Coherent Corp. (COHR) Earnings Call Transcript & Summary

Greetings, and welcome to the Coherent Corp. First Quarter Fiscal Year 2027 Earnings Webcast. [Operator Instructions] Please note this event is being recorded. It is now my pleasure to introduce your host, Mr. Paul Silverstein, Senior Vice President of Investor Relations for Coherent. Please go ahead.

Thank you, operator, and good afternoon, everyone. With me today are Jim Anderson, Coherent CEO; and Sherri Luther, Coherent CFO. During today's call, we will provide a financial and business review of the first quarter of fiscal 2027 and the business outlook for the second quarter of fiscal 2027. Our earnings press release can be found in the Investor Relations section of our company website at coherent.com. I would like to remind everyone that during our conference call, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, November 4, 2026, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. During this call, we will discuss non-GAAP financial measures. You can find 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 at coherent.com. Let me now turn the call over to our CEO, Jim Anderson.

Thank you, Paul, and thank you, everyone, for joining today's call. Q1 marked a strong start to fiscal 2027. Revenue increased 16% sequentially and 56% year-over-year on a pro forma basis. Non-GAAP EPS increased 80% year-over-year, reflecting continued gross margin expansion and operating leverage. Strong customer demand and our rapid capacity expansion are supporting this growth with near-term bookings and newly signed LTAs providing multiyear visibility. We remain on track to achieve our first $3 billion revenue quarter by the end of fiscal '27. We expect the full year pro forma revenue growth rate to exceed 60%, more than double our fiscal '26 pro forma growth rate. We also have a clear line of sight to our first $4 billion revenue quarter in fiscal '28. Coherent is a photonics platform company, bringing together technologies across the optical signal chain for materials and components through subsystems and complete solutions. Our breadth position us to support customers across data center and communications networks. We're at the center of an extraordinary expansion in optical networking infrastructure driven by rapid AI growth, the transition from copper to optical connectivity and rising demand for bandwidth and energy efficiency across increasingly large and complex data center architectures. Our established businesses continued to grow rapidly, with data center revenue up 85% year-over-year in Q1. At the same time, new growth areas are ramping as well. First ample scale data center interconnect revenue is growing rapidly with Q1 revenue roughly quadrupling year-over-year and reaching a nearly $1 billion annualized revenue run rate. In addition, PhotonLink, our newly announced integrated optics platform is also beginning to ramp, and we expect PhotonLink revenue to exceed $100 million in our March quarter. Accelerating revenue growth, continued gross margin expansion and operating leverage position us to grow profitability faster than revenue. We expect fiscal '27 to be an exceptional year for coherent. Moving to our data center and communications segment. Revenue increased 21% sequentially and 79% year-over-year, marking a fourth consecutive quarter of accelerating growth on both a sequential and year-over-year basis. The segment now accounts for 82% of Coherent's total revenue. Near-term demand remains strong and our visibility into long-term demand continues to improve. Order coverage through calendar '27 is exceptional, and customer orders increasingly extend into calendar '28. We signed multiple new LTAs in Q1, and customer LTAs typically extend through the end of the decade. We continue to see no signs of attenuation in demand. Within the segment, data center revenue increased 17% sequentially and 85% year-over-year, marking our fourth consecutive quarter of double-digit sequential growth. We expect another quarter of strong sequential and year-over-year growth in the current quarter. In data center transceivers, we're ramping 1.60 products with multiple customers, while continuing to grow 800-gig revenue. We expect strong transceiver revenue growth in Q2, driven by both 1.60 and 800 gig. We expect 1.60 revenue to continue ramping rapidly over the coming quarters, while 800-gig revenue continues to grow through calendar '27. At ECOC in September, we demonstrated our progress beyond 1.60 with a 3.2T OSFP pluggable transceiver built with our 400-gig differential EMLs and photodiodes. We expect plug gold transceivers to remain the dominant form factor for scale-out networks over the coming years. Coherent is helping shape the industry ecosystem for emerging formats, demonstrating XPO at OFC and also supporting the new USFB form factor. Turning to OCS. Customer engagement is broadening across scale across scale out and scale up networks. Spanning our 320x320 platform and denser configurations. We're expanding production at 2 sites to meet demand. As capacity ramps, we expect OCS to become an increasingly meaningful contributor to revenue growth and margin expansion. At ECOC in September, we launched PhotonLink, our new platform for integrated optics. It's designed to address the transition from copper to optical connectivity in AI data centers, creating a significant opportunity for coherent. We estimate that CPO NPO and chip-to-chip optical interconnects represents approximately $30 billion of market opportunity by 2030, bringing our total market opportunity for data center and communications to about $90 billion in 2030. PhotonLink brings together Coherent's photonic technologies and manufacturing capabilities in an end-to-end platform that spans the optical signal chain from generating and shaping light through transmission and detection to converting the signal to electrical form. The platform is designed for a wide range of architectures and applications, including CPO and NPO, scale out and scale up networks and scale in chip-to-chip links. It includes lasers, laser modules, complex fiber assemblies and other optical components and supports indium phosphide-based CW lasers and VCSEL-based technologies. We believe this breadth and depth differentiates us. For an SPU or switch chip with 100 terabits per second to bandwidth, we estimate our content opportunity can reach approximately $15,000 per chip. Customer engagement is validating the opportunity. In Q1, we signed another significant PhotonLink LTA with a major AI company. The total revenue value of this new LTA is approximately $20 billion over 5 years, with revenue beginning to ramp in early calendar '28. This is in addition to our previously announced LTA with NVIDIA. Beyond these 2 anchor customers, we have more than 10 additional CPO engagements, more than 10 NPO engagements and more than 5 chip-to-chip engagements. We expect PhotonLink revenue to ramp quickly over the coming quarters. We expect revenue to exceed $100 million in our March quarter and to exceed $250 million per quarter before the end of calendar '27. Expected shipments in the current quarter include a range of CPO products, including our ultra-high power 400-milliwatt CW laser, our fiber assembly solutions and other products. PhotonLink is initially being deployed in CPO scale-out applications. We expect to begin shipping PhotonLink products for CPO and NPO scale-up applications in the second half of calendar '27. Over time, we expect PhotonLink to become a multibillion-dollar product line for coherent. Expanding our indium phosphide capacity is a key enabler of growth in both indium phosphide pluggable transceivers in indium phosphide enabled Photon link solutions. Our 6 indium phosphide expansion is progressing well. We doubled our internal indium phosphide output capacity year-over-year in Q1, 1 quarter ahead of our original plan. Q1 was our highest production quarter ever for EMLs, including both 100-gig and 200-gig devices. The ramp contributed meaningfully to data center growth, and we expect it to remain an important driver of revenue and gross margin. Most of the gross margin benefit of our indium phosphide expansion is still ahead of us as the expansion will enable us to increase our mix of internally sourced indium phosphide components, which have a tremendous cost advantage. We remain on track to more than double our internal indium phosphide output capacity again by the end of calendar '27. We've secured the substrates and other critical inputs needed to support this ramp. And given the strength of customer demand are planning additional capacity expansion beyond 2027. Our 6-inch lines in Texas and Sweden are producing EMLs, CW lasers and high-speed photodiodes with yields that continue to exceed those of our 3-inch lines. Production includes our 400-milliwatt CW laser for CPO, which is covered by our NVIDIA partnership and is expected to begin generating revenue this quarter. We also remain on track to begin 6-inch indium phosphide production in Zurich in the first half of calendar '27, further extending what we believe is a meaningful manufacturing advantage. Moving to communications. Revenue increased 34% sequentially and 84% year-over-year, and we expect another quarter of strong sequential and year-over-year growth in the current quarter. Traditional telecom continued to grow, but the primary growth driver was scale across, which has quickly become the largest source of revenue within communications. Over the past year, we've expanded our data center interconnect portfolio to help customers connect data centers with greater capacity and efficiency. Building on our leadership in pump lasers and our broad component portfolio, we've introduced higher level products, including modules, line cards, subsystems and our new multi-rail solution. These offerings are seeing strong customer demand and help customers make better use of existing fiber while scaling high-capacity links between distributed AI data centers. In Q1, scale across revenue exceeded $200 million, up 53% sequentially and nearly fourfold year-over-year. That puts the business at a nearly $1 billion annualized revenue run rate making it one of our fastest-growing businesses. With multirail beginning to ramp in our March quarter, we expect quarterly scale cost revenue to roughly double from the Q1 level by the end of calendar '27. Turning to Industrial. Q1 revenue was flat sequentially and year-over-year on a pro forma basis. Bookings were strong, led by semiconductor capital equipment customers, and we expect growth to resume in the current quarter. Near-term growth is being driven by semiconductor capital equipment, AI infrastructure, and fusion energy. In semiconductor equipment, our lasers, Precision Optics and Engineered Materials serve front-end applications and we've seen a strong uptick in bookings. In AI infrastructure, our CO2 lasers and zinc selenide optics are used to drill advanced circuit boards for AI servers. Demand is also growing for our pulsed laser deposition systems used to produce high-temperature superconductor tape for magnetic fusion. Over the longer term, we see significant opportunities in data center XPU, cooling and quantum technologies. For AI data centers, our Thermodite material can enable higher XPU performance and token generation. We're shipping prototypes to several strategic customers this quarter, and we expect revenue to begin ramping in the second half of calendar '27. In Quantum, we supply lasers and materials to leading quantum technology developers and are engaged in next-generation programs. Given the multiple growth areas, we expect our Industrial segment to return to growth and build momentum over the coming quarters. In summary, Q1 demonstrated the strength of our growth momentum and the breadth of our opportunity. Demand remains strong, customer commitments continue to deepen our visibility, and we are expanding capacity ahead of plan. Established businesses continue to grow rapidly while new growth areas are ramping quickly. Our focus is on execution, expanding capacity, delivering for our customers and improving profitability as we grow. We believe this combination positions Coherent for sustained growth in fiscal '27 and beyond. I want to thank our team for their outstanding work this quarter. I'll now turn the call over to Sherri.

Thank you, Jim. I'm extremely pleased with the outstanding Q1 financial results. Our performance in the first quarter represents a powerful continuation of our growth trajectory, characterized by accelerating top line momentum, durable structural gross margin expansion and significant operating leverage. The compounding impact of these operational drivers fuels non-GAAP EBS growth to significantly outpace revenue growth. We achieved this strong performance while preserving balance sheet flexibility and strategically directing capital towards targeted capacity expansions and making investments in our product road map to support robust AI data center and communications demand. Let me now provide a summary of our results. First quarter revenue was a record $2.37 billion, representing a sequential acceleration of 16% and a substantial 50% increase year-over-year. This performance was driven by the continued AI infrastructure build-out across our data center and communications businesses. On a pro forma basis, excluding the financial impact of the aerospace and defense business, and the Munich, Germany product division, both of which were divested in 2026, revenue increased 16% sequentially and 56% year-over-year. Our non-GAAP gross margin for the first quarter was 40.6%, representing a 37 basis point increase sequentially and a 184 basis point improvement as compared to the year ago quarter. This continuous expansion reflects durable pricing optimization and structural cost improvements, particularly within our data center and communications segment. Improvements in gross margin, both sequentially and year-over-year were driven primarily by pricing optimization, lower product input costs and improved manufacturing yields. We have made significant progress with our pricing optimization strategy to ensure that we price our highly differentiated products for the value they provide to our customers. Our gross margin profile is also benefiting from the transition to 6-inch indium phosphide as we continue to scale our production capacity. Given the progress that we have made over the past couple of years and our current trajectory, it is clear that we need to raise our gross margin target. We now expect to achieve our first quarter with gross margin above 45% before the end of calendar 2028. We believe the drivers of this gross margin extension are continued pricing optimization, ramp of new growth platforms, full operational leverage of our 6-ish indium phosphide capacity and other cost improvements. I also want to note that the new over 45% target is 300 basis points higher than the long-term target we provided to the investment community only 18 months ago. First quarter non-GAAP operating expense was $412 million compared to $377 million in Q4 and $304 million in the year ago quarter. Non-GAAP operating expenses as a percentage of revenue decreased meaningfully to 17.4%, down from 18.4% in the prior quarter and 19.2% in the year ago quarter. This improvement reflects enhanced operational discipline and underscores the powerful operating leverage inherent in our business. From an R&D perspective, we are strategically directing our capital towards high conviction long-term growth drivers, which Jim outlined in his remarks. This disciplined approach ensures our investments are concentrated where they generate the highest financial returns and drive sustainable revenue growth. Our first quarter non-GAAP operating margin increased to 23.2% from 21.8% in the prior quarter and 19.5% in the year ago quarter. The sequential and year-over-year increases were driven by strong revenue growth, expanding gross margin and structural expense discipline. First quarter non-GAAP earnings per diluted share was $2.09, up 20% from the third quarter and up 80% from the year ago quarter. Earnings growth continued to exceed revenue growth, demonstrating gross margin expansion and operational leverage accelerating our bottom line profitability. Turning to the balance sheet. We closed the quarter with a healthy cash balance of $2.34 billion compared to $2.59 billion at the end of the prior quarter and $1.55 billion at the end of the year ago quarter. Our debt leverage ratio at the end of Q1 was 1.1x as we continue to maintain a highly resilient and flexible balance sheet. Consistent with our capital allocation priorities, we strategically invested in opportunities that will drive long-term growth and profitability. Capital expenditures for the first quarter increased sequentially to $776 million, up from $556 million in the prior quarter and $104 million in the year ago quarter. These investments directly support the future growth of our data center and communications businesses with excellent financial returns. Our conviction to deploy this capital at an accelerated rate is backed by exceptional customer visibility, a robust pipeline of committed purchase orders and additional multiyear supply agreements. Furthermore, this capacity offers significant fungibility as our infrastructure can be efficiently repurposed to support multiple product lines. Given the strong visibility and record backlog we expect capital expenditures to increase sequentially again in the second quarter. With our strong balance sheet and profitability trajectory, we possess the scale and flexibility to continue investing capital toward high ROI growth initiatives while supporting customer demand. I will now turn to our guidance for the second quarter of fiscal '27. We expect revenue to be between $2.55 billion and $2.75 billion. We expect non-GAAP gross margin to be between 40% and 42%. We expect total operating expenses of between $430 million and $450 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 non-GAAP diluted EPS to be between $2.28 and $2.48. In summary, fiscal 2027 is also a powerful start with strong financial momentum backed by deep demand visibility. Our focus remains on rapidly ramping capacity to meet demand, expanding our gross margin, capitalizing on the immense operating leverage in our model, and executing a disciplined capital allocation strategy focused on maximizing returns that drive long-term shareholder value. That concludes my formal comments. Operator, please open the line for the Q&A session.

[Operator Instructions] The first question today comes from Joseph Cardoso with JPMorgan.

Really appreciate some of the disclosures that you provided this quarter and I wanted to first start with PhotonLink and the initial visibility you provided there. Was hoping you could provide more color with respect to the ramp itself, especially just given the backdrop of the $20 billion agreement that you've highlighted? And then I have a follow-up.

Yes. Thanks, Joe. So first of all, yes, we're certainly really pleased with the momentum that we have around PhotonLink and kind of whether you measure it by customer engagement or LTAs, as you mentioned, or just the revenue outlook that I mentioned in the prepared remarks, we're just really pleased with the progress there. And just as a reminder, PhotonLink is -- we kind of consider it a one-stop shop for integrated optics. It's basically our platform for allowing customers to basically have a platform that allows for the optical link from end to end. It's the complete optical signal chain and all the technology along the optical technology along that path. And really excited about the progress, as I mentioned in the prepared remarks, over 20 customer engagements on CPO, over 10 -- or sorry, over 10 on CPO, over 10 on NPO and then over 5 chip-to-chip engagement. So the customer engagement is very extensive and they continue to grow. You mentioned or asked about the LTA, really pleased about that major AI customer and that LTA is, as I said, $20 billion over a 5-year period. And the revenue for that would start at the beginning of calendar '28. But the PhotonLink revenue ramp is starting ahead of that. We'll ship a little bit of a small amount of PhotonLink revenue this quarter but we expect to ship over $100 million in our March quarter and then before the end of calendar '25, expect to ship over $250 million a quarter. So really pleased with all of that progress. And I guess the other thing that I would add is, if we look further out, we're expecting this over time to become a multibillion dollar product line. The initial shipments of PhotonLink are all around CPO in the scale-out network. But when we start to ship into a CPO and MPO into scale up networks, I think that drives another huge leg of demand for this technology. I think that will be the much bigger adoption that we see. And that we expect to start to ship revenue into CPO and MPO applications in the scale-up domain towards the end of calendar '27. So yes, we're excited about the progress and expect this to become a major product line for us.

And maybe in a similar vein, I wanted to touch on the scale across ECI opportunity. Particularly curious how we should think about the customers and products that are underpinning the revenue outlook to double by the end of the next calendar year.

Yes. Thanks again. This has been a really great growth area for us over the past year. In fact, it's surprised us a little bit how quickly this has grown. So overall, so DCI and scale across that falls within our communications part of our business, which is essentially everything outside of all communications outside of the data center. And if we look at that segment overall, communications grew 84% year-over-year. But while telecom grew most of that -- the vast majority of that growth is driven by DCI. And so what's going on there is you're seeing these large AI workloads that are spanning multiple data centers. And so that's driving the need for much greater bandwidth and connectivity, optical connectivity between data centers. And so that's what's driving. That's the underlying market dynamic that's driving the growth. And then you asked about customers and products. So customers would be either equipment makers, so we're certainly selling into multiple different equipment makers that -- whose equipment goes into scale across applications, but also selling directly to hyperscalers as well. And so it's a mixture of both types of customers. And then the products, it's interesting, we sell in this part of the market, we sell products at multiple levels of the value chain. So we sell in components like, for instance, pump lasers that go into a wide range of different equipment at one level up in the value chain. We sell subsystems and modules, so ZZR plus modules, line cards, amplifiers, ROADMs, et cetera. And then one level up from that, in some cases, sell complete solutions to our customers as well. So we're selling across multiple levels of value chain. And so I think that's helped us really maximize the growth here as well. And as I mentioned in the prepared remarks, if we look at our Q1 revenue was over $200 million. So we're basically at about $1 billion annualized revenue run rate now. And that's -- that Q1 growth had quadrupled year-over-year. And we expect that if you take that Q1 baseline, we expect the revenue to double again before the end of calendar '27. And so that growth that we've seen to date, that's ahead of multi-rail. So we expect multi-rail revenue, which is a multi-rail are great solutions, some great technology that we have there. We expect that to start -- that revenue to start to ramp in our March quarter. And so it's been a really good area of growth, and we expect this to continue to be a very good area of growth over the coming quarters as well.

The next question comes from Simon Leopold with Raymond James.

First, Jim, I want to thank you for the increased transparency on Slide 7. I know this is something I've been probably annoying you about. So thank you. The slide did not mention OCS. I know you talked about the product group in your prepared remarks. But could you update us on your progress and expectation for this product group? And then I've got a follow-up, please.

Yes, sure. Thanks, Simon. Thanks for the feedback, as always. We're always looking to improve. So I appreciate the feedback. Yes, in OCS, I did mention in the prepared rebars falls within our data center part of our business. And just reiterating, data center was up 85% year-over-year in our Q1. OCS continued to make good progress. We've got really extensive customer engagement. We've seen that customer engagement, continue to expand across more applications and not just scale out applications but scale across and scale up applications as well. And that's across in terms of products, that's across both 320x320 systems, which are shipping as well as denser configurations. I think the denser configurations will be used more in the scale-up applications. We're ramping production at 2 different sites in parallel, and that's really to meet the demand that we're seeing. We have a very differentiated technology. It's liquid crystal. It's nonmechanical technology, has better power efficiency and better reliability than MEMS-based solutions. So we feel really well positioned. We're ramping production. And I think will be an increasingly larger contributor to our revenue growth in the quarters to come. And maybe the last thing to add is we see the market opportunity for OCS as at least $4 billion by 2030, it could be larger.

And as a follow-up, I have a hard question, one that I imagine you anticipate getting is what does the proposed consolidation of Lumentum and Marlow mean to you?

Yes. Thanks, Simon. No, I don't think that's our question at all. I think happy to answer that. I give a few thoughts on this. I think number one is it definitely demonstrates that optics and photonics is becoming an absolutely critical part of data center architecture. As we look forward, as we convert the entire scale-up network and then even the scale in chip-to-chip communication links, over time, all of that getting converted from copper to optical photonic technology is absolutely critical to making that happen to driving the [ illusion ] and data center architecture. So I think it's a proof point around just the criticality of optics and photonics. And then I think for Coherent, I think it just -- it highlights the tremendous strategic value of the portfolio that is within Coherent. There's no other company, I believe, on the planet that has a broader and deeper set of photonic and optical technology. If you look at the entire optical signal chain from the generation of the light to the transmission through our fiber optic cable that we make to the detection on the other side. I don't think there's any other company that's got a better portfolio of technology. So I think it definitely highlights the strategic importance of our technology platform. And then look, I think from a customer perspective, I think that -- I think a lot of -- for a lot of the customers, our customers, I think it's really important that they have an independent photonic optical supplier and partner. And so I think it positions us really well to be that independent optical supplier that's going to support without any competitive conflict can support multiple different customers and support both hyperscaler customers can support semiconductor customers. And I think it positions us really well to be that partner of choice in terms of optics for the industry. So look, we think we're really well positioned from both a technology standpoint, a manufacturing standpoint and strategically. And I think we're on a really great growth trajectory. And I think you can see some of that already in the PhotonLink technology and the PhotonLink revenue ramp.

The next question comes from Tom O'Malley with Barclays.

I guess the first part of the question for you, Jim, is why now in terms of giving the longer-term forecast, it's been something that you've kind of held off on doing for a while. You gave $3 billion and then $4 billion next year. And then the second part of the question is, is that all back with supply? How are you able to get visibility that far out? Is that already in the books today? Or perhaps you could give us like what percentage of that is backed with supply today? Or if you need to add any to get you to those numbers?

Yes. Thanks, Tom. I think it is a little bit different. We are providing a little bit longer-term visibility than we normally would. I think it's really backed by the -- just extraordinary level of visibility that we have on the business. When I look at the backlog, the bookings both -- so both near-term visibility and long-term visibility. If I look at just the backlog that we have, I mean, calendar '27 is basically booked out and the customers are booking out calendar '28 now. So from a near-term booking demand perspective, we have great visibility. We've signed a number of new LTAs over the past quarter. I mentioned one of the big LTAs as part of the Photonlink prepared remarks. But the LTAs also give us really good visibility because they include very high-quality forecast, long-term forecast. So I think that's -- given that really good visibility, that's certainly giving us confidence. And then also great that you mentioned supply we've done a number of things within our supply to make sure that we've got the right supply in place to support that as well. So yes, I would say that, that's a those views that we gave, whether it's the $3 billion this year and the $4 billion quarter next year is underpinned by supply agreements. Also, remember that we're highly vertically integrated. So a lot of that's underpinned by our own internal supply that we're ramping, right? One of the constraints we look back over the past 1.5 years, one of the constraints has been indium phosphide. And I'm just really pleased with how the team has executed very, very well on the indium phosphide production ramp. We've doubled production capacity a quarter earlier than what we thought we would, and that gives me the confidence that they're going to achieve. The team is going to achieve our plan to more than double capacity again by the end of calendar '27. So you put all that together and we're feeling really good about the outlook and the visibility for the business.

Super helpful. And then just as my follow-up for that LCA. Obviously, $20 billion, a pretty robust number over that 5 years. Could you just give us any color just around that customer perhaps? And then if you can talk about the customer around some of the solutions that obviously it's PhotonLink, so it spans a large number of your products, but any more specificity would be really helpful, just given the size of that customer?

Yes, sure. So definitely a leading AI data center customer name you would definitely recognize, right? And so we're really proud of that partnership, excited about it. That's all that LTA for $20 billion is all around PhotonLink technology. I would call it -- I would say it's anchored by our laser, our 400-milliwatt CW laser. That's kind of the anchor of that LTA. But there's -- it's more than -- we're selling more than just that laser. So we're selling more, call it, a higher level solution than that. So more than just that laser. So we're really, really pleased by that. As I mentioned, the revenue -- we expect the revenue to start to flow from that in early 2028. And to ramp over the quarters and years after that. And so really pleased with that. And I think given the engagement that we have on PhotonLink across many different customers, many different solutions. We certainly expect to sign more long-term agreements and partnerships with PhotonLink over the coming quarters as well.

The next question comes from George Notter with Wolfe Research.

I guess I just wanted to ask a question about the 45% gross margin outlook before the end of '28. So I guess I'm curious, like what does that -- think about your transceiver business? I'm just wondering if to hit that, you need to get your transceiver supply or transceiver ramp or is this just a case where everything can ramp in unit naturally would ramp and you might have been 5% gross margins? What's the view there?

Yes. Thanks, George. I'll start and see if Sherri has any color to add. But yes, we haven't assumed that we're kind of artificially gating the transceiver business. So there's no assumption on that. We're assuming that the transceiver business grows at what we think is a reasonable growth rate to expect from the transceiver business. But on top of that, we do have new products are ramping on top of that. full-time link, a number of new products and data center interconnect, OCS ramping over time, and so you put all those products ramping over time. And those products are accretive to the company's margin. I think the new product ramp helps as well. And then in addition to that, the other thing that I would add more on the cost side is a number of different cost activities that we're driving. But certainly, a big one of it is we expect additional leverage in terms of gross margin from our indium phosphide ramp. I think there's -- as I mentioned briefly in the prepared remarks, I think most of the benefit from indium phosphide expansion is still ahead of us. And so I think there's a good component of the margin expansion that's kind of underpinned by the indium phosphide expansion as well.

Is it possible to get the company to higher margins than 45% over time? I mean, I guess I'm maybe looking at Lumentum as an example, those guys obviously have had quite a bit of margin expansion. Obviously, the fast-growing parts of that business are one of the areas where you're kind of looking for growth going forward is 40% just a stop in a bigger picture or a bigger number? What do you think?

I don't think there's any structural barrier to us driving gross margin above 40%. In fact, I think Sherri, in her remarks, I think she said over 45% before the end of calendar '28, I think, is the way she said it, right? So I -- yes, we certainly don't view just like our old target of 42%, where we said over 42%, we never viewed that as a stopping point. We viewed that as stop along the way. And I would say 45% is, yes, stop along the way, and I don't see any structural reason why the company couldn't continue to drive gross margins beyond that.

Yes. I would just add that the target that we put out about 18 months ago at our Investor Day of over 42%, that was a 3- to 4-year target that we put out but we pulled that in, right, in only 18 months now raising our target to over 45%. So as we get close to that target, we'll certainly evaluate and look at what makes sense beyond that, but it's just a step along the way.

Yes. And George, maybe the other thing I'd add is we're certainly super focused on gross margin expansion. But the other thing that we're very focused on is operating lever trade. And I think we're quite pleased to see that we're gaining operating leverage in terms of OpEx as a percentage of sales, and we expect that to continue as well. So I think you should expect continued operating leverage as well.

The next question comes from Gianmarco Conti with Deutsche Bank.

Yes. Great. Congrats on the quarter. Maybe starting with Photo Link. I wanted to touch on the scale in scale-up opportunity with micro-VCSEL mentioned you had 5 engagements, I believe, chip to chip. I'm curious if you could talk in a little bit more detail here whether there is anything you can quantify in terms of revenue to come online next year? Anything around micro-VCSEL.

Yes. So thanks for asking about micro-VCSEL. So certainly, when I look across the Foton link engagements, there is, I would say, many VCSEL, micro-VCSEL, we call it multi-core VCSEL because it the multi-core VCSEL attaches to our multicore fiber that we produce. And so -- but multiple of those engagements involve our VCSEL technology. I mean, maybe just as a reminder, of the company's sort of depth in VCSEL technology. Number one is we've shipped over 700 million VCSELs into data center applications over the past year. So we have enormous manufacturing expertise in VCSELs. Also at the ECOC conference, when we launched PhotonLink, we talked about our technology in VCSELs, micro VCSELs, VCSEL arrays, et cetera. We showed that one of the things that we showed was that we had industry-leading energy efficiency around VCSELs of -- we showed a 1 picojoule per bit capability, which I think is very industry-leading capability. And so VCSEL is definitely a core technology, something that the company has a long history in and we have multiple engagements. I think you'll see that deployed in NPL applications relatively in scale up NPO applications in relatively short amount of time. I think you also asked about scale in chip to chip. I think that's a little further out in time. I think PhotonLink can scale in applications is more in the 2029 to 2030, but we'll definitely see, I think, VCSELs deployed in NPL applications well before that.

If I can just ask a follow-up. It's going to be a tough question, sorry to put you in the spot. But I'd be receiving a lot of questions from investors around Chinese laser suppliers. I was wondering if you could provide any kind of thoughts on basically more supply coming online? And whether you see them competing for ultra-high-powered lasers for CWs?

Yes. So I don't see that those competitors in terms of ultra-high power, if you're talking about like the 400-milliwatt CW laser. We're not seeing competition from really only have one competitor there as far as we can see, right? So really not seeing any other competitors out there with high-power seated the laser capability.