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Earnings Call Analysis

Coherent's Q1 Highlights: Growth and Strategic Focus in AI and Telecom

In the first quarter, Coherent reported revenue of $1.35 billion, marking a 28% year-over-year increase and a 3% sequential growth. Notably, their Networking segment surged 61% year-over-year, driven by AI data centers. Gross margins improved to 37.7%, rising 293 basis points annually. The firm paid down $118 million in debt, reducing leverage to 2.4x. Looking ahead, revenue guidance for Q2 is between $1.33 billion and $1.41 billion, with expected gross margins of 36%-38%. Management emphasized ongoing improvements in operational efficiency and strategic investments focused on high-return projects.

A Promising Start to FY 2025

In the first quarter of fiscal year 2025, Coherent Corp reported a 28% increase in revenue year-over-year, reaching $1.35 billion. This growth was driven primarily by the company's datacom and telecom sectors, with datacom revenues alone soaring 89% year-over-year, reflecting growing demand from AI data centers. Sequentially, revenue increased by about 3%, illustrating a steady upward momentum as the company moves through the fiscal year.

Strong Demand in Datacom and Telecom Markets

The communications market experienced robust growth, with Q1 revenues up 68% year-over-year and 14% sequentially. This success was attributed to both datacom and telecom segments, with datacom revenues alone climbing 16% sequentially. Notably, the company's new 800-gig transceivers are gaining traction, and expectations for continued growth in this market are positive, with initial sales of 1.6T transceivers anticipated to ramp in calendar year 2025.

Margin Expansion and Operational Efficiency

Coherent achieved a non-GAAP gross margin of 37.7%, representing an improvement of 293 basis points year-over-year and 49 basis points sequentially. This growth can be attributed to higher revenue volumes, better product mix, and improved yields. The company's focus on optimizing gross margins aims for sustained levels above 40%, with operational efficiency initiatives in place, including pricing optimization and product cost reductions.

Strategic Focus on Core Business

Recently, Coherent's management initiated a strategic portfolio review, resulting in increased investment in high-growth areas like datacom technology while divesting non-core assets. This includes the recent sale of the Newton A-Cliff fabrication facility for $118 million, which was used to reduce the company's net debt leverage ratio to 2.4x. The emphasis is on enhancing focus and capital allocation towards growth drivers.

Future Outlook and Guidance

Looking ahead, Coherent is optimistic about its growth trajectory. For the upcoming second quarter of fiscal 2025, the company projects revenues between $1.33 billion and $1.41 billion, with gross margins expected to be in the range of 36% to 38%. Non-GAAP earnings per share are forecasted to be between $0.61 and $0.77. The leadership anticipates continued strong performance in their communications business, although there remains a cautious outlook on the broader telecom market recovery.

Increased Customer Engagement and Supply Chain Resiliency

Over the past months, Coherent's executives have intensified discussions with key customers, aiming for deeper, more strategic collaborations that emphasize long-term innovation. Furthermore, supply chain resilience has become a priority, ensuring that the company maintains a competitive edge in the market by minimizing disruptions.

Conclusion: Navigating Through Transition

As Coherent navigates through its operations in fiscal 2025, the focus on maintaining clear communication with investors and robust financial performance is paramount. The upcoming Investor Day scheduled for May 28 is expected to provide further insights into strategic priorities and growth opportunities, reassuring stakeholders about the company's long-term potential and commitment to profitability.

Earnings Call Transcript 2025-Q1

[Operator]

Good day, and thank you for standing by. Welcome to the Coherent Corp. FY '25 First Quarter Earnings Conference Call.

[Operator Instructions] Please be advised today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Paul Silverstein, Senior Vice President, Investor Relations and Corporate Communications. Please go ahead.

[Paul Silverstein, executive]

Thank you, operator. And good afternoon, everyone.

With me today are Jim Anderson, Coherent's CEO; and Sherri Luther, Coherent's CFO. During today's call, we will provide a financial and business review of the first quarter of fiscal 2025 and the business outlook for the second 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 second 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.

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 that can be found on the Investor Relations section of our website at coherent.com.

Let me now turn the call over to Jim Anderson, our CEO.

[James Anderson, executive]

Thank you, Paul. And thank you, everyone, for joining today's call.

I'd like to begin by welcoming Sherri Luther back to Coherent as our new CFO. Sherri and I previously worked together at Lattice Semiconductor for almost 6 years, where Sherri did an outstanding job as the CFO. Prior to Lattice, Sherri worked for 16 years in various finance roles at legacy Coherent before its acquisition. Sherri's proven track record as a CFO, combined with her long history with the company, has allowed her to hit the ground running; and we're very pleased to have her join our team. I also want to thank Rich Martucci for serving as our interim CFO prior to Sherri's arrival. Rich's leadership and dedication have been a tremendous help to me and the company. And I'm deeply grateful for his commitment and continued dedication to Coherent.

Now that Sherri is onboard, I'm pleased to announce that we'll host an Investor and Analyst Day in New York on May 28 of next year. At that event, we'll outline our overall strategy, including our end market growth opportunities, product and technology road map and long-term financial model. We look forward to the event and sharing more details about our plans to create value for our shareholders.

Before I discuss our first quarter results, I'd like to provide an update on the 3 key areas of improvement that I outlined at our last earnings call: culture, strategy and execution. I believe improvements in these 3 areas will transform our extensive innovative technology portfolio and our growing market opportunity into an engine of market-leading revenue growth, expanding profitability and industry-leading shareholder value creation.

First, regarding culture. I've now had the opportunity to visit more than 20 of our sites and meet with many of my teammates across the world. We have incredible depth and breadth of talent, and our employees' dedication is inspiring. My favorite part of our culture is our focus on innovation. And we will continue to nurture this fundamental part of our culture, yet as I noted last quarter, there is also opportunity to evolve our culture. We're building a faster and more agile company. We've already made numerous changes to simplify and strengthen our organizational structure, empower our leaders, streamline decision-making and accelerate execution. Cultural change always takes time, but I'm encouraged by our early progress in this area.

Second, regarding strategy. We completed the strategic portfolio review that we initiated in June. This portfolio assessment will be the foundation for making organic and inorganic investment decisions moving forward. We applied a set of strategic and financial criteria to sort each of our product lines into 1 of 4 categories: growth engines, profit engines, long-term bets and nonstrategic. We've now moved to the next phase, which is to drive actions based on the strategic assessment. For example, we've already shifted organic investment towards our growth and profit engines where we have conviction that we can drive strong long-term profit expansion for the company. For instance, we increased investment in new datacom platforms such as next-generation transceivers and our new optical circuit switch.

We've also started the process of divesting or shutting down product lines and assets that are nonstrategic. For example, we recently announced the planned sale of our Newton Aycliffe facility, which was an underutilized and nonstrategic asset. The proceeds from the sale of the facility were used to pay down our outstanding debt and reduce overhead costs. Another example is our recent announcement that we're exploring strategic options for our battery technology platform. Although our nonstrategic businesses represent a relatively small portion of our revenue, they're dilutive to the company's margin structure and absorb investment capital and focus that would be better deployed in our core businesses. As we optimize our portfolio over the coming quarters, we'll provide further updates, including at our upcoming Investor Day.

Finally, the third area of focus for improvement is execution. Last quarter, I underscored the opportunity to significantly improve operational efficiency and effectiveness. We're tackling the greatest opportunities upfront. For example, we've begun engaging our key customers and partners in a much more strategic manner. This approach has already uncovered new areas of long-term growth opportunity with our key customers and partners. Another example is our focus on gross margin expansion. We launched initiatives for pricing optimization and product cost reduction aimed at achieving our goal of operating at a consistent, sustainable gross margin level above 40%.

On operating expenses, we are shifting R&D investment to our growth and profit engines. And we are shutting down or divesting highly speculative projects that do not suit our long-term business model. Our go-forward R&D strategy will ensure that investments are focused, efficient; and offer high return. And on SG&A, we are focused on driving greater efficiency and leverage.

Evolving our culture, optimizing our strategic portfolio and improving our operational execution will put us on a path of sustained market-leading growth, enhanced profitability and cash generation and a stronger balance sheet. I look forward to sharing more details at our upcoming investor meeting.

I'll now switch gears and provide some brief comments on our fiscal first quarter results. Revenue in Q1 increased by approximately 3% sequentially and by 28% year-over-year, driven primarily by strong AI-related datacom transceiver revenue growth, along with improvements in our telecom revenue. Non-GAAP gross margin expanded by 49 basis points sequentially. And our non-GAAP EPS grew by 22% sequentially and by well over 4x year-over-year.

Let me summarize what we're seeing by our business by end market. In the communications market, Q1 revenue increased by 14% sequentially and by 68% year-over-year. The sequential and year-over-year increases were driven by strong increases in both our datacom and our telecom revenue. Our Q1 datacom revenue grew by approximately 16% sequentially and by 89% year-over-year due primarily to AI data center demand.

We're very pleased with the continued ramp of our 800-gig transceivers and the adoption of those products across a broader set of customers. We also continue to make great progress on our 1.6T transceivers. Having delivered initial samples in the preceding quarter, we continue to expect to begin ramping sales of 1.6T datacom transceivers in calendar 2025. We're also investing in a broad portfolio of transceiver ingredient technologies. That includes VCSELs, EMLs and silicon photonics.

The breadth of our extensive technology portfolio allows us to deploy the best technology solution for each customer and application. We showcased this capability at the European Conference on Optical Communications this past September, where we presented a multi-technology datacom transceiver demonstration at 200 gig per optical lane, based on both our differential EML and our silicon photonics platforms. We also continue to make great progress on key enabling components such as 200-gig differential EMLs, 200-gig VCSELs and CW lasers for our silicon photonics solutions. We also recently announced a family of high-efficiency lasers to power 1.6T optical transceivers based on silicon photonics.

Beyond transceivers, our new datacom optical switch platform continues to progress well and is generating significant customer engagement. Our differentiated switch is based on our highly reliable solid-state liquid crystal technology and was recognized at ECOC '24 with the best product award for data center innovation. We've shipped sample units to key strategic customers, and we expect to begin ramping revenue in calendar 2025.

Shifting to telecom. Our revenue increased by 9% sequentially and by 17% year-over-year. Although we continue to take a cautious view of the telecom end market recovery, the sequential revenue growth in Q1 was a combination of end market improvement along with our ramp of new products, especially our new 100ZR and 400-gig ZR/ZR+ Coherent transceivers. We're in qualification with our "high optical output power" C-band 800-gig ZR/ZR+ Coherent transceivers. And we recently announced an L-band version to double the capacity of existing fiber infrastructure.

In our remaining markets, which are primarily industrial-related applications, aggregate revenue decreased 10% sequentially and decreased 3% year-over-year. Within these markets, ongoing strength in display capital equipment was more than offset by weakness in precision manufacturing and other subsegments. Display strength is being driven by continued strong demand for our excimer lasers for OLED screen manufacturing, which is driven by increased OLED adoption in new laptop and tablet computers. We also booked initial revenue for our new PYTHON annealing lasers that are being deployed in Gen 8 OLED display fabs. Across other industrial-related end market subsegments such as precision manufacturing, we experienced demand headwinds in Q1 that were consistent with broader industry trends. Overall, despite some near-term headwinds, we expect the industrial market to be a long-term growth driver for the company as the end markets recover and as our new products continue to ramp.

In summary. After being onboard for 5 months, I'm even more enthusiastic about the opportunity to unlock significant shareholder value based on the depth and breadth of our technology innovation, the size of the market opportunities we address and the potential to improve our operational execution. We're expecting strong growth in our communications business over the coming quarters. And while some near-term softness persists in our other end markets, we continue to expect fiscal 2025 overall to be a solid growth year for the company.

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

[Sherri Luther, executive]

Thank you, Jim.

Let me begin by saying how excited I am to rejoin Coherent, a company with a rich culture of innovation. I want to express my appreciation for the warm welcome I received from my Coherent teammates. I also especially want to thank Rich Martucci, who has helped me to quickly come up to speed and ensure a smooth transition. As Jim noted, I spent 16 years at Coherent prior to its acquisition. What attracted me to rejoin Coherent was the opportunity to drive significant shareholder value expansion. The company has a solid foundation with its innovative technology and breadth of product portfolios.

I see the opportunity to improve profitability in a number of areas. For example, I see opportunity for gross margin expansion, greater operational efficiency in the R&D investments we make and opportunity for better SG&A efficiency. In addition, capital allocation is key because we need to ensure that we are investing in the product portfolios that drive the highest return for the company while also paying down debt to deleverage our balance sheet as quickly as possible. I look forward to sharing additional thoughts with you at our investor and analyst event in May.

Now let me provide a summary of our results. Overall in the first quarter, we drove continued sequential improvement in our financial results, with solid revenue growth and gross margin expansion driving strong profitability. With a strong focus on cash and capital allocation, we paid down $118 million of our debt, which reduced our net debt leverage ratio as defined in the credit agreement to 2.4x.

First quarter revenue was $1.35 billion, an increase of approximately 3% sequentially and 28% year-over-year. From a segment perspective, Networking revenue increased 12% sequentially and 61% year-over-year due to AI data center demand. Lasers segment revenue decreased 2% sequentially and increased 4% year-over-year, reflecting relatively stable end market demand. Materials segment revenue decreased 15% sequentially and 3% year-over-year primarily due to weak automotive end market demand.

Our first quarter non-GAAP gross margin was 37.7%, an increase of 49 basis points compared to the prior quarter and an increase of 293 basis points compared to the year ago quarter. The improvements in gross margin were driven by higher revenue volume, favorable mix and yield improvements.

First quarter non-GAAP operating expenses were $276 million compared to $266 million in the prior quarter and $234 million in the year ago quarter. The sequential and year-over-year increases were primarily driven by increased R&D investments in our product portfolio as well as variable compensation. Looking ahead, we plan to continue to be disciplined in managing our SG&A expenses while ensuring that we invest in our product portfolio.

Our first quarter non-GAAP operating margin was 17.3% compared to 17% in the prior quarter and 12.6% in the year ago quarter. First quarter non-GAAP tax rate was 20.3%, compared to 25.9% in the prior quarter, as a result of nonrecurring onetime items.

First quarter non-GAAP earnings per diluted share were $0.74 compared to $0.61 in the prior quarter and $0.16 in the year ago quarter.

We paid down $118 million in debt during the quarter, using cash from operations and the proceeds of the sale of our Newton Aycliffe fabrication facility, for incremental debt reduction.

I will now turn to our guidance for the second quarter of fiscal 2025. Revenue is expected to be between $1.33 billion and $1.41 billion. Non-GAAP gross margins is expected to be between 36% and 38%. Total operating expenses are expected to be between $275 million and $295 million on a non-GAAP basis. Tax rate for the quarter is expected to be between 19% and 22% on a non-GAAP basis. EPS is expected to be between $0.61 and $0.77 on a non-GAAP basis.

In summary. I'm very excited to return to Coherent. I see a bright future with significant opportunity to drive shareholder value expansion, transforming the company's strong foundation in technology and innovative products into a stronger operating model.

That concludes my formal comments. Operator, please open the call for Q&A.

[Operator]

[Operator Instructions] Our first question comes from Samik Chatterjee with JPMorgan.

[Samik Chatterjee, analyst]

Maybe if I can start with one for Jim. And then I have a quick follow-up. Jim, I think you mentioned it's been now 5 months since you've joined the company. What's been the feedback that you've received from key customers or partners that you've talked to in terms of areas to focus on, areas that they really think Coherent is good and -- or even areas they think Coherent can improve on? And then I have a quick follow-up.

[James Anderson, executive]

Yes. Thanks, Samik, for the question, yes. Great question. Always happy to talk about customers; definitely spent a lot of time with customers over the last 5 months, meeting as many as possible. I'd say that, first of all, I think we're -- we have a lot of really strong existing relationships with our big strategic customers across both our networking accounts and our big data center customers but also our industrial customers as well. And so in a lot of cases, there's a long history with these customers that's very strong and very positive. I think, when I talk to our customers, the opportunity that we have is to build relationships with those customers that are much more strategic, much more multigenerational long-term engagements to move from solving problems that are right here in the here and now to focusing on much more multigenerational innovation; and partnering with our customers on future generations that are 1, 2, 3 generations out. And so I think that's our opportunity, to drive a deeper strategic engagement with our key customers moving forward. And I think the -- a couple of things that I would say are really resonating with our customers when we have those longer-term strategic discussions is, I would say, number one, definitely the technology portfolio and road map that we can bring to those customers to help drive their innovation, but the second area I would highlight too is supply chain resiliency and the breadth and depth of our supply chain.

If I take -- if I just take for instance our AI -- our big AI data center customers as an example because that's where we're seeing the fastest growth in our revenue right now. On that first area of technology road map, I think our customers really recognize the breadth and the depth of the technology portfolio that we can bring to bear, especially in the optical networking space, where we don't just assemble the modules, but we build a lot of the ingredient components that go into the module, the lasers, whether they're pixels or EMLs or silicon photonics that we design; or a lot of the other ingredients that go into those modules. So the breadth of technology that we can bring for that multigenerational partnership, I think, is really unparalleled.

And then the second thing, which is definitely becoming more and more important to all of our big strategic customers, is supply chain resiliency. And there again I think we can bring a really differentiated supply chain where we have incredible geographic diversity in terms of our manufacturing footprint. And then our verticalized structure could be a real advantage, especially in a very fast-ramp situation, which we're in right now with our data center customers. When demand is increasing very quickly, it's really important to have that verticalized strategy and structure that we have because, I think, that's really allowed us to supply them in a really reliable way. And so a couple -- those are a couple of things that are really resonating with our customers, but I think that back to the high-level point would be our opportunity to really build much deeper strategic engagements with our partners moving forward. And I think our customers are definitely receptive to that, and that's definitely an area we'll be focused on moving forward.

[Samik Chatterjee, analyst]

Got it, got it. And for my follow-up, I'm just trying to think of the gross margin here; and what we should be tying it to, the improvement on the gross margins; and what we should be tying it to as we move through the year. You are sort of guiding to sequentially a bit better revenue at the midpoint. Should we be tying those improvements to revenue improvement through the year? Or should we be thinking about some of the pricing that you've talked about start to sort of accrete to that? I'm just trying to think about sort of the gross margin trajectory for the rest of the year. I'm not looking essentially for a guidance but more how to think about what drives it from here on.

[Sherri Luther, executive]

Yes. Samik, I'll take that question. So I'll start off with a little bit of context on Q1 and then talk about the guide for Q2 and then how we're thinking about it a little bit more long term. When you look at Q1, the 50 -- approximately 50 basis points sequential improvement, we're really pleased with that; and 290 basis points year-over-year improvement. That really came from a few different areas. One was, of course, higher revenue volume contributed. We also had favorable product mix. An example of where we saw that was in our Lasers segment, where we saw continued strong demand for our excimer lasers for OLED screen manufacturing. We also had improvement in yield. And we saw that in our datacom business, where we saw improvements in our -- the transceivers part of that business, so really a few different areas that drove the sequential and year-over-year improvement there.

When we look at Q2, the guide for Q2. That is just -- that is a range, right? 36% to 38% is a range. And there can certainly be fluctuations on a quarterly basis with respect to gross margin, but we did talk about -- last quarter, Jim mentioned that we launched our gross margin expansion strategy, which includes [ product ] pricing optimization as well as product cost reduction. And so that's an area where we're going to focus on because we want to achieve a long-term gross margin of greater than 40%. And so that's really how to think about where our -- what our goal is for our long-term gross margin. And we're in the very early stages of that, certainly, but you can be -- rest assured that we're focused on really driving to that greater than 40% target. And when we get to our Investor Day in May of next year, we'll certainly give more color on the [ model and ] all the different elements of that.

[Operator]

Our next question comes from Simon Leopold with Raymond James.

[Simon Leopold, analyst]

I've got maybe 2. One is more thematic, the other more reflective. The first one is I'd like to really see if we can get some thoughts, particularly from Sherri, regarding priorities for the capital structure, right, and really just sort of weighing the options of delevering, investing in OpEx, maybe making acquisitions. How are you thinking about these?

And my follow-up is in terms of the strength of the datacom business. I know, previously, management had talked about the products below 800 gig, basically 400 gig and below, being relatively flattish for the year. And I guess what I'm trying to understand is where was the really upside surprise this quarter. Was it really 800 gig and above? Or was there more strength from the more traditional products below -- 400 gig and below. Did that provide any upside, or was it all coming from the higher performance?

[Sherri Luther, executive]

Thank you, Simon. I'll take the first part of the question, on capital allocation. And I'll take -- let Jim take the second part of that. So from a capital allocation perspective, certainly lots of opportunity that I see in this area, in joining the company. And really the #1 priority is in the organic growth of the company and making those investments that drive the highest ROI. Jim mentioned the strategic portfolio review that was undertaken. That was completed. And we're really in the next phase there where we're shifting our R&D spend toward those programs that drive the highest ROI for the company in order to drive the long-term growth. So that's the #1 priority.

The second priority. And it's a very close second priority. And that is in reducing our debt to deleverage the balance sheet -- and really overall strength in the balance sheet. This also serves to reduce the debt service costs that hit our P&L as well. In Q1 '25, we paid down $118 million to reduce our debt and brought our debt leverage ratio down to 2.4x as defined in the credit agreement, so we're pleased with the sequential progress there, but in order to pay that down, we did use cash from operations but -- and took an incremental -- or a component of that payment was -- paydown was coming from the proceeds of the sale of our Newton Aycliffe facility, fabrication facility, that we sold off during the quarter. And so the sale of that facility really gave us the opportunity to pay down additional debt to further deleverage. And so I certainly have a history of aggressively paying down debt. And that's something that's going to continue to be a focus area for me and a very close second priority.

[James Anderson, executive]

And Simon, on the second part of your question, around the datacom business. So first of all, yes, we're really pleased with the performance of that part of our business. Just to reiterate: The datacom transceiver business was up 16% sequentially. And it was up 89% year-over-year. And you're right. We did see growth as well in -- from a sequential basis in the 400-gig and below transceiver speeds. We did see sequential growth there that was very nice to see. When you look across the customer base, customers at -- are at different stages of adopting the different transceiver speeds, so we still have customers that are doing significant volume on 400G and below as well. And so it's really a mix of different transceiver speeds.

And then back on 800 gig, I would say look. We're really pleased with the ramp, the overall ramp, of our 800-gig transceivers. And then the other color I would add is that one of the things I'm really pleased to see is the breadth of customers that we have. The number of customers that are ramping 800 gig has significantly increased. If I look, like, a year ago, it was only maybe a couple customers. Now we have many customers ramping 800 gig, so there's a much bigger diversity of revenue streams underneath that 800 gig ramp. And we do expect 800 gig to continue to grow over the coming quarters as well.

[Operator]

Our next question comes from Thomas O'Malley with Barclays.

[Thomas O'Malley, analyst]

Welcome, Sherri. It's great to have you. I just wanted to ask broadly into the out-year. You guys have talked about some strategic alternatives that you guys are taking. You've reviewed the business. You've kind of said the review has concluded. You talked about the sale of a facility. You paid down some debt. And then you pointed out specifically the battery business, but I was curious. Is that all that you identified as nonstrategic? Could there be additional sales on the way? And just any color you'd give. I honestly understand that there's an Analyst Day coming up, but is your intent to give more there, or is that kind of the extent of the nonstrategic thus far?

[James Anderson, executive]

Yes, thanks, Thomas, for the question. No. There are definitely other things that we're working on in the category of nonstrategic. So as we said, we completed that portfolio assessment. It could -- wrapped up pretty much at the end of August. And then we've since moved into execution mode, and there's a number of different things that we're looking at. And just the 2 examples that I gave in the prepared remarks were, from an asset standpoint, the sale of the Newton Aycliffe facility; and then from a product line standpoint, that battery technology platform, but there definitely are other things that we're working on within that nonstrategic category. We'll certainly share that with investors as -- at the right time. It's a little premature to share some of that, but we will definitely share that at the right time. And then certainly we'll give a better picture at the Investor Day as well, but even between now and the Investor Day, we'll share any key milestones along the way. And then I just want to reiterate what I said in the prepared remarks, that -- even though the overall nonstrategic category is a relatively small part of our revenue, again, it is dilutive to our operating margins. And more importantly, it draws away capital and focus from the management teams. We are anxious to execute quickly on that to improve focus, to improve where our assets and where our investments are focused.

And then just -- beyond just the nonstrategic category, in our other categories of, for instance, key growth drivers and key profit drivers, that's a place where we've been adding investments. And so we've been shifting investment away from the nonstrategic areas, into the fast-growing areas. And best example of that is the data center AI transceiver growth, so we have increased R&D investment in new technology platforms for datacom transceivers. So these are new future technology platforms that we're really excited about. As well as the other example I would give would be the optical circuit [ switching ], which we're excited about as well. So we're also shifting organic investment towards those high-growth, high-profitability categories as well. So that's certainly already happened or in process as well.

[Thomas O'Malley, analyst]

Helpful, Jim. And then the second I had is on 1.6T. I think you mentioned calendar year '25 as a ramp for those transceivers, but do you think that you'll have -- this is a multi-parter here, so forgive me. Do you think that you'll have any contribution from 1.6T in the fourth calendar quarter of this year? Or are you going to see any this year? And then when do you see the volume ramp of 1.6T coming? We've heard from others in the space that there are constraints on the laser sides, on the DSP side. Are you seeing any of those constraints? And then if you think that the world is kind of ramping on 1.6T, do you guys see kind of more of a silicon photonics world or an EML world as that 1.6T ramps? Sorry for the multi-parter, but I appreciate it.

[James Anderson, executive]

Okay, thanks. [ Thomas, you're right ]. That was multi-parter. I'll do my best to get to all of that. So at this point, what we're saying is we'll ramp within calendar '25. Certainly we're focused, along with our customer, on getting our solution into production as quickly as possible. To the -- so to the extent that we can ramp sooner, we'll certainly execute as fast as we can. I think I was really pleased that the team delivered samples last quarter. We're working very tightly with our customers, now our lead customers, to get that into production as quickly as possible and -- but for now I think I'll leave the expectation at calendar '25. And as we get close to that revenue ramp, we will certainly share more details about when exactly we expect that ramp and the contribution.

And then with respect to the specific technology that we're using, what I would say is I think one of our real strengths and something that really differentiates us as a technology -- as an optical networking technology provider is the breadth of technology that we can bring to bear, right? We look at it as we'll deploy whatever the best technology is for the benefit of the customer and the application that we're trying to drive. So whether that's an EML, a VCSEL or silicon photonics, we're developing all of those different options. And we'll deploy whatever technology is strongest to create the biggest differentiation for our products and the biggest benefit for our customers. So that's kind of the approach that we take to the technology. And I think we've got the broadest set of technology options of certainly any of our peers and competitors, so I think that's a real competitive strength for us.

[Operator]

Our next question comes from Meta Marshall with Morgan Stanley.

[Meta Marshall, analyst]

Great. Maybe a couple of questions for me. You mentioned some strength out of telecom in the quarter. I just wondered, is that more Asia-based or U.S.-based? And then as a second question: You had mentioned kind of some increase in yields for reason for upside on gross margins in the quarter. I wanted to get a sense of is that some of the kind of tailwinds from some of the yield disruptions we saw in fiscal Q3 earlier this year. Or is that just kind of additional improvements you guys have made to the business?

[James Anderson, executive]

Yes, thanks, Meta. First, on the first part of the question, around telecom strength. So yes, telecom was a bit stronger than we had originally forecasted. Really pleased to see that. It was -- first of all, just to reiterate, it was a combination of 2 things. We saw end market improvement, but it was also due to some of the new products that we have ramping in telecom. And specifically on those new products, and I talked about this at last quarter's earnings, the 100ZR and the 400-gig ZR/ZR+ that we have begun ramping, we continue to see good ramp in contribution from those products. And so that certainly benefited us, but we did see some improvement in the end market, specifically around DCI, data center interconnect, but also, even in the traditional transport area, the traditional telecom transport area, we did see some strengthening there. We are still taking kind of a cautious view and cautious outlook on telecom recovery overall, but it was nice to see some good end market demand signals and strength in Q1. And then with respect to Asia versus -- I think you asked a question about Asia versus U.S. I'm actually not sure which market in particular. I believe we saw some improvement across both of those markets.

And then on the second part of your question, on yield increase, yes. So as Sherri mentioned, in the Q1 -- sequential improvement from Q4 to Q1, there were 3 different factors. She highlighted yield being one of those. Yes, I wouldn't really characterize it as a tailwind. I would characterize it as new yield improvements. And this is actually something that I highlighted last earnings call. When I talked about the gross margin improvement initiative that we were putting in place, I said there was 2 components of it. There was a pricing component of it, but there's also a big focus on product costs. And I mentioned yields as one of the key areas we've been focusing on. And the team has definitely been focused on that over the past few months.

In fact, some real-time information. Sherri and I were actually sitting in a review with a team this morning, the datacom transceiver team with -- this morning. And we were reviewing yields and really pleased with the progress that, that team has made on yield improvements over the past few months and really pleased with the plan that they're showing moving forward. Now we're still in the early stages of the gross margin improvement strategy and we have a lot more work in front of us, but I want to say thanks to the team for the initial work, good work, that they've done; and for the plan that they have moving forward. So yes, yields will continue to be a key area of focus for us.

[Operator]

Our next question comes from Karl Ackerman with BNP Paribas.

[Karl Ackerman, analyst]

Jim, I was hoping you could discuss whether you are seeing data center customers reallocating procurement of optical transceivers to U.S.-domiciled suppliers like Coherent. And then second, are you able to quantify your expanding TAM opportunity as AI clusters now have the option of being disaggregated into white box components that seem to benefit yourselves?

[James Anderson, executive]

Thanks, Karl. 2 really good questions. On the first one, on data center customers. And I touched on this briefly, I -- in, I think, one of the earlier questions, but one of the things that's very important to data center customers is supply chain resiliency. And I would -- and the 2 things that we always talk about is, of course, number one, the technology road map that we have and the breadth and the depth of the technology and the innovation we can bring, but the other big part of the discussion is around supply chain resiliency. And this is something that I think customers are really -- this is becoming more and more important to customers, but they're also really appreciating the differentiation and the value that Coherent brings in terms of supply chain resiliency. Because there's really 2 components of our resiliency. Number one is we have tremendous geographic diversity in our production platforms and where our devices and modules are built and assembled. And so that geographic diversity, I think, is a big benefit to our customers.

And then the second piece is around the verticalization. So we don't just assemble the transceiver, for example. We manufacture a number of the key components that go into that transceiver. So whether that's a VCSEL laser or an EML or that's isolator or even the garnet material that goes into the isolator that goes into the transceiver, a lot of that, we do ourselves. We do leverage outside suppliers sometimes as well if it's to our benefit, but that verticalization is also the second piece that gives us, again, that really strong supply chain resiliency. And I think that is definitely recognized by our data center customers and becoming a more important factor moving forward.

And then on the second part of your question, around expanding TAM. Yes, that's a great question. I would say definitely the TAM is expanding for us, for the reasons that you noted. I don't have a good quantification of that today, but I think we will definitely talk about that in the context of our Investor Day in May when we share the full breadth of the market opportunity in front of us. And we'll certainly talk about the data center transceiver opportunity, and we'll talk about that expanding TAM at that time.

[Operator]

Our next question comes from Ruben Roy with Stifel.

[Ruben Roy, analyst]

Jim, I actually had a similar question to the last one. And you started talking a little bit about some of the components that go into transceivers. I was wondering if -- last quarter, you talked about build versus buy. And earlier this year, the company talked about expansion of the 6-inch wafer fab, [ inphi ] fab. I'm wondering if that's an area that you could maybe accelerate. And if so, how are you thinking about sort of build versus buy and kind of insourcing some of these components, certainly on the EML side, as we're hearing about constraints, et cetera as you think about '25 and '26?

[James Anderson, executive]

Yes. Thanks, Ruben. So first of all, our philosophy in general -- let me start with what is our general philosophy on build versus buy or develop ourselves versus leverage the outside ecosystem. What we want to always be doing is applying our R&D dollars to the areas that we can truly differentiate, right? So if we believe that we can create true differentiation for our customers that benefits our customers and do something that's not available in the rest of the market, then that's a good use of our R&D dollars. And that can benefit our customers both in terms of the technology advantage or maybe the cost structure advantage, so to the extent that we drive true differentiation, we'll do that. And if we can't, then we should be leveraging the outside solutions, right? So if we can't generate some real advantage for our customers, then we should be leveraging the ecosystem. And I think that same philosophy applies to our supply chain as well, is if we can generate an advantage for our customers, that may be technical or cost structure advantage or supply chain resiliency advantage, then we should do that, right? But if they're -- if we can't generate a genuine advantage, then we should be leveraging the outside ecosystem.

And so there are times when we choose to verticalize and build those components ourselves. And there are other times where we choose to leverage outside suppliers. And I think we're -- moving forward, we're going to be much more strategic and deliberate about that than maybe we have been in the past and -- but that's our general philosophy.

[Ruben Roy, analyst]

Very helpful. And just a quick follow-up. I might have missed this, but on the telecom commentary, last quarter, you had a little bit more of a muted outlook on telco; nice surprise here to the upside. Was that mostly driven by DCI? Or were some of the traditional telecom products also a little bit better than you had thought?

[James Anderson, executive]

Yes, thanks, Ruben. It was a combination of both, yes. The end market was a bit stronger, and that was a combination of DCI but also traditional telecom transport as well. We saw an uptick in end market demand there too. And as I mentioned earlier, we're still taking a cautious approach to the telecom market. I'd like to see a couple more quarters of improvement before we're positive that the market is fully recovering, right? But some good, positive signs, so far.

[Operator]

Next question comes from Christopher Rolland with Susquehanna.

[Christopher Rolland, analyst]

And I guess, firstly, welcome, and also welcome back Sherri. My question, I guess, first is a follow-up to Ruben for EMLs. Are you guys going to be commercially shipping your own EMLs into either 800 and 1.6 next year? And additionally, are you concerned at all about data center capacity constraints for you guys into what could be a pretty robust 2025. And this is either for transceiver assembly or light source.

[James Anderson, executive]

Yes. Thanks, Chris. So on the first part of the question on EML usage in 800 gig and [indiscernible] on EMLs, I'll just start by saying we use a combination of our own internally developed and produced EMLs as well as we do leverage EMLs for very good partners as well. And so again, back to that prior question on kind of philosophy, where we think there's benefit for our customers, we will do that internally, but where we can leverage the outside ecosystem, we'll also do that. And so I would anticipate us continuing to do that in -- whether it's 800 gig or 10 us continuing to leverage both internal as well as external sources.

And then I also want to reiterate the fact that we take a multi-technology approach, right? So not just EML, but to the extent we can leverage VCSEL or a silicon photonic solution, we'll do that as well, right? So again, we'll take whatever is whatever we believe is the best technology path for our customers that gives the greatest benefit. And I think that's one of the benefits we bring to our customers is -- our expertise is really at a deeper level of being able to manipulate photons for the benefit of data transmission, and we look at whether TML VCSEL or silicon photonics is, that's just a method by which we bring our innovation around using photons to transmit data.

And then on the second part of your question on, I think it was, Chris, around capacity constraints as we see -- as we continue to ramp in data center AI. I would say that first of all, I would say that I want to take the opportunity to thank my production and engineering, manufacturing teams. We're doing a great job of supporting the ramp of our data center AI business. They've really done an outstanding job making sure that we deliver for our customers. And that's not to say that we don't have a strain here or there. But I think overall, we've done a really outstanding job meeting the demand needs of our customers. And that's certainly our focus moving forward. We're certainly increasingly ramping up our capacity internally, whether that's for transceiver assembly or whether that's for the the individual ingredients that go into that transceiver isolators, VCSELs, EMLs, whatever, right? So we're ramping up our capacity. And certainly, our goal to make sure that we've got the right capacity for the demand that we're seeing from our customers.

[Christopher Rolland, analyst]

Excellent. And then perhaps a follow-up, Jim. Now that you've had some time to kind of look under the hood, some of the pushback that I get is around margin expansion opportunities in data center, particularly on the transceiver your old Finisar business as you look to your path for greater than 40% total company GMs. And what I'm getting at here is there seems to be a balance here between upside from surging units obviously driven by AI versus what I think are fairly aggressive capacity expansion plans for guys, particularly out of Asia, but in the science, but you've Cloud light, you have some other transceiver guys here as well. So when you balance those together, do you think there is sizable room here to expand margins on the transceiver side, which is a big chunk of your datacom business?

[Richard Shannon, analyst]

Yes. Thanks, Chris. Let me start at the company level, and then I'm going to come back to a data center seventh fits in. The short answer on data center transceivers is yes. its product cost, but I want to paint company picture first, right? So at a company level, we're going to march towards that 40% gross margin goal. And I think there's two -- like we talked about, there's two big initiatives: one around pricing and one around product cost. I think the pricing optimization that we can do probably applies more to our industrial businesses. So we have many different product lines and many different industrial submarkets underneath the umbrella of the industrial business. And I do see time opportunity to do a much better job of optimizing the pricing of those products and capturing what I would say -- what I would call is the fair value for the technology and the innovation that we're bringing to those industrial markets.

Now on pricing in the datacom transceiver space, there, I think there's -- I would say there's not as much opportunity on the pricing side. But what I would say is -- but there's definitely opportunity on the product cost side. And that's one of the examples I gave earlier on the call is on product cost within transceivers and I highlighted, I believe this on the last earnings call, yields is definitely an opportunity. And Sherri and I, as I said earlier, we're in an operational review this morning, spending time talking to the team about yields, the improvements that they've driven over the past few months and what we need to see in terms of yield improvements moving forward as well.

And that is definitely an area of focus for us. So I would -- back to your datacom transceiver question in particular, I would say, maybe not so much on pricing, but definitely, there's opportunity for us in cost and we're certainly very focused on that.

[Operator]

next question comes from Jack Egan with Charter Equity Research.

[Jack Egan, analyst]

So I didn't hear or see anything about segment operating margins, but through June, the networking segment had been kind of range bound in the mid-teens despite being at record revenue. So I was just wondering, are you seeing the margin benefit from a higher mix of 800 gig transceivers today? And if not, just when exactly does that impact kind of kick in?

[James Anderson, executive]

Yes, Jack, maybe I'll start with that question. Sherri wants to add anything, she's welcome to add. What I would say is, yes, if you look at historically with -- it sounded like your question was focused on the data center or communications segment, which is mostly a networking, which is mostly data center AI data center. If you look historically at when we move to new technology nodes, yes, you're right, the newer speed grades for the transceiver are generally higher margin. And so to the extent that we're ramping quickly ramping a higher speed, more advanced transceiver that's usually at a higher gross margin. So yes, the general rule would be as we ramp those higher speeds, we would expect to see margin improvement on that.

[Sherri Luther, executive]

Yes, I'll just add that if you look into our Q, you'll see, Jack, that we do show a segment profit and on the networking side of the business, we did see higher segment profit sequentially. So you will see that in there when you dig in.

[Jack Egan, analyst]

Okay. Great. I appreciate that. And then my follow-up is a bit of a kind of a higher-level question. So it was good to see a rebound in telecom, but we've seen this prolonged slowdown in that market after the carrier spend quite a bit on 5G spectrum license as a first, but -- and then obviously, on the 5G equipment build out itself. But when you look at some of the commentary kind of across the telecom supply chain, it's been pretty difficult to monetize 5G. So the carriers might not have much incentive to keep spending and adding new capabilities.

So that being said, I'm just kind of curious on your long-term growth outlook for telecom and whether it may be challenged in the long term just because those newer, more advanced generations like 5G advance or 60 are just difficult to monetize.

[James Anderson, executive]

Yes. Thanks, Jack, and that's a great point, and that's exactly why we're taking here in the more near-term quarters, we're taking a more cautious view on telecom, right? That's why last quarter, I said we're taking a cautious view and the same applies to this quarter as well as until we see a dramatic pickup in telecom operator CapEx, I think that market may be challenged in terms of recovery. Now, that said, we did see in Q1 some strong positive signs, as I said earlier. And I think the clear area of growth is around data center interconnect. We are definitely seeing strong demand signals in DCI, right? And obviously, that's only a portion of the telecom market but we are seeing very strong demand signals there.

And then as I mentioned before, we did see a little bit of recovery in telecom -- traditional telecom transport as well. But we agree in the nearer term, we're definitely taking a more cautious view of the telecom recovery. Now over the long term, we still do believe that telecom over the long term will continue to grow, and we believe that's a great growth area for the company. We've got a lot of new products that are ramping in that segment. And then we'll paint a more complete picture of what we see as a long-term opportunity as part of our Investor Day in May.

[Operator]

Next question comes from Richard Shannon with Craig-Hallum Capital Group.

[Richard Shannon, analyst]

Allow me to ask a couple of questions here. Jim, I guess maybe a quick 2-parter related to datacom here. When I look at 1.6, how are you thinking about the coherent time to market relative to your competitors? And do you also expect to ramp at a breadth of customer base more like what you have now in 800 gig or kind of what you saw in the earlier stages of 800-gig as you just noted today, the customer base has expanded nicely here over this period.

[James Anderson, executive]

Yes. Thanks, Richard. The first one, we delivered -- just reiterate what I said earlier, we delivered samples last quarter, we're working really carefully with our customers to get that into production as quick as possible. And at this point, we expect revenue to begin to ramp in calendar '25. As we get closer to that ramp will certainly share more specifics around that. And clearly, we're motivated to get that into production as quick as possible on our side. And then in terms of the second part of the question on breadth of customer base, I think it would be similar to the breadth of customers that we saw at the beginning of the 800 gig ramp might be could be a little bit different, but it will be kind of a similar magnitude in terms of number of customers.

[Richard Shannon, analyst]

Okay. Fair enough for that, Jim. My quick follow-on question here is just following up in the last couple of recent questions related to your telecom business. You just noted in response to the last one here about seeing really nice growth in DCI versus traditional telecom transport. Any way you can give us a sense of how big each of those buckets are? I know it's not easy to necessarily know where it goes, but is the DCI relatively close to traditional telecom or a small portion? Or just help us out a little bit there, please?

[James Anderson, executive]

Yes. We don't really break out to that level of level granularity. But DCI was a smaller portion, but is a rapidly growing portion of that revenue base, right? And so we do expect to become a bigger component of that overall telecom TAM as well as our revenue base over the coming quarters. It's certainly faster growing than kind of the rest of that part of the market.

[Operator]

Thank you. Ladies and gentlemen, this does conclude today's question-and-answer session. I'd like to turn the call back over to Jim Anderson for any closing remarks.

[James Anderson, executive]

Thank you, everyone, for joining us on our call today. I want to once again thank Sherry, for joining the team as well. It's good to have her at the table here with me again. And just in closing, I want to thank all my coherent teammates for all their hard work and dedication and really proud of them and proud to be on the same team as them. And we thank you for all of your support and look forward to updating you on our progress. And operator, that concludes today's call.

[Operator]

Thank you. Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.