expansion of our production capacity to meet the rapid growth in our demand. I'm equally excited regarding our progress on other key data center products and technologies.

Specifically, I want to provide updates on our CPO and OCS products, which we expect to be significant contributors to our long-term growth and profitability. Transceiver technology platforms continue to evolve, and we are well-positioned as we continue to make progress on LPO, LRO, CPO, and MPO-related products and technologies, with a growing number of engagements across a wide range of customers. In particular, we recently secured an exceptionally large purchase order from a market-leading AI data center customer for a CPO solution that includes our new high-power CW laser that began sampling last year.

Beyond the outstanding performance of this solution, a key factor in the customer's decision to partner with Coherent was the fact that our high-power CW laser is produced on our six-inch indium phosphide line in our Sherman, Texas facility. We expect this significant design win to generate initial revenue toward the end of this calendar year, with a more significant revenue contribution next calendar year and beyond. We also have engagements across multiple other customers for both indium and 200 gig VCSEL-based solutions for CPO and MPO applications. In Q2, we also saw strong progress for our optical circuit switch platform based on our differentiated non-mechanical liquid crystal technology.

OCS backlog grew sequentially in Q2, and we now have over 10 customer engagements. Shipments and backlog include both 64 by 64 and 320 by 320 system sizes, with most of the backlog weighted toward the larger system size. We expect OCS revenue to grow sequentially in the current quarter and the coming quarters as we ramp production capacity as fast as possible to meet the rapidly growing demand and the over $2 billion of expected addressable market opportunity for this over the coming years. In our communications market, Q2 revenue grew 9% sequentially and 44% year over year.

Growth continues to be driven by our products for data center interconnect and scale across as well as strong growth in traditional telecom applications. We expect our communications business to grow sequentially in the current quarter as well as our June. The strength we are seeing in communications is broad-based in terms of both products and customers. We continue to see extremely strong demand for our products addressing the data center interconnect market opportunity. These include our ZR and ZR plus coherent transient products as well as lasers and other components that we sell to system OEMs. For example, we recently secured a significant multiyear design win with a leading DCI OEM which utilizes Coherent's industry-first uncooled three-pin micropump solution.

We're also seeing strong demand in our traditional telecom business, driven by ongoing market recovery and new product introductions, such as our new award-winning multi-rail technology platform. We're also experiencing very strong demand across our broader communication product portfolio, including pumps, amplifiers, line cards, and systems. Turning to our industrial segment, revenue grew 4% sequentially and was flat year over year on a pro forma basis, excluding revenue from the recently divested aerospace and defense business. Sequential growth in Q2 was driven by our industrial lasers and engineered mid-materials product lines. We expect the industrial segment to be roughly flat sequentially in the current quarter on a pro forma basis. However, looking ahead, we expect improving demand.

For example, we saw a significant increase in orders in Q2 from our semi-cap customers, which we expect to translate into sequential growth for our industrial business in our June quarter and the remainder of this calendar year. At the recent Photonics West Conference, we highlighted a number of compelling long-term growth areas for our industrial product lines, including data center XPU cooling solutions based on our 300-millimeter silicon carbide and thermodyte technology. Thermoelectric generators for improving data center energy efficiency through waste heat recovery, excimer laser annealing systems for Gen 8 OLED fabs, high-power lasers for direct fusion energy generation, and excimer lasers for processing superconducting tape used in magnetic fusion applications.

This wide range of differentiated solutions positions our business for significant long-term growth. Finally, I'd like to provide an update on our portfolio optimization. Last week, we completed the sale of our product division based in Munich, Germany, which makes tools for materials processing. The sale of this product division is expected to be immediately accretive to both gross margin and EPS. As a result of this sale and other operational streamlining initiatives, we exited 10 sites over the past quarter, which brings the total number of sites that we've either sold or exited to 33 over the past roughly six quarters since we began this initiative.

We plan to continue to streamline our footprint and exit additional underutilized and unnecessary sites over the coming quarters. In summary, we delivered strong revenue and EPS growth in Q2 and expect both fiscal 2026 and fiscal 2027 to be strong growth years for Coherent, given our exceptional demand from our customers and the rapid expansion of our production capacity. I'd like to thank my Coherent teammates for their strong execution and the incredible innovation that they are driving every day for our customers. I'll now turn the call over to our CFO, Sherri Luther.

Sherri Luther: Thank you, Jim. In our second quarter, we continued to drive strong double-digit year-over-year revenue growth, gross margin expansion, and strong profitability. Capital allocation continues to be an area of focus where we maintained our debt leverage ratio below two times. I will now provide a summary of our Q2 results. Second quarter revenue was a record $1.69 billion, up 7% sequentially from the first quarter and up 17% year over year, driven by growth in AI data center and communications demand. On a pro forma basis, excluding revenue from our aerospace and defense business, which we sold in Q1, Q2 revenue increased 9% sequentially and 22% year over year.

Our Q2 non-GAAP gross margin was 39%, a 24 basis point improvement compared to the prior quarter and a 77 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 data center and communications segment. These improvements were driven by reductions in product input costs, efficiency gains from improved cycle times in the manufacturing process, as well as yield improvements. Pricing optimization also continued to contribute meaningfully to our gross margin expansion. Second quarter non-GAAP operating expenses were $321 million compared to $304 million in the prior quarter and $283 million in the year-ago quarter.

Operating expenses as a percentage of revenue declined to 19% as compared to 19.2% in the prior quarter and 19.7% in the year-ago quarter. SG&A expense as a percentage of revenue declined to 9.6% in Q2 as compared to 9.8% in the prior quarter and 10.2% in the year-ago quarter. Due to our continued progress on driving efficiencies and greater leverage in SG&A. We have made significant progress on our ERP consolidation project, where we expect most of the company to be on a single ERP platform by the end of this fiscal year.

In addition, we are executing on our low-cost region within our G&A functions, that will continue to show benefits throughout this fiscal year and more meaningfully into our fiscal year 2027. The sequential and year-over-year increases in R&D were primarily in the Data Center and Communications segment as we continue to focus on investments with the highest ROI that drive the future growth of the company. Our second quarter non-GAAP operating margin was 19.9% compared to 19.5% in the prior quarter and 18.5% in the year-ago quarter. Second quarter non-GAAP earnings per diluted share was $1.29 compared to $1.16 in the prior quarter and $0.95 in the year-ago quarter.

From a capital allocation perspective, we maintained our debt leverage ratio at 1.7 times, down from 2.3 times in the year-ago quarter. Our capital expenditures in the second quarter were $154 million as compared to $104 million in the prior quarter and $106 million in the year-ago quarter. We are focused on supporting the exceptional customer demand in data center and communications. As a result, we are rapidly expanding our capacity and expect our capital expenditures to increase sequentially over the remainder of this fiscal year. We have made good progress in strengthening our balance sheet, including significantly reducing our debt leverage, refinancing our debt, and improving our working capital.

With a strong balance sheet and focus on improving profitability, the company is well-positioned to support the exceptional customer demand with investments to rapidly expand our production capacity. As Jim noted, at the end of last month, we closed the sale of our product division based in Munich, Germany, that makes tools for materials processing. For reference, over the past four quarters, this business contributed average quarterly revenue of $25 million with a gross margin well below Coherent's corporate gross margin. The sale will reduce our employee headcount by approximately 425 employees.

We expect to use the proceeds from the sale to reduce our interest expense by paying down debt, which will be immediately accretive to our gross margin and EPS. I will now turn to our guidance for 2026. Our Q3 outlook includes $5 million of revenue from the period prior to the close of the sale of the Munich product division at the January. We expect revenue to be between $1.7 billion and $1.84 billion. We expect non-GAAP gross margin to be between 38.5% and 40.5%. We expect total operating expenses of between $320 million and $340 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 $1.28 and $1.48 on a non-GAAP basis. In summary, I'm very pleased with the strong results in our second quarter. We remain focused on expanding profitability with disciplined execution against our long-term financial target model. We are excited about the significant growth trajectory ahead. This momentum reinforces our confidence in driving long-term growth and durable value creation for our shareholders. That concludes my formal comments. Operator, please open the call for Q&A.

Operator: We will now be conducting a question and answer session. You may press 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. We ask analysts to limit themselves to one question and a follow-up so that others have an opportunity to do so as well. One moment, please, while we poll for questions. Our first question comes from Samik Chatterjee with JPMorgan Chase and Co. Please proceed with your question.

Samik Chatterjee: Yes. Hi. Thank you. Thanks for taking my questions. And Jim, hope your leg is healing. Now. Hopefully, things are better on that front. Maybe for the first question, really just on demand, how would you characterize? I mean, you gave some of the book-to-bill numbers that you're seeing, but how would you characterize the visibility there in terms of maybe duration, like how long is the visibility in terms of demand that the customers are providing? And vis-a-vis, how should we think about the capacity ramp for indium phosphide in particular? How are you planning that out? Particularly, how to think about the contribution of six-inch to that capacity ramp? I have a follow-up. Thank you.

James Anderson: Yeah. Thanks, Samik. And, yes, the leg is doing much better. Thank you for that. I appreciate that. On the demand question, yeah, I would say, you know, I'd call the demand that we're seeing and the visibility extraordinary. If I just look at, you know, a couple highlights from last quarter, you know, if we look at our data center business, you know, I was really pleased with the acceleration of our sequential growth rate to 14% sequential growth. And then we also saw, as I mentioned in the prepared remarks, over 4x book-to-bill ratio.

So just seeing incredibly strong demand, and we're seeing bookings go further out in time than we would have in the past, which is great for us for visibility. So number one, you know, bookings being booked out, you know, through the rest of this calendar year and most of the bookings we're getting now are into calendar '27. So most of our calendar '26 is booked out and calendar '27 is filling very, very quickly. That's important to us because it gives us just great visibility. And then we're also getting really good detailed long-term forecasts from our big customers. You know, a lot of times those forecasts go out, you know, two, three years.

So we're getting forecasts that go out into calendar '28, which, again, is great for visibility. And then the third thing I would mention with respect to visibility is the number of long-term supply agreements that we've either signed with customers or are in the process of signing. Where, you know, the LTA will provide a guarantee to our customers for a certain amount of supply in exchange. They give us a guarantee on a certain amount of demand. And there's often some sort of financial commitment from our customers like investment for CapEx, etcetera. So I would say all those things combined, the visibility of the business is the best it's ever been.

Which gives us just kind of great confidence in terms of the go-forward growth that we're seeing. On the second part of your question on indium phosphide ramp, again here, really pleased with the team's execution here on the six-inch indium phosphide ramp. You know, one of the key metrics that I look at in terms of how we're making progress is wafer starts. And remember our goal that we mentioned last quarter was that we wanted to double indium phosphide capacity by the end of this calendar year. And if you look at the number of wafer starts that we're starting this quarter, we're basically at 80% of that target capacity already.

So we're starting wafers at 80% of the goal of doubling capacity, which is really strong and frankly, ahead of schedule. In fact, last quarter, we more than quadrupled the number of wafer starts from our September quarter to our December quarter. So I think that for me, that's a really good important leading indicator on how we're progressing on the indium phosphide ramp is that, you know, being at 80% of target in terms of initial wafer starts. Now that's the beginning of the production line. Right? It does take a number of quarters before those wafer starts or a number of months before those wafer starts transition into products and to customers.

And the typical time from a wafer start to a transceiver shipment is about six months. So but that's a great leading indicator on our indium phosphide ramp. And we're already seeing the benefits this quarter from the initial production that started in our September. So I'm really pleased with that ramp. And again, you know, the reason we're so focused on that is because a six-inch wafer versus a three-inch wafer is more than four times as many chips at less than half the cost. And so we're really pleased with that ramp. And then, Samik, it sounded like you had a follow-up.

Samik Chatterjee: Yep. Yep. Just quick. OCS, I mean, clearly demand is strong, but any way to quantify for us what the magnitude of the backlog from the 10 customers is? Or maybe in terms of, like, material impact to revenues, how should we be thinking about when does it get to maybe more than, like, a $100 million revenue number? In terms of timing? Should it be this fiscal year or next year? How to think about that? Thank you.

James Anderson: Yeah. Thanks, Samik. Yeah. In terms of OCS, this is gonna sound like a common theme. But here again, demand is very strong. We are very focused on the production ramp now. So backlog is good. It grew in the December versus the September. We expect revenue to ramp to grow this quarter. And really, the revenue to ramp throughout this calendar year and into next year. And we are just 100% focused on ramping capacity and production as fast as possible. The demand is very strong. We're engaged with over 10 customers. The size of the market has only grown since we assessed it about a year ago.

And so tremendous opportunity, and we're ramping production as fast as possible. And we'll probably give some more specific milestones in terms of revenue as we progress through the year, but it will certainly contribute to our revenue growth throughout this calendar year and certainly contribute next year as well.

Samik Chatterjee: Got it. Great. Great. Thank you. Thanks for taking my questions.

Operator: Our next question comes from Simon Leopold with Raymond James. Please proceed with your question.

Simon Leopold: Thanks very much for taking the questions. The first thing I wanted to ask about was you had highlighted some progress correction on the 1.6 terabit, which is, I guess, I'd call it an emerging cycle. So maybe if you could put some milestones around this to help us understand when does that cost $100 million per quarter? And how does the competitive landscape stack up for that product? And then I've got a longer-term question I'll follow-up with.

James Anderson: Yeah. Thanks, Simon. So first of all, both 800 gig and 1.6 we expect to continue to grow for this calendar year. We saw growth in both 800 gig and 1.6 last quarter. We expect both to grow again this quarter. You know, 800 gig is the biggest portion of revenue still. We expect that to grow on a year-over-year basis this year. 1.6 is growing much faster, but it's growing off of a smaller base than 800 gig. I would say the 1.6 ramp has accelerated the demand from the customers as it accelerated. We're ramping with multiple customers. I see that as a really a key main growth driver for us throughout this year.

We don't typically break out revenue by data rates, but those two 800 gig and 1.6 will absolutely be key growth drivers for the company this year, this calendar year. And 1.6 will continue to ramp into the following calendar year as well. In fact, a lot of the orders that we're seeing right now are certainly for 800 gig, but a tremendous amount of orders on 1.6 T. And so that's great. That provides great visibility in terms of the demand moving forward. And then maybe just mention what I did on the prepared remarks, which is our initial ramp is driven by both EML-based transceivers for 1.6 T as well as silicon photonics.

But we expect VCSEL-based 1.6 T transceivers to start to ramp in the second half of this year. So really pleased with the progress and the rate and pace and the growth we see ahead for 1.6.

Simon Leopold: That's good. And then I heard also you've gotten a qualification on the CPO package optics. I'm gonna ask about what happens next, which is thinking about scale-up opportunities. Are we in the time frame yet where you're engaging customers for scale-up architectures? Maybe if you could give us some sense of kind of thinking about that market opportunity, which I imagine may be years away, but have to get you're engaged in the engineering aspects already. Thank you.

James Anderson: Yeah. Certainly. So that CPO purchase order that we received, and it was a massive purchase order. And that's for a solution based on our high-power CW laser. We're really pleased with that. That is initially, that will be deployed in scale-out, but we expect that to lead to scale-up deployments over time. And I would say that, you know, there is very active engagement and design win progress on scale-up on CPO, all sorts of CPO-related solutions for scale-up across multiple customers. I would call that very active, deep engagements. On the size of the scale-up opportunity, I would say it's actually difficult to size. It is tremendous.

Some of the forecasts that we've seen from our customers are very, very large. Right? If you think about, you know, within the scale-up opportunity, you know, all of that network today, the networks within the racks are electrical. And as those networks convert to optical over the coming years, the amount of optical content that we gain in the scale part of the network is just tremendous. And we're very well-positioned. You know, there's a couple different ways that we expect to supply customers in that space. You know, we can certainly supply them at the component level by providing high-power CW lasers, detectors, fiber optical cable.

But we're also planning to supply those customers at a higher level as well. So for instance, external laser sources, the pluggable laser sources that would plug into the front panel, also CPO module assemblies, etcetera. So there's a variety of ways that will support that market. But we see that as a tremendous growth opportunity as in scale-up, and I wouldn't call it years out, I think it's sooner than that based on the plans that we're seeing from our customers.

Simon Leopold: Great. Thank you very much.

Operator: Our next question comes from Ruben Roy with Stifel. Please proceed with your question.

Ruben Roy: Jim, I'd like to keep the discussion going on CPO. And it's great to hear about the large order and the timeline end of the year into next year. High level, how are you thinking about content CPO relative to the strength you're seeing currently with 800 gig and the nascent 1.6 terabit module strength? Do you think that these will I think the consensus is that these technologies will coexist, but I'd love to get your thoughts on the content opportunity and the growth opportunities that you look at into 2027 as CPO ramps? Thank you.

James Anderson: Yeah. Thanks, Ruben. Yeah. We really view it as it's additive. The way we think about it is, you know, pluggable transceivers will remain the dominant form factor in certainly, in scale across and in the scale-out networks, through at least the rest of this decade. Right? So we see very strong growth in those pluggable formats in scale across and scale out over the coming years. And what we see in CPO is CPO starting to get deployed initially in scale-out, and we're seeing that. That was the purchase order that we procured, etcetera. But we believe that CPO the big growth in CPO is actually driven by scale-up.

And that is a very tangible opportunity based on the customer engagements that we have. And that will we believe the scale-up CPO opportunity will dwarf the opportunity in scale-out. It will be orders of magnitude larger. And so we view that as all incremental TAM for the optical industry in general and certainly for us as well, since that network is 100% electrical today. All of that optical content and scale-up is incremental TAM.

Ruben Roy: That's helpful. Thanks, Jim. And a quick follow-up. You talked about 800 gig versus 1.6 terabit mix. And just wondering, I assume you're starting to see some demand for 200 gig in differential EMLs and that type of thing. As you think about later this year into next year and sort of the mix, what are the margin implications as you approach 40% gross margins here on the modules themselves?

James Anderson: Yeah. The 1.6 T gross margins we expect to be higher. Generally, what we see as an industry is with each new data rate, the ASPs of each new data rate go up over the prior data rate. So we expect 1.6 We're seeing 1.6 ASPs that are higher than 800 gig. And then, generally, especially at the beginning of the life cycle of the data rate, the gross margins are higher. So we expect 1.6 gross margins to be higher. And so we view the 1.6 ramp as margin accretive for us. And then certainly, you know I'm sorry. Yeah.

Just one other point also factor in that is as, you know, as we ramp six-inch indium phosphide capacity, which supports both 800 gig and 1.6 transceivers, that six-inch capacity is a gross margin driver for us as well in our transceiver business.

Ruben Roy: Great. Thanks for the detail, Jim.

Operator: Our next question comes from Thomas O'Malley with Barclays. Please proceed with your question.

Thomas O'Malley: Thanks for taking my question. Jim, in preamble, you talked about a book-to-bill ratio that exceeded 4x as customer demand continues to increase. And customers are placing orders further out in time. Obviously, a lot of really good opportunities in the data center segment, but maybe you could spend some time talking about the components of that backlog. Where is the greatest area of strength? Obviously, you have the OCS side, the module side, on the laser side. Maybe spend a little time just measuring out those vectors to give us a little bit of a feel for what's contributing to most of that strength given we're hearing from others in the industry a lot specific numbers.

I know you don't do that, but anything that you can to help us on that.

James Anderson: Yeah. Thanks, Thomas. In terms of that book-to-bill last quarter, I would say the majority of that vast majority was driven by 800 gig and 1.6 transceiver bookings. It's a combination of, you know, growth that we expected from 800 gig, continued growth even maybe stronger, a little bit stronger than we had expected, and then an acceleration in 1.6 T. So both 800 gig and 1.6 T bookings were incredibly strong. We expect that to continue into this quarter as well. In addition to that, bookings for OCS contributed last quarter. If I look at the current quarter and what we're expecting in bookings, we expect it to be another incredibly strong quarter in terms of bookings.

And it's really a combination of those four things I mentioned, primarily 800 gig and 1.6 transceiver bookings. Over time, it starts to be more and more 1.6 bookings. And then, you know, I would say CPO and OCS as well. So those are really the main drivers within the data center bucket of bookings. The other place where we are seeing very strong bookings is in the communications business. So I would say the growth that we're seeing in DCI data center interconnect products, very, very strong. That's growing faster than our overall growth rate in communications. But we continue to see strong demand beyond DCI in the kind of traditional telecom space, as well.

So that would be the other place where we're seeing strong bookings.

Thomas O'Malley: Thanks, Jim. And then just as a follow-up, you talked about indium phosphide capacity doubling by year-end. Your competitor talked about 40% increases, which they're kind of blowing through in a short period of time. It seems like the industry is bringing a lot of supply online. Broadcom's talking about some additional capacity as well. Maybe talk about when you see the industry getting the product that it needs. Are we still in a position where the industry is short? Just given the incremental capacity additions, when do you think you'll be at equilibrium in that business? Thanks.

James Anderson: Yeah. It's a great question. It seems like every quarter, we think we're gonna catch up and then the demand increases. So I don't foresee the supply-demand getting back in balance this calendar year. I don't think it happens next calendar year. And if the forecasts that we're seeing from customers for indium phosphide laser supply that they need for scale-up, I think we could be in a very sustained long period of supply-demand imbalance on indium phosphide, which is exactly why we're super focused on ramping our six-inch capacity as quickly as possible. That near-term goal is to double our capacity by the end of this year.

But we're driving goals beyond that are very aggressive in terms of our continued ramp of indium phosphide capacity. And the demand that we're seeing from the customers absorbs all of that capacity and then some.

Thomas O'Malley: Operator, if we could go on to the next question.

Operator: Our next question comes from Blayne Curtis with Jefferies. Please proceed with your question.

Ezra Weener: Hi, Ezra Weener on for Blayne. Thanks for taking my questions. Just the first one, obviously, pricing is coming up for your externally sourced components. But at the same time, you guys are signing LTAs. Talk a little bit about pricing and how you're thinking about gross margins within that context?

James Anderson: Yeah. In terms of input cost, I think you're talking about input cost to our pricing. Yeah. We view it as we are seeing some higher pricing input costs with respect to externally sourced things like EMLs. But that is really offset by our internal indium phosphide ramp. Right? So I would say the net is, you know, we're in a much better position over the coming quarters as we continue to rapidly expand our indium phosphide production capacity, and that's a gross margin benefit for us. So the net is positive for us. So we feel pretty good in terms of our position with respect to indium phosphide cost.

Another way to look at it is anytime the kind of market price of indium phosphide goes up, it makes our internally sourced indium phosphide that much more valuable. Right? In terms of a differential. And then, you know, I would say in terms of our own pricing, you know, we continue to see, you know, the ability to continue to optimize pricing. I think Sherri mentioned in her prepared remarks that some of our gross margin improvement last quarter was based on pricing optimization. We continue to see opportunity to optimize pricing, especially in an environment where demand is very strong. And so, you know, we believe we're in a good price environment across all of our businesses.

And maybe, Sherri, do you want to comment anymore on the effects of gross margin, or did that cover it?

Sherri Luther: Yeah. Sure. Just a couple of things I can add. You know, when you look at the improvement that we saw both quarter on quarter and sequentially in gross margin, or quarter on quarter and year over year, key elements of that were certainly cost reductions where we saw lower product input costs in the data center and communications part of our business was actually an area where we saw more of the magnitude of that benefit. We had lower product input costs for key elements, you know, larger components of our BOM, so that was really good to see. We also had improvements in the manufacturing process that enabled greater throughput and efficiency and yield improvements.

And, again, that was in the data center part of our business, so that was really good to see as well. And then on the pricing optimization side, we actually sequentially saw even greater improvement in price optimization in a number of areas in our business. So these are key elements of our gross margin expansion strategy that we've rolled out as part of our strategy at our Investor Day last year. And we're continuing to focus on that. Really pleased with the progress that we've made to date on that.

In fact, the other thing I'll add is that if you look at our 39% gross margin for this most recent quarter that we achieved and you compare that to where we our FY 2024 gross margin, we've actually improved our gross margin by 470 basis points through the elements of the strategy that I've described here. So I'm, you know, really pleased with the progress. We're still I would consider to be in early stages as we continue to drive toward that greater than 42% target.

Ezra Weener: Got it. Thank you. Then for the follow-up, just wanted to ask about the six-inch ramp and kind of the timing of that and also what the long term looks like. So how should we expect that to layer in? And longer term, do you expect the heavy majority of your capacity to be six-inch and you talk a little bit about the advantage of that relative to peers?

James Anderson: Yeah. On the second part of the question over the long term, yeah, essentially, all of the capacity that we're adding now is six-inch. We're adding a little bit of three-inch, but all of the but beyond that, the vast majority is six-inch capacity. And that'll continue. So over time, six-inch capacity would just become more and more, a bigger percentage. And if you can if you think about us doubling capacity year over year and almost all of that coming from six-inch. The other way to think about it is by the end of this calendar year, about half of our capacity will be six-inch, and it'll grow it'll grow from there in the following years.

And in terms of the ramp progress, as I shared, in terms of wafer starts, we're already at 80% of that goal to double our capacity this year. We have plans to significantly expand it beyond just doubling capacity in the following years. It's a little too early to talk about that, but as we get move throughout this year, I'll get some guideposts on future years and the expected continued ramp of indium phosphide. And then I think you asked about cost structure advantage. Yeah. So the basic cost structure advantage is a six-inch wafer compared to a three-inch wafer.

You get, you know, over four times as many products out of that wafer at less than half the cost. So it's a tremendous cost savings. And that's been a key factor in, I think, why, you know, our customers have been selecting us as well. So for instance, that very large, high-power CW purchase order that we just received. A big reason for that was because that high-power CW laser will be manufactured on six-inch indium phosphide, and it will be made in Sherman, Texas, US-based manufacturing. So that's definitely something that's factoring into our customers' decisions on why to select Coherent is that advantage in six-inch capacity. And the location of it.

Ezra Weener: Got it. Thank you very much.

Operator: Our next question comes from Papa Sylla with Citigroup. Please proceed with your question.

Papa Sylla: Thank you for taking my and congrats on the results. So Jim, I guess my first question is on indium phosphide capacity. Ramp as well. So any way you can update us, at this point on the mix of your internally kind of developed indium phosphide transceivers I believe previously you reached 50% or so. Any color on where we are at this point? And perhaps ties to that as well, do you have any target in mind on longer term, what kind of mix you are looking at?

James Anderson: Yeah. Thanks, Papa. What we've said in the past to what we've shared is that, you know, in the past, our amount of indium phosphide internal versus external supply is the majority of our indium phosphide, for instance, lasers are supplied from internal sources. And now if I look forward, I would expect just given the rapid pace of our six-inch production over the coming, you know, this year and following years, I think the percentage that's internally sourced will grow over time. Now that said, you know, we expect to continue to utilize external suppliers as well. We think there's, you know, there's good reasons for that with customers and with supply chain resiliency.

And so we expect to continue to utilize external sources. But over time, you know, the internal sources will become a bigger proportion of the supply.

Papa Sylla: Got it. That's helpful. And for my follow-up is kind of on OCS. It's very good to hear that your engagement is growing. I think you're about seven now. Kind of it's go it went up to 10 now. So it would be helpful if you can remind us, kind of the prior seven, what kind of workload would those seven engagement or projects relate to? Related to? Or and also for the additional three as well. Any color on are those AI focus or what kind of workload they are kind of related to?

James Anderson: Yeah. Thanks, Papa. Hey. Yeah. I'll talk in terms of applications that we're seeing OCS. You know, I think initially, we were seeing OCS adoption in where, you know, OCS has historically been used for instance, in a spine part of the network or in a redundancy type of application. But, you know, as we've engaged with more customers and as we've engaged more deeply with existing customers, then there's been a broadening of the applications that we're seeing for OCS. So whereas, you know, maybe initially, there most of the applications were in the scale-out portion of the network, we're certainly seeing now applications of OCS even in the DC portion of the network.

And as we're deeply engaged with customers on their scale-up plans, so optical within scale-up, we're now seeing customers, you know, talking about using OCS within scale-up network as well. And so it's really been a broadening of not just customers, but application. And that's why, you know, when we assess the size of this market a year ago, we assessed it at about I think it was about $2 billion by the end of this decade. That we likely undersized it. And if we reassessed it now, it would be well above $2 billion. So we've seen customers and applications just continue to grow.

Papa Sylla: Thank you. That's very clear.

Operator: Our next question comes from George Notter with Wolfe Research. Please proceed with your question.

George Notter: Hi, guys. Thanks very much. I just want to come back and ask about your ability to manufacture all this stuff. Obviously, the demand is quite impressive right now. I think we hit the kind of indium phosphide pretty well, but I'm just curious, like, you know, transceiver supply in Malaysia, Vietnam, obviously, you've got a telecom business as well. I'd be curious on, like, what things look like in terms of utilization rates, you have enough capacity? Do you need to expand capacity? And then any sense that you'd look to use outsourcing as well? Thanks a lot.

James Anderson: Yeah. Thanks, George. Yeah. So we've been more focused on updating you on indium phosphide because that's kind of been the constraint across the industry, and we've been by that. But in parallel, we have certainly been building out capacity of, for instance, transceiver assembly and test. So I shared last quarter that within Malaysia, we opened a new facility within Malaysia. Second facility in Penang, Malaysia. We also are now planning to build transceivers at our Vietnam facility. So Vietnam already makes a number of the components that go into our transceivers. We're now starting to build transceivers within Vietnam, so that's an expansion. So we've been expanding assembly and test capacity. We're also expanding you mentioned about telecom.

For our DCI and telecom products, we're also rapidly expanding capacity for that as well. So, yeah, I would say really across the board, we're ramping capacity as quickly as possible. I feel like that's kind of my main job right now is ramping capacity. And so, yeah, given the strong demand that we're seeing, that's definitely a focus across the organization and across many different product lines. And then I think you asked about outsourcing as well. Yeah. We are very open to outsourcing, and we do use a number of different partners for outsourcing.

And the way we always approach it is if manufacturing something provides us a technical, like, a technology benefit that our customers care about or if it provides a cost structure benefit, then we'll do it in-house. But if it doesn't provide either one of those two benefits, then yes, we will look to outsource. And there's a number of places where we've historically outsourced things that we're looking at moving forward. So what we keep insourced is things that are technically beneficial to our products and cost structure advantage. You know, obvious example of that is six-inch indium phosphide where we're the world's only producer of six-inch indium phosphide.

So, yeah, we're certainly open to outsourcing, and we'll continue to look for opportunities to leverage outsourcing.

George Notter: Super. Thanks very much. I appreciate it.

James Anderson: Thanks, George.

Operator: Our next question comes from Karl Ackerman with BNP Paribas Asset Management. Please proceed with your question.

Karl Ackerman: Yes, thank you. Jim, thanks for more detail on the growth magnitude into 2027. But could you speak to the investments you're making today to drive growth and whether OpEx growth could grow at perhaps half of sales growth? I ask because in March, would have thought you'd see maybe less growth, more stability in OpEx from the sales and material processing business. So if you could tie that together too, that'd be helpful. And I have a follow-up, please.

James Anderson: Yeah. Maybe I'll let Sherri talk about the OpEx growth, but maybe just a little bit of a preamble as from an OpEx standpoint, from maybe from an R&D standpoint, you know, our approach is, you know, we have a large number of businesses that have tremendous growth ahead of them. And we want to make sure we're maximizing that opportunity. And so if those businesses require R&D, we're certainly going to scale the R&D to maximize the opportunity. Think, you know, and we'll certainly scale, you know, at revenue, maybe a little bit less than revenue. But I think the big opportunity to drive operational leverage is in SG&A.

And so maybe with that, I'll hand it off to Sherri and maybe provide some additional comments on that.

Sherri Luther: Sure. Absolutely. Thanks for the question, Karl. So, from an OpEx perspective, on the R&D front, as Jim said, I mean, we're focusing on making those investments that drive the long-term growth of the company and when you look at our year-over-year R&D growth, you see that it increased 16%. So we're, you know, we're definitely investing in R&D, and those areas are, you know, very heavily in data center and communication part of our business, because that's where we're seeing the long-term growth. And so that's very important.

But on the flip side of it, from an SG&A perspective, the target that we put out at our investor day for SG&A was 8% of revenue, and that is, you know, we've got a little ways to go. We've certainly improvement. I'm really pleased with the progress that we've made on that. We are sequentially and year over year, we are, you know, have come down in terms of the percentage of revenue and are driving towards that target. And then, you know, on the R&D side of it, just to complete the picture, the target that we've given at our investor day was 10% of revenue. And so, you know, we're focused on making those investments.

I think it's just a matter of, you know, how fast you can spend because, you know, certainly commitment is there, and we want to make sure that we make those investments. And so I'm pleased with the investments we've made to date, and that's the way that we're going to continue looking at this. Right? Investing in R&D, but at the same time trying to get more efficiency and leverage out of SG&A. That's how you can kind of think about it going forward.

Karl Ackerman: Very helpful. And for my follow-up, at SPIE, you presented several new products across your industrial portfolio. And you spoke about improving orders today in semi-cap. Are you seeing a marked recovery across your broader industrial business excluding semi-cap, or is it too early to call out definitively yet? Thank you.

James Anderson: Yeah. Good question. I would say across broader industrial probably too early to call out a broad-based industrial recovery, but we're certainly seeing a very strong pickup in semi-cap. So we saw strong orders in the prior quarter, in our December quarter. And we expect those orders to start to generate sequential revenue growth for us in our June quarter. And through the second half of this calendar year as well. Semi-cap is a big segment for us, and so a pickup in growth in orders there is meaningful for us.

Karl Ackerman: Thank you.

Operator: Our next question comes from Ryan Koontz with Needham and Co. Please proceed with your question.

Ryan Koontz: Super. Thank you. I wanted to ask about the comms business. You highlighted multi-rail, which I assume is kind of a would be driven by some of these scale across densifications. Jim, how are you thinking about kind of the timing and your content there for these multi-rail density upgrades on long-haul fiber?

James Anderson: Yeah. Thanks for asking, Ryan. So first of all, we love this new multi-rail product. It provides a really great ability to upgrade for, you know, service providers, network operators to upgrade within their existing footprint and get essentially a lot more traffic through an existing optical infrastructure. So really pleased with this product. We think it's very distinctive in the marketplace. And we would expect the ramp to start in the end of the second half of this year. We're seeing really good design wins and orders in on this product, and revenue contribution would start in the second half of this year.

And then I would say just more generally, you know, that kind of DCI portion of our business and even just the traditional telecom we've seen really good growth there. You know, last quarter, we saw a 9% sequential growth, but it was 44% year-over-year growth. We expect that segment of communications to be sequentially up in the March and the June. Based on the strong demand that we're seeing. And here again is another place where we've seen growing backlog. And we sell at multiple different kind of levels within that part of the market. We sell at the system level as we were just talking about. We also sell at the module level with ZR, ZR plus.

Coherent transceivers, and then we'll sell components as well. So things like pump lasers, and other products like that. And we've seen strong demand across all those categories.

Ryan Koontz: Great. And just a follow-up, if I could, maybe touching on the 3D sensing market. Jim, and transition to multi-junction. How are you thinking about that transition relative to that part of the business?

James Anderson: Yeah. The 3D sensing I would just reiterate what we've said before, you know, that we won, you know, significant new agreement with Apple that they announced as part of their American manufacturing program, this past summer. And that revenue from that new partnership with Apple starts to kick in the second half of this calendar year. It's a great multiyear partnership. We're really happy with that. You know, it's another example of a major customer leveraging our US manufacturing footprint in Sherman, Texas. In the case of that business, that's six-inch gallium arsenide that's been running in Sherman, Texas for quite a while. And so it's six-inch gallium arsenide VCSEL technology. And, yeah, big new partnership.

We're really happy about that. And, you know, revenue should kick in here in the second half of this calendar year.

Ryan Koontz: Appreciate that very much. Thanks.

James Anderson: Operator, I think we have time for maybe one more question, operator.

Operator: Sure. Vivek Arya with Bank of America Securities. Please proceed with yours.

Michael Mani: Hi. This is Michael Mani on for Vivek Arya. Thanks so much for taking our questions. To start, I just want to understand how much gross margin leverage is your six-inch indium phosphide ramp driving for you right now? And as you look out over the next couple of quarters, like, what is the expected gross margin improvement as you are able to double supply year over year? And just bigger picture, as you think about the 42% longer-term target for gross margins, where you stand today? Like, what are the biggest contributors to getting there? Thank you.

James Anderson: Yeah. Maybe I'll start with the first part of the question on maybe the indium phosphide, and Sherri can answer the second part sort of on broader gross margin drivers. But I would say, you know, this quarter, we're starting to see the benefits of the six-inch production this quarter because, remember, we started six-inch production in the September, and it usually takes roughly six months from, you know, the start of wafer production to when the products get put into a transceiver and actually ship to customers. So we'll see a little bit of benefit this quarter, but that benefit will start to build over the coming quarters.

And if you fast forward to instance for the end of this year, where half of our internal capacity is running on six-inch, you can kind of think about it as that half of our internal six-inch capacity is roughly half the cost of the other half. Right? Because six-inch is, yeah, where the cost is roughly or the product is the product cost is roughly half of three-inch. So that's kind of a rough way to think about the cost benefit. And, Sherri, do you want to talk about some more general gross margin drivers?

Sherri Luther: Sure. Sure. Michael, so when you look ahead to our gross margin, you know, whether it's, you know, 39.5%, which is the midpoint of our guide for Q3, and certainly to our long-term target model of over 42%. The biggest contributors there are going to be, you know, certainly cost reductions, and that is a large bucket which includes product input costs, some of which I talked about earlier.

And we certainly saw benefits during the quarter from product input cost reductions in our data center and communications business, but that also includes yield improvements that we continue to drive and that we every quarter, we're seeing benefits from yield improvements, and I'm really excited, you know, to continue to see that. There's always going to be opportunity for that, so we're going to keep driving that, as well as the lower product input cost. And the other part is going to be pricing optimization. As we continue to get the value for our products. And so we've continued to see sequential improvements in the magnitude of pricing optimization. So that's really good as well.

Now the timing of these programs, it's going to differ. Some will be near term, some will be longer term just depending on the various initiatives. So the magnitude of the benefit in any particular quarter is, you know, will likely fluctuate just because of the nature of the projects. But the other benefit certainly will also be volume. You know, as we ship higher volume, that will benefit us as well. And then mix, you know, there can always be headwinds from mix on a quarterly basis. So that's kind of the puts and takes within the gross margin line.

Michael Mani: Great. Thank you. Very helpful. And just my quick follow-up. As we are as the 1.6 terabit ramp gets underway, understood that, you know, it's mainly EML and CW lasers within the way right now, but between two, do you see a significant shift between silicon photonics and EML? In terms of what that mix looks like for 1.6 especially and as you look out over the next year with CPO seemingly getting bigger as an opportunity, does that make you rethink how much CW laser capacity you need understanding, you know, there's plenty of flexibility to do both, but just curious on that shift. Thank you.

James Anderson: On the first part on EML versus silicon photonics, since we have both products and we're ramping both products, it's really up to the customer on what mix they want, and it just kind of depends on the application. And so we just build whichever version is needed for the customer application. And there's not a big financial difference for us on either one of those. And we believe we're, you know, we're just we're very well positioned competitively on both an EML-based 1.6 T transceiver and silicon photonics.

And then the second part of the question is, you know, we're certainly ramping the indium phosphide capacity for the transceiver demand that we're seeing, but we're also on top of that ramping capacity to support the high-power CW laser demand that we've got ahead of us as well.

Michael Mani: Thank you.

James Anderson: Thanks, operator.

Operator: We have reached the end of our question and answer session. I would now like to turn the floor back over to James Anderson for closing comments.

James Anderson: All right. Thanks, everyone, for joining today's call, and we're certainly on track for another outstanding year of revenue and profit growth for our fiscal 2026 and very well positioned for an even stronger fiscal 2027. Given the exceptional demand we're seeing and our rapidly expanding capacity. Once again, I want to thank all of my Coherent teammates for all their hard work and dedication. Operator, that concludes today's call.

Operator: You may disconnect your lines at this time. Thank you for your participation.

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. Parts of this article were created using Large Language Models (LLMs) based on The Motley Fool's insights and investing approach. It has been reviewed by our AI quality control systems. Since LLMs cannot (currently) own stocks, it has no positions in any of the stocks mentioned. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

The Motley Fool has positions in and recommends Coherent. The Motley Fool has a disclosure policy.