Coherent - Earnings Call - Q3 2025

Executive Summary

• Record quarter: Revenue $1.50B (+23.9% Y/Y, +4.4% Q/Q), non-GAAP gross margin 38.5% (+490 bps Y/Y), and non-GAAP EPS $0.91; strength driven by AI datacenter and a third straight quarter of telecom growth.
• Beat vs S&P consensus: Revenue $1.498B vs $1.441B estimate (+$57M beat); non-GAAP EPS $0.91 vs $0.857 estimate (+$0.05 beat). EBITDA came in below consensus ($292M vs $323M)*.
• Q4 FY25 outlook: Revenue $1.425–$1.575B; non-GAAP GM 37–39%; non-GAAP OpEx $290–$310M; non-GAAP EPS $0.81–$1.01; tax 21–24%.
• Segment dynamics: Networking +10% Q/Q and +45% Y/Y; Lasers -3% Q/Q, +4% Y/Y; Materials -3% Q/Q, -1% Y/Y.
• Balance sheet catalyst: $136M debt paydown in Q3; leverage 2.1x (credit agreement)—continued deleveraging and margin expansion remain core focus.

Items marked with * are Values retrieved from S&P Global.

What Went Well and What Went Wrong

What Went Well

• AI-driven Networking strength and product cadence: “We delivered strong growth and profitability… record revenue driven by another quarter of strong AI-related datacenter demand.” — CEO Jim Anderson.
• Margin execution: Non-GAAP GM rose to 38.5% (+30 bps Q/Q, +490 bps Y/Y) on pricing optimization, manufacturing cost reductions, and yield improvements.
• Portfolio/technology milestones: Multiple 1.6T transceiver demos (EML, VCSEL, SiPh), 400G differential EML (foundation for 3.2T), and NVIDIA collaboration on co-packaged optics.

What Went Wrong

• GAAP drag from restructuring and mix: $73.8M restructuring charges and unfavorable mix; GAAP EPS was $(0.11) despite strong non-GAAP results.
• Industrial softness: Materials and broad-based industrial end-markets were soft; Materials -3% Q/Q and -1% Y/Y; management remains cautious near-term.
• Higher non-GAAP tax rate: Increased to 25% (vs 17.4% prior quarter) primarily due to restructuring charges in higher-tax jurisdictions, modestly weighing on EPS leverage.

Transcript

Operator (participant)

Greetings, and welcome to the Coherent Fiscal Year 2025 Third Quarter Earnings Webcast. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star then zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Paul Silverstein, Senior Vice President of Investor Relations for Coherent. Please go ahead.

Paul Silverstein (SVP of Investor Relations)

Thank you, Operator, and good afternoon, everyone. With me today are Jim Anderson, Coherent CEO, and Sherri Luther, Coherent CFO. During today's call, we will provide a financial and business review of the third quarter of fiscal 2025 and the business outlook for the fourth quarter of fiscal 2025. Our earnings press release can be found in the investor relations section of our company website at coherent.com. I would like to remind everyone that during our conference call today, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions based on information that is currently available and that actual results may differ materially. We refer you to the documents that the company files with the SEC, including our 10-Ks, 10-Qs, and 8-Ks.

These documents contain and identify important risk factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements. This call includes and constitutes the company's official guidance for the fourth quarter of fiscal 2025. If at any time after this call we communicate any material changes to this guidance, we intend that such updates will be done using a public forum such as a press release or publicly announced conference call. Additionally, we will refer to both GAAP and non-GAAP financial measures during this call. By disclosing certain non-GAAP information, management intends to provide investors with additional information to permit further analysis of the company's performance and underlying trends.

For historical periods, we provided reconciliations of these non-GAAP financial measures to GAAP financial measures in our earnings release and investor presentation that can be found on the investor relations section of our website at coherent.com. Let me now turn the call over to our CEO, Jim Anderson.

Jim Anderson (CEO)

Thank you, Paul, and thank you, everyone, for joining today's call. I'd like to start by thanking my Coherent teammates for another quarter of strong execution and the continued focus on accelerating our pace of innovation as we introduced a number of outstanding new products over the past quarter that will help drive long-term growth for the company. Our fiscal third quarter revenue increased by approximately 4% sequentially and 24% year over year to a record $1.5 billion. This was primarily driven by ongoing strong AI data center-related revenue growth and a third quarter of growth in our telecom revenue. We also continued to make solid progress towards achieving our gross margin target of operating above 40% on a non-GAAP basis. In fiscal Q3, our non-GAAP gross margin improved on both a sequential and year-over-year basis to 38.5%.

Our revenue growth and gross margin expansion drove a 2.4x increase year-over-year in our non-GAAP EPS. While I'm pleased with the progress to date, we have much more work and opportunity ahead of us. I'd now like to share some updates on our products and markets. Starting with our data center and communications end market, Q3 revenue increased by 9% sequentially and by 46% year-over-year, with growth in both our AI data center and telecom end markets. In the data center market, we achieved record Q3 revenue, which grew 11% sequentially and 54% year-over-year due to ongoing strong AI data center demand. We have the broadest and deepest portfolio of photonic technologies required for high-speed optical data transmission. Our customers value both the breadth and depth of our technology portfolio, as well as our supply chain flexibility and resiliency, especially in the current environment.

At the Optical Fiber Communications Conference in March, we introduced many new optical networking products and technologies. For example, six of our products received awards reflecting innovations at the component, module, and system level. At OFC, we showcased three different 1.6T transceiver designs based on three different types of lasers: a design based on our EML technology, a design based on our new 200 gig per lane VCSEL technology, and a third design based on our silicon photonics technology. The three different 1.6T demonstrations illustrate the wide breadth of technology options that we bring to our customers as we partner with them over multiple generations of data rate and architectural transitions. We continue to expect 1.6T to begin ramping during this calendar year. We're making good progress with our lead customers, and we continue to execute well through the typical stages of engineering milestones and customer qualifications.

We are also pleased to see continued expansion of our 1.6T customer engagements. While we approach the 1.6T ramp, our engineering team is also focused on the development of our portfolio of 3.2T transceiver products and technologies, which will support a range of optical data transmission form factors. For example, at OFC, we reached a key technical milestone for the industry when we demonstrated our 400 gig per lane differential EML, which is the foundation of 3.2T transceivers and paves the path for future industry adoption of 3.2T transceivers. We also expect to see adoption of our 400 gig EMLs in 1.6T transceivers, where they can provide meaningful benefit to our customers. We also showcased a wide range of co-packaged optical solutions over the past quarter. We announced our collaboration with NVIDIA on co-packaged optics and networking switches for AI infrastructure.

At OFC, we showcased a comprehensive portfolio of optical networking components for CPO applications in both the scale-out and scale-up domain. Indium phosphide is the key technology behind our internally produced EML and CW lasers, with the latter being used in our silicon photonics and CPO solutions. We've had in-house indium phosphide capability for over 20 years. Indium phosphide-based EML transceivers already account for the majority of our data center transceiver revenue, and a majority of our EML-based transceivers utilize our internally manufactured lasers. To meet rising demand for optical networking solutions that use either EML or CW lasers, we continue to expand our indium phosphide capacity. In Q3, we once again expanded our capacity both sequentially and year-over-year, with year-over-year capacity growing by over 3x.

We remain on track to introduce our 6-inch indium phosphide platform, which will provide significant advantages in terms of both lower cost and higher volume production. We expect to begin ramping 6-inch volume production next quarter. We also continue to make good progress with our new data center optical circuit switch, or OCS platform, which drives a significant expansion in our data center addressable market opportunity. The underlying technology in our OCS switch is based on field-proven digital liquid crystal technology that has been deployed for many years in demanding telecom applications. Our technology has tremendous benefits versus the mechanical MEMS-based solutions offered by others, and our customer engagement and enthusiasm around our OCS platform continues to grow. As I noted last quarter, we've already received our first customer order for this key new differentiated platform, and we continue to expect initial OCS revenue in calendar 2025.

In telecom, our Q3 revenue increased 2% sequentially and 21% year-over-year. Q3 was the third consecutive quarter of sequential growth. Revenue growth in Q3 was driven primarily by data center interconnect, along with further improvement in traditional transport market. We saw continued growth in the ramp of our new products, including our 100G, 400G, and 800G ZR/ZR+ coherent transceivers, and expect these products to continue to ramp over the coming quarters. We also continued to expand our product portfolio and announced new products at OFC to address increasing demand for high-speed, efficient, and scalable metro, regional, and DCI applications. We expect this to continue to be a key growth area for us over the long term. In our remaining markets, which are primarily industrial-related applications, aggregate revenue was relatively stable, with a decrease of 2% sequentially and an increase of 1% year-over-year.

In Q3, we saw healthy year-over-year growth in the semicap equipment and display capital equipment end markets that was offset by soft demand in broad-based industrial end markets, such as precision manufacturing. Growth in our semicap equipment revenue was driven by increased demand for advanced packaging tools, where our lasers, optics, and advanced materials are being increasingly adopted. In our display capital equipment market, year-over-year growth was driven by ongoing demand for our differentiated Exmer laser annealing systems, which support both Gen 6 OLED fab expansions and new Gen-8 fabs, as OLED screen adoption continues to grow. We expect the total surface area of OLED screen production to double over the coming years, as OLED screens are adopted across a broader range of devices. In support to the OLED expansion, we continue to ramp shipments of our laser systems for new Gen-8 OLED fabs.

Shifting now to our investment strategy, I'd like to provide an update on our strategic portfolio optimization. We continue to drive a series of actions stemming from the portfolio assessment that we completed last year, with several parallel initiatives in motion. One area of focus to optimize our portfolio is to exit or divest non-core product lines. For example, during the March quarter, we shut down development of silicon carbide devices and modules and eliminated the related headcount and operational expenses. We have refocused our silicon carbide business on substrate and EPI production, where we have differentiated technology and healthy customer demand. We also discontinued several other unprofitable product lines. Another area of focus is to continue to streamline our asset base and divest underutilized assets. For example, we recently announced our intent to sell our underutilized production facility in Champaign, Illinois.

We are also pursuing several other asset optimization actions. As we reduce investment in non-core product lines and streamline our asset base, we continue to concentrate and grow investment in our core growth and profit engines to accelerate shareholder value creation for the long term. We will provide additional details and examples regarding our strategic portfolio realignment at our upcoming investor day. Regarding the current tariff policy environment, the impact of tariffs to our business in the current quarter is not expected to be significant. One of our strengths, which is valued by our customers, is supply chain resiliency and flexibility. We have a global manufacturing footprint that spans roughly 60 different locations across 14 countries, with roughly half of our manufacturing sites located in the U.S.

Our geographically diverse supply chain, combined with the internal production, many of our most critical technology infeeds, provides adaptability and optionality that benefits our customers. To the extent there are changes in the landscape, we will adapt as necessary to support our customers. In summary, I'm pleased with the additional progress we made in our fiscal third quarter and especially proud of the large number of new products and technologies that we introduced. With a high level of uncertainty in the current macroeconomic environment, we're taking a more cautious near-term view of our end market demand. However, we continue to expect fiscal 2025 to be a strong growth year for the company, and we believe we are well-positioned for continued long-term growth. I look forward to sharing more details about our long-term plans for the company at our upcoming investor day.

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

Sherri Luther (CFO)

Thank you, Jim. In the third quarter, we drove continued sequential improvement in our financial results, with strong revenue growth and gross margin expansion driving strong profitability. In addition, we strengthened the balance sheet by paying down $136 million in debt. Third quarter revenue was a record $1.5 billion, an increase of approximately 4% sequentially and 24% year-over-year. From a segment perspective, networking revenue increased 10% sequentially and 45% year-over-year, driven by strong AI data center demand. Laser segment revenue decreased 3% sequentially and increased 4% year-over-year. The year-over-year growth was driven primarily by demand for our Exmer annealing lasers in our display capital equipment business, as well as higher demand in semicap equipment. Material segment revenue decreased 3% sequentially and decreased 1% year-over-year.

Both the sequential and year-over-year declines were due to softness in the consumer electronics end market. Our third quarter non-GAAP gross margin was 38.5%, an increase of 30 basis points compared to the prior quarter, and an increase of 490 basis points compared to the year-ago quarter. The sequential and year-over-year improvements in non-GAAP gross margin were driven by higher revenue volume, as well as benefits from our gross margin expansion strategy, where we saw improvements in both pricing optimization as well as cost reductions, offset somewhat by unfavorable mix. Cost reductions included lower manufacturing costs as well as yield improvements. Third quarter non-GAAP operating expenses were $297 million compared to $283 million in the prior quarter and $254 million in the year-ago quarter. The R&D increases were primarily driven by increased investments in our product portfolio.

The SG&A increases include debt repricing fees incurred in Q3 to reduce the interest rate on our term loan B by 50 basis points. As a result of our strategic portfolio optimization, the company incurred restructuring costs of $74 million on a GAAP basis in Q3 related to a number of restructuring actions, including the elimination of certain non-strategic product lines, site closures and consolidations, workforce reductions, contract terminations, and other associated cost reductions, as well as initiatives to drive greater efficiency and lower costs. From an R&D perspective, we continue to focus on investing our R&D in those projects with the highest ROI while driving efficiency and greater leverage in SG&A. Our third quarter non-GAAP operating margin was 18.6% compared to 18.5% in the prior quarter and 12.6% in the year-ago quarter.

Third quarter non-GAAP tax rate was 25% compared to 17.4% in the prior quarter due to the restructuring charges that I mentioned, which were primarily in higher tax rate jurisdictions. Third quarter non-GAAP earnings per diluted share was $0.91 compared to $0.95 in the prior quarter and $0.38 in the year-ago quarter. We paid down $136 million in debt during the quarter using cash from operations. This brings our fiscal year-to-date total debt payments to $386 million, reducing our debt leverage to 2.1 times as defined in the credit agreement. I will now turn to our guidance for the fourth quarter of fiscal 2025. We expect revenue to be between $1.425 billion and $1.575 billion. We expect non-GAAP gross margin to be between 37% and 39%. We expect total operating expenses of between $290 million and $310 million on a non-GAAP basis.

We expect the tax rate for the quarter to be between 21% and 24% on a non-GAAP basis. We expect EPS of between $0.81 and $1.01 on a non-GAAP basis. Our guidance comprehends the impact of tariffs based on the current policy environment. The current impact is not expected to be significant. In summary, I am very pleased with the progress we have made in Q3. We will continue to focus on improving profitability through gross margin expansion as well as operational efficiency. It's important that we make investments for the long-term growth of the company while driving operating leverage and efficiency. Cash and capital allocation will continue to be key focused areas to further strengthen and deleverage our balance sheet. As a reminder, we will host an investor day in New York on May 28th at the New York Stock Exchange.

At that event, we will outline our overall strategy, including our end market growth opportunities, product and technology roadmap, and long-term financial model. That concludes my formal comments. Operator, please open the call for Q&A.

Operator (participant)

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press Star and then 1 on your telephone keypad. You may press Star and then two if you would like to remove your question from the queue. Again, if you would like to ask a question, please press Star and then one now. The first question we have comes from Samik Chatterjee of JPMorgan. Please go ahead.

Samik Chatterjee (Managing Director and Equity Research Analyst)

Hi. Thanks for taking my questions and congrats on the robust results.

Or maybe, Jim, if I can start you off on the—you in your prepared remarks did mention the pace of innovation, and we're seeing that across the industry and from Coherent as well. You had a bunch of product announcements at OFC. Can you just help us think about the significance and the impact, as well as somewhat in relation to timing of when investors should expect those to become more material in terms of revenue and impact the P&L? And then I have a follow-up. Thank you.

Jim Anderson (CEO)

Yeah. Thanks, Samik. Yeah, I appreciate that. I'm always happy to talk about products, so thanks for asking. So we did have quite an outstanding month in March in terms of new product announcements and technology demonstrations, most of that happening at OFC. I think it really showcased the great innovation that happens every day within Coherent.

I could go on and on about the product announcements, but maybe I'll just highlight two or three. One of the ones I was most proud about of what the team accomplished was we showed three different versions of a 1.6T transceiver. Obviously, for the industry, for the data center, the next big transition in terms of data rate is 1.6T. We showed three different versions: one that was based on our 200 gig EML technology, one that was based on our 200 gig VCSEL, and then another one based on our silicon photonics. I thought that was a great way to showcase the breadth and the depth of technology that Coherent brings to our partners when we partner on a multi-generational basis. My other one that I really liked was we demonstrated a 400 gig differential EML.

The reason that one's important is because that's really the foundation laser technology for 3.2T transceivers. We're deep into development of our portfolio of 3.2T transceivers and demonstrating that key laser capability of 400-gig EML is a really important milestone. Really proud of the innovation the team had demonstrated there. We're really pleased with the progress on that. You asked about kind of timing of impact. All of what I just mentioned we view as significant to the company. Timing of impact would be on 1.6T. We continue to view the 1.6T ramp as we've said in past quarters. We expect 1.6T revenue to start in this current calendar year. We're making good progress through kind of what I would call the normal engineering milestones and qualification milestones with the customers across multiple customers.

Continuing to see that beginning as a ramp in this calendar year and then obviously continuing into the following calendar year.

Samik Chatterjee (Managing Director and Equity Research Analyst)

Got it. Got it. Thanks for those insights. Maybe for my follow-up, clearly there's a lot of concern both with investors as well as the broader industry in relation to the macro as well as tariffs right now. You outlined that you're not really seeing tariff as a headwind, but still maybe if you can flesh out the strength of your U.S. manufacturing footprint, how that gives you some level of flexibility with your overall manufacturing plans. At the same time, how are you incorporating any second-order demand impact in your guidance for the fourth quarter in relation to any demand hiccups to expect because of the macro where we stand today? Thank you.

Jim Anderson (CEO)

Got it. Thanks.

On the first part of your question on the kind of flexibility of our manufacturing footprint, as we mentioned in the prepared remarks, when we look at the current tariff policy environment, we do not expect any significant impact on our financials this quarter. With respect to the manufacturing footprint, I think the company has really done a great job over the past years of building a very resilient and adaptable supply chain. Just a couple of data points around that. I mentioned in the prepared remarks, if you look at the global footprint of the company, we have over 60 different production facilities worldwide, and those are across 14 different countries. From a geographic diversification perspective, we have really great geodiversity in our production footprint. Of those 60-plus production sites, actually roughly half are within the U.S.

We're very proud of our strong U.S. manufacturing presence, and we view that as a key capability. The second point I would make in terms of supply chain resiliency is around vertical integration. This applies to not just our data center business, but also to our industrial business, for instance, our laser business. If you look at a lot of the very key technology in feeds for whether it's a data center transceiver or an industrial laser, we make ourselves, manufacture ourselves a lot of the very key components that go into our transceivers or laser systems or other products. That's an important part of our supply chain resiliency and flexibility.

To the extent that there are changes in the landscape, the tariff landscape, and to the extent we need to adapt manufacturing, move manufacturing to different places for the benefit of our customers, we certainly feel like we've got a very good, resilient, adaptable supply chain to leverage for that. I think the second part of your question was on demand impact. With respect to tariffs, I would say the one place where we're taking a more cautious view on the end market demand, I would say, is more in the industrial part of our business. The current tariff environment, I think, is creating just a higher level of uncertainty across the environment. We are taking a bit of a more cautious near-term view on our industrial business.

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

Samik Chatterjee (Managing Director and Equity Research Analyst)

Got it. Thank you. Very helpful. Thanks.

Operator (participant)

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

Simon Leopold (Managing Director)

Thanks for taking the question. I wanted to first ask you about what you are seeing in the trends for the 800gig, which I guess is more of a foundational element today of your data center business. We have been getting a lot of questions or hearing about debate about excess inventory. If you could help level set us of where are we and where are we going in that category of equipment. I have a quick follow-up, which I will ask after this one.

Jim Anderson (CEO)

Okay. Thanks, Simon.

On 800gig, I would say first, if I look at 800gig shipments last quarter, I would say the demand was strong and as expected. I mean, if you look at, as I mentioned in the prepared remarks, our data center business, so these are primarily datacom transceivers, that grew 11% sequentially and grew about 54% year over year. We continue to see strong demand in 800gig, but also, I would say 400gig and below, we also saw strong demand. Good, strong demand. I think with respect to inventory, I think you're asking about customer inventory. Yes. Clearly, we do not have perfect visibility into our end customer inventory. I will say that from our experience and from our interactions with customers, when as we're shipping them, for instance, transceivers, they are using those or deploying those very quickly after we ship them.

So we're not seeing any obvious pockets of inventory because we're seeing customers deploy those transceivers very quickly after shipment.

Simon Leopold (Managing Director)

Thanks. That's helpful. My other question is regarding the mix of technologies in the data center. I think it's great in terms of the new products you've talked about having, offerings in VCSELs, in silicon photonics, and with EMLs. I want to get a better understanding of how does that mix line up with your revenue. The reason I'm asking is I feel like there's a perception that you're overly dependent on VCSELs for revenue. You've got all the tools in the tool chest, and it's just trying to understand what's the mix and how does that evolve over time. Thank you.

Jim Anderson (CEO)

Yeah. Thanks, Simon. Yeah, definitely, if there is a perception that we're over-indexed on VCSELs, that's certainly not the case.

As I mentioned in the prepared remarks, if we look at our transceiver revenue, actually over half the revenue is based on EML. Over half of our transceiver revenue comes from EML-based transceivers. If I look at that portion of EML transceivers, the majority of those EML transceivers actually ship with our own internally designed and manufactured EML. We do utilize external EML sources as well, but as I said, over half of our EML transceivers are from our own EML factories. Hopefully that addresses a little bit of the mix. VCSEL is still, we view, an important part of our tool chest. As I said, the majority of transceivers are EML-based now. I'll also say that a growing portion of the transceiver is now silicon photonics too. We do have silicon photonics transceivers.

As I mentioned earlier, in terms of 1.6T transceivers, we have all three solutions, right? We're intending to offer our customers 1.6T transceivers based on EML, VCSEL, and silicon photonics so we can deploy the best technology for whatever particular application the customers are trying to address.

Simon Leopold (Managing Director)

Thank you.

Operator (participant)

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

Hi, [as you're reading.] I'm from Blaine. Thanks for taking my question. Two, I guess. The first one, kind of following up on the last question in 800G and some of the technological changes there as you move to EML. Can you talk a little bit about the traction of your own EML and what that means in terms of your supply demand and capacity growth there and how it looks when you move from 400G to 800G?

Then the second question would be, can you talk a little bit about your guidance from a segment basis?

Jim Anderson (CEO)

Yeah. In the first part of your question on 800G, I would say the traction on our own EML is quite good considering, as I mentioned, the majority of our total transceiver revenue ships on our own EMLs, right? I think our strategy of using both external and internally produced EMLs is a good way to provide greater supply chain resiliency, again, to our customers. We're able to offer a very resilient, adaptable supply chain because we're able to shift and adapt our own internal capacity as well as our externally supplied EML capacity. We view that as a key tool of our supply chain resiliency. Certainly, internally produced EMLs is an important part of our strategy.

I'll also mention that and just reiterate that, remember, we've shared that our indium phosphide capacity has tripled on a year-over-year basis. Our intention is to continue to expand our indium phosphide capacity. Our 6-inch indium phosphide line will go into—we'll start production next quarter. That 6-inch line, moving from 3-inch to 6-inch, provides a significant increase in capacity, but it also provides a significant step function improvement in cost structure as well. We see that as a big benefit. One of the reasons we're ramping indium phosphide capacity beyond just the immediate need for transceivers is also for CW lasers for, for instance, CPO applications. Indium phosphide capacity is used for both EML as well as CW lasers. We're ramping that capacity in preparation for that as well.

We see it, again, we see indium phosphide as a key capability in the company, something we've had in-house for over 20 years and something we expect to continue to invest in. On the second part of your question around guidance, yeah, if you look at the midpoint of the guidance that Sherri provided on revenue, roughly flat at the midpoint sequentially. Within that, what I would say is we're expecting data center and communications to be sequentially up in the current quarter, and our industrial-related end markets to be sequentially down. With the industrial-related markets, as I mentioned earlier, I think just given the kind of more uncertainty in the environment, we're taking a bit more of a cautious view on the end market outlook around industrial. In data center and communications, we expect to continue to see growth.

Awesome. Appreciate it.

Operator (participant)

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

Thomas O'Malley (Director of Equity Research)

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

Jim Anderson (CEO)

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

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

Thomas O'Malley (Director of Equity Research)

Helpful. Just something I noticed, obviously going into the June quarter, you're getting a bit of revenue uplift, obviously a little flattish, but gross margins are pressured a bit.

Should we be thinking about mixed differential that gets you to lower gross margins, or are there any other factors that we should be weighing as to why you're seeing the sequential step down?

Sherri Luther (CFO)

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

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

From a pricing optimization perspective, we did see benefits in our lasers business and in our datacom business, examples of where we were executing on pricing improvements there. I'm really pleased with the progress that the team has made so far. We are definitely in the early stages. We're continuing to focus on that. Those levers for pricing optimization and cost reduction really help when we do have mixed headwinds. The other thing I would mention is that the timing of these initiatives can kick in some near term, some longer term, and the rate and pace can differ. That's just a few other little specifics that I can share with you in terms of that gross margin optimization strategy. We are focused on the target of over 40%.

I look forward to giving more color on that at our investor day in May.

Operator (participant)

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

Michael Mani (Equity Research Associate)

Hi, this is Michael Mani on for Vivek Arya. Thanks so much for taking our questions. Just first on the 1.6T ramp, at this stage of your visibility, do you have any insight into what your relative share could be for the upcoming ramp, maybe relative to 800 gig? And then further on that, could you give us a sense of what the pattern of adoption is across your customer base? Is it just starting with a few customers and kind of like 800 gig? Maybe later in the ramp, there will be a longer tail of customers that then eventually catch up? Just how should we think about that progression? Thank you.

Jim Anderson (CEO)

Yeah. Thanks, Michael.

On the first part of the question, it's probably too early for us to talk about share of 1.6T ramp. But as we said, we still continue to expect revenue to start this calendar year and then ramp through the course of the following year and beyond. One of the things that we're seeing in the industry, which has changed versus, say, a number of years ago, is we're seeing these faster adoption cycles of new data rates. We're seeing overlapping cycles. We expect 800 gig to continue to ramp as the 1.6T adoption starts. We still expect 800 gig demand to remain strong, I would say, into next year as well, with 1.6 kind of ramping on top of that.

We will actually give a picture of what we expect the industry adoption rate of 1.6T to be at our investor day at the end of May. We will map out what we think is kind of the 800 gig to 1.6T transition. We would view our revenue profile will kind of match the industry adoption rate. On the second part of your question, in terms of pattern of customer adoption, yeah, I think the way you described it is accurate is we would see probably a smaller number of early adopters of 1.6T and that expanding out over time. That is what we saw in 800 gig as a small number of initial adopters of 800 gig. Although that did expand pretty rapidly over the course of about a year, we would expect the same to happen on 1.6T.

Michael Mani (Equity Research Associate)

Great. Thank you.

Just one on gross margins. Just to confirm, I know you said no significant impact from tariffs, but is there any cost headwind contemplated in your gross margin guide for the next quarter? From here through the end of the year, could you give us a sense of where most of the expansion opportunity could come from, whether it is cost reductions, yield, product mix, further pricing optimization, just among those big buckets, what would be the biggest contributors for maybe the medium term? Finally, on the pricing optimizations, I know you said you have already begun to do that. How early are we in that process? How much of a benefit will that be over the next couple of quarters? What are some areas where you still see great opportunity to maybe optimize price? Thank you.

Sherri Luther (CFO)

Sure. Thank you for the number of questions there. I got to make sure I cover them all. In terms of the, I think the first one had to do with sort of cost impact and tariffs and gross margin. I think that was what sort of your first question was. What I can tell you is that in addition to what I've already said, I mean, right, the gross margin guide, it's based upon the best information that we have for Q4. It incorporates all the best information that we have, the current environment related to tariffs, which, as we have said, Jim has said, and both of us have said in our prepared remarks, is not significant. We're going to continue focusing our gross margin expansion strategy for pricing optimization and cost reductions.

The unfavorable component that could occur is mix, and that I responded to in the earlier question. All of those earlier comments apply to your question. In terms of the rest of the year, where are the opportunities for improvements in gross margin? How can we get it up? We do not guide beyond the current quarter, but we are focused on the product cost reductions and the pricing optimization. The way to think about that, and of course, we will give more color to investor day, but the way to think about that is when we think of product cost reductions, that is the entire company, right? We are looking everywhere in the company, every segment, no stone unturned, product costs, manufacturing costs, fixed costs, all elements of cost, as well as yield improvements.

Every part of the company, every part of each business is participating in that and really driving toward those improvements. When you think about pricing optimization, that is primarily in the industrial and other part of our business. It does not mean datacom will not have benefits there. In fact, we did have benefits from pricing in Q3 from datacom. Most of that benefit, if you think about where most of the opportunity is coming from in the company for pricing, will be in the industrial and other part of our business. For datacom, we are focused on growing revenue growth, market share, all of that. That is the way you can think about in terms of where in the company we would be generating these benefits that are part of this optimization strategy.

In terms of the relative magnitude of each of these elements, that'll give you more color at our investor day where I think we've got some good information that we'll share with you that'll help give you that better perspective at that time. Hopefully, I covered them all. I don't know if I missed any part of your question.

Michael Mani (Equity Research Associate)

No, that was super helpful. Thank you.

Operator (participant)

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

Papa Sylla (Equity Research Analyst)

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

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

Jim Anderson (CEO)

Thanks, Papa. Yeah, I think we're in the traditional telecom. We're still in that cautiously positive mode that I mentioned last quarter. Yeah, we're still seeing incremental improvement on a kind of quarter-by-quarter basis. We're certainly happy to see that. Now, where we're seeing bigger growth is, of course, in DCI, kind of the second part of your question. That's still a smaller portion of our telecom revenue, but no doubt the bigger growth driver in that segment. When we look at our telecom revenue grew over 20% year over year. Some of that was improvement in traditional telecom, but the majority of that growth was driven by DCI. We expect that DCI component to continue to grow over the coming quarters.

Papa Sylla (Equity Research Analyst)

You got it. No, that's helpful.

My follow-up is kind of on margin and kind of alongside prior questions. Here, obviously, you have been quite successful in your efforts to improve margin through kind of reducing manufacturing costs, improving yield, and price increases. I guess for this quarter in particular, what would you maybe attribute primarily your margin outperformance between those three? The second part of this question is how far along in terms of the yield improvement efforts, how far along are you? Is there still a lot of room there, or are you getting really close to your internal targets?

Sherri Luther (CFO)

Yeah, sure, Papa. I think you cut out a little bit, but I think your question was, where does most of the benefit in Q3 come from in terms of pricing and cost? I think is what you're asking.

Really, cost reductions tend to be a little bit higher in terms of the contributor versus pricing. Again, that can fluctuate on a quarterly basis, and that's not necessarily always the rule. That's generally what we saw for Q3, cost reductions a little bit higher than the pricing improvement. In terms of where we are on the yield improvement, I mean, as you can imagine, for a manufacturing company, there's manufacturing a number of different products. There's lots of opportunity for yield improvements all throughout the manufacturing processes and many of our businesses. It's not the situation that you sort of make a yield improvement and you're done. It's always ongoing. There's always opportunity for improving yield. Also, as new products come out, there are additional opportunities that present themselves to create yield improvements.

That is going to be an ongoing part of our strategy.

Papa Sylla (Equity Research Analyst)

Got it. Thank you.

Operator (participant)

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

Chris Rolland (Senior Equity Analyst of Semiconductors)

Hey, guys. Thanks for the question. Perhaps first, a follow-up on your manufacturing footprint, specifically for transceivers. I think you're in China and Malaysia with that manufacturing. Do you have the capacity to serve American customers via Malaysia, or how is China involved in that? Perhaps if you could give us some color as to what % of your business might actually end up in America. Yeah, can you fully serve America out of Malaysia, and what % goes to the U.S.? Thank you.

Jim Anderson (CEO)

Yeah. The first part of the question, the answer is yes.

In fact, today, if you look at our U.S.-based, for instance, customers like Hyperscaler customers, most transceivers come from Malaysia. Yeah, today we're supporting our U.S. customers almost entirely from Malaysia. On the second part of the question, I think you were asking about total revenue by geography, how much is North America-based? I don't have it. For transceivers, yeah. For transceivers, Chris, I don't have that in front of me, but it's certainly a very significant percentage, right? I don't have that right in front of me.

Chris Rolland (Senior Equity Analyst of Semiconductors)

Yeah, that's fine. I think you answered it. Secondly, the comments and the additional focus on EMLs this quarter, it seems like this is an increased emphasis for the company.

I guess at what point in time do you think you could fill all your EML needs internally, or do we have to wait for that 6-inch fab to come online? Conversely, Lumentum last night talked about doing more in CW. Do you see that as becoming an increasingly crowded space? Thank you.

Jim Anderson (CEO)

Yeah, Sean, on EML, I think today our strategy is actually to use a mix of both external and internally produced EMLs for our transceivers. I would expect to continue to use a mix. We have a number of external EML vendors that are great partners and have been very reliable suppliers. We view it as a nice way to have just even more supply chain resiliency.

As I shared, the majority of our EML-based transceivers ship with our own internally produced EMLs, but I would expect to continue to utilize external suppliers as well. On CW lasers, maybe just to clarify that on CW lasers, we have produced CW lasers for our telecom products for many years. Remember, we've had indium phosphide capability for over 20 years. We've been doing CW lasers for a long time for telecom. Moving forward with the adoption of silicon photonics in some transceiver applications and potentially in CPO applications as well, we believe there's certainly opportunity for increased usage of CW lasers in data centers.

Part of the capacity ramp that we are doing is in support of making sure that we have the right capacity in place to support our customers with respect to CW laser needs over the long term as well. Definitely that 6-inch line actually will be introducing 6-inch capacity at two sites, two separate physical sites. That 6-inch capacity is definitely a key enabler of our capacity expansion. I will just reiterate a significant cost structure advantage as well.

Chris Rolland (Senior Equity Analyst of Semiconductors)

Thanks, Jim.

Operator (participant)

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

Karl Ackerman (Managing Director)

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

Sherri Luther (CFO)

Yeah, thanks, Carl.

I think you're referring to some of the restructuring that we've taken in the portfolio actions associated with it. What I would say is that the actions that were taken in terms of an underutilized asset or underutilized businesses, that benefit certainly will contribute to our financials from a gross margin and OPEX perspective, depending on the nature of the actual divestiture. For example, the device and modules business that Jim talked about from our silicon devices business, I mean, that didn't affect our revenue because that was pre-revenue, as he described. It really affected more from an OPEX perspective going forward and not really from a revenue or gross margin perspective. It depends on the nature of the businesses in terms of where it will impact in the P&L.

When you go forward in terms of going to the future, in terms of our long-term model, we'll give you more color on how to think about our gross margin at our investor day, as well as our complete operating model from an OpEx perspective and revenue growth. I think it's really all of those elements that come into play longer term that will be more useful for you to see at our investor day from looking at our overall model perspective versus the actions that we took during the quarter having a significant impact in the quarter. I think it's more long-term impact, I think, is really the short answer to the question where you would see the benefit. The results that we had for Q3, I wouldn't say that there were significant impacts related to the portfolio analysis directly in the P&L.

What you have been seeing even prior to Q3 is the shift in R&D spend. I mean, that was a big part of what we talked about in looking at the portfolio review analysis was really making sure that we pull R&D out of those non-strategic or underperforming assets and really focus it towards the profit and growth engines. Those are the things that you already see that we're doing. We're seeing that in Q3 and prior quarters. You will continue to see that going forward. Otherwise, I would say it's more longer term that you'll see the benefits of some of our restructuring actions that we took.

Karl Ackerman (Managing Director)

Yep. Thank you. Jim, I was hoping you could address how you see the demand outlook for datacom transceivers, particularly 800 gig, in the June quarter and throughout the calendar year.

The reason why I ask is some investors have been concerned about this inventory build and heightened competition pressuring margins. That does not seem to be the case for you. Perhaps you could highlight how you see second half relative to first half in the context of your datacom transceiver business. Thank you.

Jim Anderson (CEO)

Yeah, we do not guide beyond the current quarter. What I would say is in datacom, we continue to see strong demand signals from our customers, both kind of shorter-term demand signals, which would be purchase orders and backlog, but also longer-term demand signals like the forecast that they will give us, a 12 or 18-month forecast. We continue to see strong demand from the data center customers. We are expecting that business to continue to grow.

Certainly, we're not just, maybe to clarify, we're not just focused on matching the market growth. We're also focused on share gain. We believe we gained share over the last two to three quarters. Certainly, we're very focused on continuing to gain share of wallet out of our customers and overall share in the market.

Karl Ackerman (Managing Director)

Thank you.

Operator (participant)

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

Meta Marshall (Managing Director)

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

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

Jim Anderson (CEO)

Thanks, Meta. On industrial, we haven't seen any signs of pull forward. The customer ordering patterns have been very normal. Our sort of more cautious outlook around the industrial and market demand is really related to the second thing that you mentioned, just macroeconomic uncertainty. That's causing us to just take a more cautious outlook on that market in the near term. We still believe that that is a long-term growth area for the company and certainly an area we'll highlight as long-term growth in our investor day later in May.

On the second part of your question around the aerospace and defense business, I would say that business is a smaller part of our revenue, but that business has been doing quite well recently. We saw good sequential growth. If I take our most recent quarter, we saw good sequential growth in the most recent quarter and year-over-year growth as well.

Meta Marshall (Managing Director)

Great. Thank you.

Operator (participant)

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

Ryan Koontz (Managing Director and Research Analyst)

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

Jim Anderson (CEO)

We do two things with respect to DCI and ZR modules. We make our own modules and sell our own modules, but then we also sell components into other suppliers of those modules. We kind of address the market from both perspectives. I think your question was about the second piece of it of when you sell. That's right. Yeah. I don't know how to really break down the BOM opportunity, but I would say it's a significant opportunity for us. And it's a very good part of our business. We see good demand there. And also, I would say it's a reasonably good gross margin as well. I think we could probably give you a better picture when we meet at our investor day this month. DCI and our products in the DCI space is one of the topics we'll hit at the investor day.

I would say probably stay tuned, and we can provide a little bit more color at the investor day.

Ryan Koontz (Managing Director and Research Analyst)

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

Jim Anderson (CEO)

Yeah. Happy to. Really great product. I'm really excited about it. First of all, in the use case, the OCS replaces an electrical switch. The reason a customer would want to switch or change from an electrical switch to an optical switch is because then the data transmission stays in the optical domain, which has performance and power efficiency advantages. Our OCS solution is very differentiated versus what else is out there in the market. The other solutions are mechanical MEMS-based solutions.

Ours is based on digital liquid crystal technology from our telecom business, which has much higher reliability and other benefits as well. We continue to expect to generate revenue from that product line this calendar year. We do have existing customer orders in place. It is a product line we're really excited about in terms of TAM expansion and future revenue growth.

Ryan Koontz (Managing Director and Research Analyst)

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

Jim Anderson (CEO)

Yeah. Good question. It can go into multiple parts of the market or the data center deployment. You would find it in potentially multiple different parts of the data center.

Ryan Koontz (Managing Director and Research Analyst)

Got it. Thanks so much.

Jim Anderson (CEO)

Thanks.

Operator (participant)

Thank you.

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

Jim Anderson (CEO)

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

Operator (participant)

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