Coherent Corp. Q2 2026 Earnings Call Transcript

Coherent Corp. (NYSE: COHR) Q2 2026 Earnings Call dated Feb. 04, 2026

Presentation

Operator

Greetings and welcome to the coherent second quarter fiscal year 2026 earnings call. It is now my pleasure to introduce your host, Mr. Paul Silverstein, Senior Vice President of Investor Relations for Coherent. Please go ahead.

Paul Silverstein — Senior VP, Investor Relations

Thank you, operator and good afternoon everyone. With me today are Jim Anderson, Coherent CEO, and Sherry Luther, Coherent cfo. During today’s call, we will provide a financial and business review of the second quarter fiscal 2026 and the business outlook for the third quarter fiscal 2026. Our earnings press release can be found in the Investor Relations section of our company website@coherent.com I would like to remind everyone that during our conference call we may make projections or other forward looking statements regarding future events or the future financial performance of the company. We wish and 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 10Ks, 10Qs and 8Ks. 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 the third quarter fiscal 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’ll 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 provide a reconciliation of these non GAAP financial measures to GAAP financial measures in our earnings release and investor presentation that can be found on the Investor Relations section of our website@coherent.com let me now turn the call over to our CEO Jim Anderson.

Jim Anderson — Chief Executive Officer

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 buildout, we saw strong revenue and profit growth in our December quarter. 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 and 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 27 revenue growth rate to exceed our fiscal 26 growth rate. The key growth drivers that we see over the coming quarters are growth in both 800g and 1.6t transceivers, growth from the ramps of new products such as OCS and CPO solutions, and ongoing exceptionally strong demand in our products 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 semicap 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 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 and 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 1.6g 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 1.60 and 800 gig transceivers as well as growth in our OS LCS systems. We see strong demand for our 1.6T transceivers across multiple customers and continue to expect both 800G and 1.6T to grow significantly in calendar 26.

We expect 1.6T 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 200G VCSEL based 1.6T transceivers ramping in the second half of this calendar year Year on the supply side to address the extraordinary growth in demand, we are investing in the rapid expansion of our production capacity. For example, we significantly increased our indium phosphide production capacity in Q2 and we are executing on track to our plan to double our internal indium phosphide production capacity by the fourth quarter of this calendar year.

As a reminder, our indium phosphide capacity expansion is driven by our ramp of 6 inch wafer production. A 6 inch wafer compared to a 3 inch wafer will produce more than 4 times as many chips at less than half the cost. Our production team is doing an outstanding job ramping our 6 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 6 inch indium phosphide, EMLs, CW lasers and photodiodes.

Our 6 inch yields continue to exceed the yields of our 3 inch production lines. In addition, we have multiple 6 inch indium phosphide substrate suppliers and we have secured committed substrate supply that supports our expected doubling of capacity by our December quarter. In short, we are very pleased with our ramp of the world’s first 6 inch indium phosphide production lines and expect this production ramp to support significant revenue growth and margin expansion of our transconnected receiver 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 6 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 phosphide and 200g 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 with shipments and backlog include both 64 x 64 and 320 x 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 platform 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 quarter. 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 transceiver products as well as lasers and other components that we sell to system OEMs.

For example, we recently secured a significant multi year 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 are also experiencing very strong demand across our broader communications 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 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 industrial business for significant long term growth. Finally, I’d like to provide an update on our portfolio optimization initiative. Last week we completed the sale of our product division based in Munich, Germany. The that 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 strengthen, 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 26 and fiscal 27 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 Sherry Luther.

Sherri Luther — Chief Financial Officer

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 2x. 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 improvement. 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% 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 sga. 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 initiatives within our GNA 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 and 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 the third quarter of fiscal 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 end of 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 and A.

Question & Answers

Operator

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press Star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press Star two 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 as One moment please while we poll for questions.

Our first question comes from Sameet Chatterjee with JP Morgan Chase and co. Please proceed with your question.

Samik Chatterjee

Yep. 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 contribution of 6 inch to that capacity ramp.

And I have a follow up. Thank you.

Jim Anderson — Chief Executive Officer

Yeah, thanks Amic. And yes, the leg is doing much better. Thank you for that. I appreciate that. On the demand question. Yeah, I would say I would call the demand that we’re seeing and the visibility extraordinary. If I just look at a couple highlights from last quarter, if we look at our data center business, I was really pleased with the acceleration of our sequential growth rate, 14% sequential growth. And then we also saw, as I mentioned in the prepared remarks over 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. A lot of times those forecasts go out 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 number of long term supply agreements that we’ve either signed with customers or in the process of signing where the LTA will provide a guarantee to our customers for a certain amount of supply and 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, et cetera. 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 capacity ramp, again here, really pleased with the team’s execution Here on the 6 inch indium phosphide ramp. You know, one of the key metrics that I look at in terms of how the progress, 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, 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 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 ship to customers.

And typical time from a wafer start to like a transceiver shipment is about six months. But that’s a great leading indicator on our Indian phosphides ramp. And we’re already seeing the Benefits this quarter from the initial production that started in our September quarter of last year. So I’m really pleased with that ramp. And again the reason we’re so focused on that is because a 6 inch wafer versus a 3 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 same.

It sounded like you had a follow up.

Samik Chatterjee

Yeah, 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 100 million revenue number in terms of timing, should it be this fiscal year or next year? How to think about that? Thank you.

Jim Anderson — Chief Executive Officer

Yeah, thanks Amik. Yeah, in terms of ocs, this is going to sound like a common theme, but here again, demand very strong. We are very focused on the production ramp now. So backlog is good. It grew in the December quarter versus the September quarter. 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 contributor next year as well.

Samik Chatterjee

All right, great, great. Thank you. Thanks for taking my questions.

Jim Anderson — Chief Executive Officer

Thank you.

Operator

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

Simon Leopold — Analyst, Raymond James

Thanks very much for taking the question. 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 call it an emerging cycle. So maybe if you could put some milestones around this, help us understand when does that cross 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.

Jim Anderson — Chief Executive Officer

Yeah, thanks Simon. So first of all, if both 800 gig and 1.6 t, we expect to continue to grow for this calendar year. We saw growth in both 800 GHz and 1.60 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 1.60 is growing much faster, but it’s growing off a smaller base than 800 gig. I would say the 1.6 T ramp has accelerated. The demand from the customers has accelerated. We’re ramping with multiple customers.

I see that as 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 1.6t will absolutely be key growth drivers for the company this year. This calendar year year. And 1.60 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 800g but tremendous amount of orders on 1.6t 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 1.6T as well as silicon photonics. But we Expect VCSEL based 1.6T 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 T.

Simon Leopold — Analyst, Raymond James

That’s good. And then I heard also you’ve gotten a qualification on the coat package optics. I’m going to 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 how to think about that market opportunity which I imagine may be years away, but I have to guess you’re engaged in the engineering aspects already. Thank you.

Jim Anderson — Chief Executive Officer

Yeah, certainly. So that CPO purchase order that we received and it was a. It was a massive purchase order and that’s for our 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 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 up 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.

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, et cetera. So there’s a variety of ways that will support that market. But we see that as a tremendous growth opportunity 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 — Analyst, Raymond James

Great. Thank you very much.

Operator

Our next question comes from Ruben Roy with Steeple. Please proceed with your question.

Ruben Roy — Analyst, Steeple

Thank you, Jim. I’d like to keep the discussion going on cto and it’s great to hear about the large order on the timeline, end of the year into next year. High level, how are you thinking about content in CTO relative to the strength you’re seeing currently with 800 gig and the nascent 1.6 terabyte module strength? Do you think that, you know, 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 as you look out into 2027 as GPO ramps.

Thank you.

Jim Anderson — Chief Executive Officer

Yeah, thanks, Ruben. Yeah, we really view it as its additive. The way we think about it is pluggable transceivers will remain the dominant form factor 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, et cetera. But we believe that cpo, the big growth in CPO is actually driven by scale up.

And that is, 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. Today all of that optical content and scale up is incremental tam.

Ruben Roy — Analyst, Steeple

That’s helpful. Thanks, Jen. And a quick follow up. You talked about 800 gig versus 1.6 terabyte mix and just wondering, I assume you’re starting to see some demand for 200 gig and differential EMLs and that type of thing. If 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?

Jim Anderson — Chief Executive Officer

Yeah, 1, the 1.6t 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 1.60. We’re seeing 1.60 ASPs that are higher than 80. And then generally, especially at the beginning of the life cycle of a data rate, the gross margins are higher. So we expect 1.6 t gross margins to be higher. And so we view 1.6t ramp as margin accretive for us. And then certainly. I’m sorry, yeah, just one other point.

Also a factor in that is as you know, as we ramp 6 inch indium phosphide capacity which supports both 800 gig and 1.6 T transceivers, that 6 inch capacity is a gross margin driver for us as well in our transceiver business.

Ruben Roy — Analyst, Steeple

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 the preamble you talked about a book to bill ratio that exceeded forex. As customer demand continues to increase and customers are placing orders or 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 on 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 on specific numbers. I know you don’t do that, but anything that you can to help us on that.

Jim Anderson — Chief Executive Officer

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 1.60 transceiver. Bookings. It’s a combination of 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 1.6T. So both 800Gig and 1.6G bookings were incredibly strong. We expect that to continue into this quarter as well. In addition to that, bookings for OCS contributed last quarter and 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 of 1.60 transceiver bookings. Over time it starts to be more and more 1.6g 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 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 is talking about some additional capacity as well. Maybe about when you see the industry getting the product that it needs. Are we still in a position where the industry is short and just given the incremental capacity additions, when you think you’ll be at equilibrium in that business. Thanks.

Jim Anderson — Chief Executive Officer

Yeah, it’s a great question. It seems like every quarter we think we’re going to catch up and then the demand keeps increasing. 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 forecast 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 6 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 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.

Unidentified Speaker

Operator, if we could go on to the next question.

Operator

Our next question comes from Blaine Curtis with Jefferies. Please proceed with your question.

Blayne Curtis — Analyst, Jefferies

Hi. Ezra Wiener. I’m from Blinn. Thanks for taking my questions. Just the first one. Obviously component pricing is coming up for your externally sourced components, but at the same time you guys are signing LTA’s. Can you talk a little bit about. Pricing and how you think about gross margins within that context?

Jim Anderson — Chief Executive Officer

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. So I would say the net is 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. 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 Sherry 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 we believe we’re in a good pricing environment across all of our businesses. And maybe. Sherry, do you want to comment any more on the effects of gross margin or did that cover it?

Sherri Luther — Chief Financial Officer

Yeah, sure. Just a couple things I can add. When you look at the improvement that we. We saw both quarter and quarter and sequentially in gross margin or quarter on quarter, 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 Brazilian. So it was actually an area where we saw more of the magnitude of that benefit. We had lower product input costs for key elements, 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 pricing 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 you know, we’re continuing to focus on that. Really pleased with the progress that we’ve made to date on that. And 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 FY24 gross margin, we’ve actually improved our gross margin by about 470 basis points through, you know, the elements of the strategy that I’ve just described here.

So I, you know, really pleased with the progress. We’re still, I would consider to be in our early stages as we continue to drive toward that greater than 42% target.

Blayne Curtis — Analyst, Jefferies

Got it. Thank you then for the follow up. Just wanted to ask about the 6. 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 would be 6 inch? And can you talk a little bit about the advantage of that relative to Pierce?

Jim Anderson — Chief Executive Officer

Yeah, on the second part of the question over the long term. Yeah. Essentially all of the capacity that we’re adding now is 6 inch. We’re adding a little bit of 3 inch, but all of the, but beyond that, the vast majority is 6 inch capacity and that’ll continue. So over time, 6 inch capacity will just become more and more a bigger percentage. And if you think about us doubling capacity year over year and almost all of that coming from 6 inch, the other way to think about it is by the end of this calendar year, about half of our capacity will be 6 inch and it will 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 move throughout this year, I’ll give 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 6 inch wafer compared to a 3 inch wafer.

You get over four times as many product 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 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 6 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 6 inch CO capacity and the location of it.

Blayne Curtis — Analyst, Jefferies

Got it. Thank you very much.

Operator

Our next question comes from Papasala Citigroup. Please proceed with your question.

Papa Talla Sylla

Thank you for taking my question and congrats on the results. So Jim, I guess my first question is on indium phosphate capacity ramp as well. So anyway 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 targets in mind on longer term what kind of mix you are looking at?

Jim Anderson — Chief Executive Officer

Yeah. Thanks Papa. What we said in the past, what we’ve shared is that 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. Now if I look forward I would expect just given the rapid pace of our 6 inch production over the coming this year and following years, I think the percentage that’s internally sourced will grow over time. Now that said, we expect to continue to utilize external suppliers as well. We think 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 the internal sources will become a bigger proportion of the, of the supply.

Papa Talla Sylla

Got it. That’s, that’s helpful. And for my follow up it’s kind of on ocs. It’s very good to hear that your engagement is growing. I think it was seven now kind of, it went up to 10 now. So it would be helpful if you can remind us kind of the prior seven. What, what kind of workload was those seven engagement or kind of projects relate to, related to or and also for the additional tree as well, any color on other AI focus or what kind of workloads there are kind of related to.

Jim Anderson — Chief Executive Officer

Yeah, thanks papa. 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 spying part of the network or in a redundancy type of application. But as we’ve engaged with more customers and as we’ve engaged more deeply with existing customers, there’s been sort of a broadening of the applications that we’re seeing for ocs. So whereas maybe initially most of the applications were in the scale out portion the of of the network, we’re certainly seeing now applications of OCS even in the DCI portion of the network.

And as we’re deeply engaged with customers on their scale up plan, so optical within scale up, we’re now seeing customers talking about using OCS within scale up networks as well. And so it’s really been a broadening of not just customers but applications. And that’s why when we assessed 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 Talla Sylla

Thank you. That’s very true.

Operator

Our next question comes from George Nader with Wolff Research. Please proceed with your question.

George Notter — Analyst, Wolff Research

Hi guys, thanks very much. I just wanted 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 Indian phosphide discussion pretty well. But I’m just curious like, you know, transceiver supply in Malaysia, Vietnam, obviously you’ve got a big telecom business as well. I’d be curious on like what things look like in terms of utilization rates. Do 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.

Jim Anderson — Chief Executive Officer

Yeah, thanks George. Yeah, so we’ve been more focused on updating you on indium phosphide capacity because that’s kind of been the constraint across the industry and we’ve been constrained 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 facilities. 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 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 something provides us, 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, do I 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 and things that we’re looking at moving forward. So what we keep in sourced is things that are technically beneficial to our products and cost structure advantage. You know, obvious example of that is 6 inch indium phosphide where we’re the world’s only producer of 6 inch indium phosphide.

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

George Notter — Analyst, Wolff Research

Super. Thanks very much. I appreciate it.

Jim Anderson — Chief Executive Officer

Thanks, George.

Operator

Our next question comes from Carl Ackerman with BNP Paribas Asset Management. Please proceed with your question.

Karl Ackerman — Analyst, BNP Paribas Asset Management

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 asked because in March I would have thought you’d see maybe less growth, more stability in OPEX from the sale of material processing business. So if you tie that together too, that’d be helpful. I have a follow up, please.

Jim Anderson — Chief Executive Officer

Yeah, maybe I’ll let Sherri talk about the OPEX growth, but maybe just a little bit of a preamble is from an OPEX standpoint, maybe from An R and 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 and D, we’re certainly going to scale the RD to maximize the opportunity, I think, you know, and we’ll certainly scale, you know, at revenue, maybe a little bit less in revenue.

But I think the big opportunity to drive operational leverage is in sga. And so maybe with that I’ll hand it off to, to Sherri and to maybe provide some additional comments on that.

Sherri Luther — Chief Financial Officer

Sure, absolutely. Thanks for the question, Carl. So from an OPEX perspective on the R and D front, as Jim said, I mean, we’re focused on making those investments that drive the long term growth of the company. And when you look at our year over year R and D growth, you see that it increased 16%. So we’re definitely investing in R and D and those areas are very heavily and, and data center and communications 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 SGA 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 made improvement and 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 as a percentage of revenue and are driving toward that target. And then, you know, on the R and 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 the 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 investor investing in R and D but at the same time trying to get more efficiency and leverage out of sga. So that’s how you can kind of think about it going forward.

Karl Ackerman — Analyst, BNP Paribas Asset Management

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 semicap. Are you seeing a marked recovery across your broader Industrial business, excluding semicap or is it too early to call out definitively yet?

Jim Anderson — Chief Executive Officer

Yes, good question. I would say across broader industrials, probably too early to call out a broad based industrial recovery, but we’re certainly seeing 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. Semicap is a big segment for us and so a pickup in growth in orders there is meaningful for us.

Karl Ackerman — Analyst, BNP Paribas Asset Management

Thank you.

Unidentified Speaker

Thanks.

Operator

Our next question comes from Ryan Kunst with Nepom and company. Please proceed with your question.

Ryan Koontz — Analyst, Nepom And Company

Super, thank you. When you asked about the comms business, you highlighted multi rail, which I assume is kind of 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?

Jim Anderson — Chief Executive Officer

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 service providers, network operators to upgrade kind of 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 kind of the second half of this year. We’re seeing really good design wins and orders and un 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 9% sequential growth, but it was 44% year over year growth.

We expect that that segment of communications to be sequentially up in the March quarter and the June quarter just 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 a couple components as well. So things like pump lasers and other products like that. And we’ve seen strong demand across all those product categories.

Ryan Koontz — Analyst, Nepom And Company

Great. Just to follow if I could, maybe touching on the 3D sensing market, Jim, and transition to multi junction, how are we thinking about that transition relative to that part of the business?

Jim Anderson — Chief Executive Officer

Yeah, the 3D sensing. I would just reiterate what we said before that we won a 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 in the second half of this calendar year. It’s a great multi year partnership. We’re really happy with that.

It’s another example of a major customer leveraging our US Manufacturing footprint in Sherman, Texas. In the case of that business, that 6 inch gallium arsenide that’s been running in Sherman, Texas for quite a while. And 6 inch gallium arsenide VCSEL technology and yeah, big new partnership. We’re really happy about that. And revenue should kick in here in the second half of this calendar year. Appreciate that very much. Thanks. 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 Mondio. I’m from Vivek Aria. Thanks so much for taking our questions. To start, I just want to understand how much gross margin leverage is your 6 inch Indian false side ramp driving for you right now. And as you look out over the next couple of quarters, like what, 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.

Jim Anderson — Chief Executive Officer

Yeah, maybe I’ll start with the first part of the question on indium phosphide. And Sherry can answer the second part sort of on broader gross margin drivers. But I would say this quarter we’re starting to see the benefits of the 6 inch production this quarter because remember we started 6 inch production in the September quarter and it usually takes roughly six months from the start of wafer production to when the products get product put into a transceiver and actually shipped 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 6 inch, you can kind of think about it as that half of our internal 6 inch capacity is roughly half the cost of the other half. Right. Because six inch is 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 Sherry, do you want to talk about some more General gross margin drivers.

Sherri Luther — Chief Financial Officer

Sure, sure, Michael. So when you look ahead to our gross margin, whether it’s 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 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, you know, every quarter we’re seeing benefits from yield improvements.

And, and I’m really excited to continue to see that. There’s always going to be opportunity for that and so we’re going to keep driving that as well as the lower product input costs. 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 is going to be near term, some are going to be longer term term, just depending on the various initiatives.

So the magnitude of the benefit in any particular quarter will likely fluctuate just because of the nature of the projects. But the other benefit certainly will also be volume. As we ship higher volume, that will benefit us as well. And then mix, there can always be headwinds from mix on a quarterly basis. So that’s kind of the puts and takes within the gross margin.

Michael Mani

Great, thank you, Very helpful. And just my quick follow up as we are as the 1.6 gets underway. Understood that, you know, it’s mainly EML and CW lasers leading the way right now. But between the two, do you see a significant shift between Silicon Photonics and AML in terms of what that mix looks like for 1.60 especially. And as you look out over the next year, with CPO seemingly getting bigger as an opportunity, does that make you rethink Humpa? But how much CW laser capacity you would need understanding there’s plenty of flexibility to do both.

But just curious on that shift. Thank you.

Jim Anderson — Chief Executive Officer

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 just, we’re very well positioned competitively on both an EML based 1.6 C transceiver and silicon photonics. And then the second part of the question is, you know, we’re certainly ramping the NT phosphide capacity for the transceiver demand that we’re seeing, but we’re also on of top, 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. Thanks, Opera.

Operator

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

Jim Anderson — Chief Executive Officer

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 26 and very well positioned for an even stronger fiscal 27 given the exceptional demand we’re seeing and our rapidly expanding production 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.