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 in form eight-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 multi-year visibility. We remain on track to achieve our first $3 billion revenue quarter by the end of fiscal 2027. We expect the full year pro forma revenue growth rate to exceed 60%, more than double our fiscal 2026 pro forma growth rate. We also have a clear line of sight to our first $4 billion revenue quarter in fiscal 2028. Coherent is a photonics platform company, bringing together technologies across the optical signal chain, from materials and components through subsystems and complete solutions.
Our breadth positions us to support customers across data center and communications networks. We are 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 continue 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. For example, Scale Across 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 2027 to be an exceptional year for Coherent. Moving to our data center and communication 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 2027 is exceptional, and customer orders increasingly extend into calendar 2028. 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 are ramping 1.6T products with multiple customers while continuing to grow 800G revenue. We expect strong transceiver revenue growth in Q2, driven by both 1.6T and 800G. We expect 1.6T revenue to continue ramping rapidly over the coming quarters, while 800G revenue continues to grow through calendar 2027. At ECOC in September, we demonstrated our progress beyond 1.6T with a 3.2T OSFP pluggable transceiver built with our 400G differential EMLs and photodiodes. We expect pluggable 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 USFP form factor.
Turning to OCS, customer engagement is broadening across Scale Across, scale-out and scale-up networks, spanning our 320 by 320 platform and denser configurations. We are expanding production at two 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 is 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 represent 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 XPU or switch chip with 100 terabits per second of 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 five years, with revenue beginning to ramp in early calendar 2028. This is in addition to our previously announced LTA with NVIDIA. Beyond these two anchor customers, we have more than 10 additional CPO engagements, more than 10 NPO engagements, and more than five 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 2027. 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 2027. Over time, we expect PhotonLink to become a multi-billion-dollar product line for Coherent. Expanding our indium phosphide capacity is a key enabler of growth in both indium phosphide pluggable transceivers and indium phosphide-enabled PhotonLink solutions. Our six-inch indium phosphide expansion is progressing well. We doubled our internal indium phosphide output capacity year-over-year in Q1, one 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 2027. 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 six-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 six-inch indium phosphide production in Zurich in the first half of calendar 2027, 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 DCI 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 MultiRail 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 Across revenue to roughly double from the Q1 level by the end of calendar 2027. 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 Thermadite 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 2027. 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 2027 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 am 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 EPS growth to significantly outpace revenue growth. We achieved this strong performance while preserving balance sheet flexibility and strategically directing capital toward targeted capacity expansions and making investments in our product roadmap to support robust AI datacenter 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 datacenter 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 datacenter and communications segment. The 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 six-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 expansion are continued pricing optimization, ramp of new growth platforms, full operational leverage of our six-inch 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 toward 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 prior 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 1.1 times, 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 datacenter 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 multi-year 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 2027.
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 off to 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.
We will now begin the question-and-answer session. To ask a question, you may press star, then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing any keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. The first question today comes from Joseph Cardoso with J.P. Morgan. Please go ahead.
Hi, good afternoon, and thank you for the questions here. Really appreciate some of the disclosures that you provided this quarter and 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. Thank you.
Yeah, thanks, Joe. First of all, yeah, we're certainly really pleased with the momentum that we have around PhotonLink, and whether you measure 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. 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. Really excited about the progress. As I mentioned in the prepared remarks, over 20 customer engagements on CPO, over 10 on, or sorry, over 10 on CPO, over 10 on NPO, and then over five chip-to-chip engagements.
The customer engagement's 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 five-year period, and the revenue for that would start at the beginning of calendar 2028. 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 2027, expect to ship over $250 million a quarter. So, really pleased with all of that progress. I guess the other thing that I would add is, if we look further out, we're expecting this over time to become a multi-billion dollar product line.
The initial shipments of PhotonLink are all around CPO in a scale-out network. But when we start to ship into CPO and NPO and to 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 NPO applications in the scale-up domain towards the end of calendar 2027. So, yeah, we're excited about the progress and expect this to become a major product line for us.
No, thank you for that, Jim. And maybe in a similar vein, wanted to touch on the Scale Across DCI 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.
Yeah, 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, DCI and Scale Across, that falls within our communications part of our business, which is essentially everything outside of all communications outside of the datacenter. 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 was driven by DCI. So what's going on there is you're seeing these large AI workloads that are spanning multiple datacenters, and so that's driving the need for much greater bandwidth and connectivity, optical connectivity between datacenters. 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.
Customers would be either equipment makers, so we're certainly selling into multiple different equipment makers whose equipment goes into Scale Across applications, but also selling directly to hyperscalers as well. 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. One level up in the value chain, we sell subsystems and modules, so ZR+ 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 the value chain, and so I think that's helped us really maximize the growth here as well.
As I mentioned in the prepared remarks, if we look at our Q1 revenue was over $200 million, so we're basically at about a billion dollar annualized revenue run rate now, and 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 2027. So that growth that we've seen to date, that's ahead of MultiRail. So we expect MultiRail revenue, which is a MultiRail is a great solution, some great technology that we have there. We expect that revenue to start to ramp in our March quarter. 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.
Thank you, Jim. Appreciate all the color.
Thanks, Joseph.
The next question comes from Simon Leopold with Raymond James. Please go ahead.
Thanks for taking a question. First, Jim, I want to thank you for the increased transparency on slide seven. 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? Then I've got a follow-up, please.
Yeah, sure. Thanks, Simon, and thanks for the feedback as always. We're always looking to improve, so appreciate the feedback. OCS, I did mention in the prepared remarks, OCS falls within our datacenter part of our business, and just reiterating, datacenter was up 85% year-over-year in our Q1. OCS continue to make good progress. We've got really extensive customer engagement. We've seen that customer engagement continue to expand across more applications, so not just scale-out applications, but Scale Across and Scale-Up applications as well. That's across, in terms of products, that's across both 320 by 320 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 two 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 non-mechanical 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 it will be an increasingly larger contributor to our revenue growth in the quarters to come. 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 than that.
Thanks. 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 Marvell mean to you? Thank you.
Yeah. Thanks, Simon. No, I don't think that's a hard question at all. I think happy to answer that. I'd 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 datacenter 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 innovation in datacenter architecture. So I think it's a proof point around just the criticality of optics and photonics. Then I think for Coherent, I think 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 detection on the other side, I don't think there's any other company that's got a better portfolio of technology. I think it definitely highlights the strategic importance of our technology platform. Then, look, I think from a customer perspective, I think for a lot of our customers, I think it's really important that they have an independent photonic optical supplier and partner. 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.
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. I think you can see some of that already in the PhotonLink technology and the PhotonLink revenue ramp.
Thank you.
The next question comes from Tom O'Malley with Barclays. Please go ahead.
Hey, guys. Thanks for taking my question. Thanks for the additional color as well. I guess the first part of the question for you, Jim, is, why now in terms of giving the longer-term forecast? It has been something that you have kind of held off on doing for a while. You gave $3 billion and then $4 billion next year. The second part of the question is that all backed 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 what percentage of that is backed with supply today, or if you need to add any to get you to those numbers?
Yeah. 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 is really backed by the just extraordinary level of visibility that we have on the business. When I look at the backlog, the bookings, so both near-term visibility and long-term visibility, if I look at just the backlog that we have, calendar 2027 is basically booked out, and the customers are booking out calendar 2028 now. So from a near-term booking demand perspective, we have great visibility. We have signed a number of new LTAs over the past quarter. I mentioned one of the big LTAs as part of the PhotonLink prepared remarks. The LTAs also give us really good visibility because they include very high-quality forecasts, long-term forecasts. I think that is, given that really good visibility, that is certainly giving us confidence.
Also, great that you mentioned supply. We have done a number of things within our supply base to make sure that we have got the right supply in place to support that as well. So, yeah, I would say that those views that we gave, whether it is the $3 billion this year and the $4 billion quarter next year, is underpinned by supply agreements. Also, remember that we are highly vertically integrated, so a lot of that is underpinned by our own internal supply that we are ramping, right? One of the constraints, if we look back over the past year or year and a half, one of the constraints has been indium phosphide. I am just really pleased with how the team has executed very, very well on the indium phosphide production ramp.
We have doubled production capacity a quarter earlier than what we thought we would, and that gives me the confidence that the team is going to achieve our plan to more than double capacity again by the end of calendar 2027. So you put all that together, and yeah, we are feeling really good about the outlook and the visibility for the business.
Super helpful. Then just as my follow-up for that LTA, obviously $20 billion, a pretty robust number over that five years. Could you just give us any color just around that customer perhaps? Then if you cannot talk about the customer, around some of the solutions that obviously it is 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.
Yeah, sure. So definitely a leading AI datacenter customer name you would definitely recognize, right? We are really proud of that partnership, excited about it. That LTA for $20 billion is all around PhotonLink technology. I would say it is anchored by our laser, our 400mW CW laser. That is kind of the anchor of that LTA. But we are selling more than just that laser. So we are selling more, call it a higher-level solution than that. So, more than just that laser. So we are 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 course of the quarters and years after that.
We are 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.
Thanks a lot, Jim.
The next question comes from George Notter with Wolfe Research. Please go ahead.
Hi, guys. Thanks a lot. I guess I just wanted to ask a question about the 45% gross margin outlook before the end of 2028. I guess I'm curious, what does that assume about your transceiver business? I'm just wondering if to hit that, you need to gate your transceiver supply or transceiver ramp, or is this just a case where everything can ramp in unison as naturally would ramp, and you wind up at 45% gross margins? What's the view there? Thanks.
Yeah. Thanks, George. I'll start and then see if Sherri has any color to add. 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. On top of that, we do have new products that are ramping on top of that. PhotonLink, number of new products in DCI, OCS ramping over time as well. 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. In addition to that, the other thing that I would add more on the cost side is number of different cost activities that we're driving.
Certainly a big one of it is we expect additional leverage in terms of gross margin from our indium phosphide ramp. As I mentioned briefly in the prepared remarks, I think most of the benefit from indium phosphide expansion is still ahead of us. 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 guess I'm maybe looking at Lumentum as an example. Those guys obviously have had quite a bit of margin expansion. Obviously, the fastest growing parts of that business are many of the areas where you're kind of looking for growth going forward. Is 45% 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 2028, I think is the way she said it, right? 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 a stop along the way. I would say 45% is a stop along the way, and I don't see any structural reason why the company couldn't continue to drive gross margins beyond that.
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 three to four-year target that we put out, but we pulled that in, right, in only 18 months, now raising our target to over 45%. As we get close to that target, we'll certainly reevaluate and look at what makes sense beyond that. But it's just a stop along the way.
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 leverage, right? 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. I think you should expect continued operating leverage as well.
Thank you.
The next question comes from Gianmarco Conti with Deutsche Bank. Please go ahead.
Yeah, great. Thank you for taking my questions. Congrats on the quarter. Maybe starting with PhotonLink, I wanted to touch on the scale-in/scale-up opportunity with micro VCSEL. You mentioned you had five 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. Thank you.
Yeah. Thanks for asking about micro VCSEL. When I look across the PhotonLink engagements, there is, I would say, many VCSEL, micro VCSEL. We call it multi-core VCSEL because the multi-core VCSEL attaches to our multi-core fiber that we produce. Multiple of those engagements involve our VCSEL technology. Maybe just as a reminder of the company's depth in VCSEL technology, number one is we've shipped over 700 million VCSELs into datacenter applications over the past year. 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 one of the things that we showed was that we had industry-leading energy efficiency around VCSELs. We showed a one picojoule per bit capability, which I think is very industry-leading capability.
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 NPO 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 and scale-in applications is more in the 2029 to 2030, but we'll definitely see, I think, VCSELs deployed in NPO applications well before that.
If I could just ask a follow-up, it's going to be a tough question. Sorry to put you on the spot. But I've been 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 in online, and whether you see them competing for ultra-high-powered lasers for CWs.
Yeah. I don't see that those competitors in terms of ultra-high power, if you're talking about like the 400mW CW laser.
Yeah
We're not seeing competition from. We really only have one competitor there as far as we can see, right? We're really not seeing any other competitors out there with high-power CW laser capability.
Got it. Thank you.
Yep.
Operator, before we go to the next analyst, if we could ask all the other analysts to limit themselves to one question with a goal of trying to accommodate everybody on the call. All right? Thank you.
The next question comes from Dan Zhu with Bernstein. Please go ahead.
Hey, thanks for the question. You mentioned that scale-up optics should start towards the end of calendar 2027. Anything you can share about whether the initial deployments are NPO or CPO, and also about whether this is primarily going to be on VCSELs, or will this start with InP-based lasers?
Yeah. Thanks, Dan. I think what we'll see, we'll definitely see CPO in scale-up. We certainly believe that. I think we'll see NPO scale-up soon after that as well, if not by the end of calendar 2027. I think we'll certainly see deployment in the early part of 2028. Think in scale-up, both CPO and NPO within either that late 2027 or early 2028 timeframe in the scale-up applications. Then I think, did you ask what was the second part of your question, Dan? VCSELs?
How much of it is VCSEL versus InP?
Yeah. I think the initial deployment is indium phosphide, the high-power CW lasers. That's for CPO in both initially scale-out and then in scale-up. Then I think VCSELs will happen in that NPO kind of early 2028 timeframe.
Got it. Thank you
The next question comes from Ryan Koontz with Needham. Please go ahead.
This is Jeff Hobson on for Ryan. Thank you for the question. You noted ramping the indium phosphide supply for your own laser supply, and that would be able to lead to the margin expansion from weaning off external sources. I'm just curious if there's any color on what the split is currently versus internal versus external, and kind of how, or the timeline of that over time as it relates to the margin expansion. Thank you.
Yeah. Thanks, Jeff. We haven't broken out the split, but I can tell you the split hasn't changed much in a year. We're using about the same mix of internal versus external now as we were a year ago. So although we've doubled our internal indium phosphide supply, the primary usage of our internal indium phosphide parts is in our datacenter transceivers. If you look at the growth rate of our datacenter business, datacenter transceivers, it's basically tracked the growth of our indium phosphide capacity, basically one quarter later. Because in the quarter we produce the lasers, the next quarter is when we ship the transceivers. Essentially, our transceivers business has grown at the same rate as our internal indium phosphide, which means that our mix of internal versus external really hasn't changed much over the past year.
Now, as we continue to expand indium phosphide now looking forward, more than doubling it by the end of calendar 2027, we do believe over the coming quarters we'll start to shift more of the mix from external towards internal. We always believe we'll have some portion of our supply from external for our transceiver business, but we believe over the coming quarters we'll start to shift more towards internal. That's really because it's a tremendous cost advantage for us to use our internally produced lasers, especially the ones that are made on the six-inch platform. In my prepared remarks when I said, "The majority of the benefit from six-inch indium phosphide is ahead of us," that's actually really what I'm referring to, is that benefit of changing the mix towards internal is largely ahead of us, and that's a much bigger cost structure improvement.
Got it. Thank you very much.
The next question comes from Papa Sylla with Citi. Please go ahead.
Thank you. Thank you for taking my question, and congrats on the very impressive results. Jim, I wanted to maybe double-click on the $15,000 of content per chip, I think, 100 chips you mentioned earlier and at ECOC. Assuming that is probably the full stack opportunity, which might be a longer-term figure, but I thought it would be helpful to also have a sense, even qualitatively, on what percentage, I guess, of that $15,000 you expect to capture in the near term versus longer term and how it may change kind of beyond calendar 2027?
Yeah. Thanks, Papa. The $15,000 basically represents, if you take an example of a chip that needed 100 terabit of IO, and if you were using our full PhotonLink portfolio, which would include not just the lasers, but all the other components, isolators, thermoelectric coolers, laser modules, our full fiber assembly kit, all the connectors, et cetera. So everything that we do, if you used all that, the content per chip would be, we estimated, about $15,000 per chip. Now, it'll depend on the customer and their particular application, how much of that content they utilize. Whether they utilize a portion of that, all of it, that'll really depend on the particular engagement. But that $15,000 is sort of the opportunity that's out there for us.
I think we'll see over the next year or two as PhotonLink ramps, I think we'll see customers that leverage the vast majority of that, and I think we'll also see customers that leverage a subset of that. I think we'll definitely see a mix of that. We're happy to support our customers whether they want the entire solution or they want a portion of it. We'll work with them on whatever works best for them. But regardless of the amount of content they take, for us, we see this as all greenfield growth, because most of PhotonLink adoption over time will be driven by scale-up. Again, that's all greenfield growth for us, because that's us and the industry converting copper links to optical links over time. So we see it as greenfield revenue growth.
Got it. That's very helpful. Thank you.
Yep.
The next question comes from Cody Acree with StoneX Financial. Please go ahead.
Hey, guys. Thanks for taking my question. Sherri, maybe for you, if we can go back to the gross margin discussion. Can you maybe help to stratify the contribution part of that? You talked about the indium phosphide six-inch ramp yields, increasing utilization rates, maybe even your mix thoughts, and just if you can also factor into that the competitive dynamics on your module and your transceiver piece of more global Chinese competition and what's inherently just a more price-sensitive market.
Yeah, sure, Cody. I think you cut out a little bit, but I think you were asking for more color on what the drivers are to gross margin expansion over 45%. That is what I think your question is.
It is, that is right.
Yeah. Okay. If I were to rank order, I think that the largest contributors are going to be our new product ramps and that full operational leverage of our six-inch indium phosphide capacity, and then pricing optimization, followed by cost reductions. That is kind of how I would rank order it. And the timing of some of those things kicking in, right, will vary. But certainly new product ramps, I mean, those are gross margin accretive, the new products that Jim referred to earlier in his prepared remarks. Those are gross margin accretive, and so that will benefit our gross margin. As we continue to shift our supply from external to internal, as Jim talked about a little bit ago, that is going to drive significant opportunity in our gross margin.
Pricing optimization, rather, I mean, that is an area where I think we will continue to have benefit there, fully in our datacenter communication segment, certainly in our industrial too, but definitely in datacenter communications, there is opportunity for that. We saw that to be a large contributor during the current quarter as well as in prior quarters. And so that will continue to be a benefit as well to drive to over 45%. And cost reductions, that will always continue to be something that we focus on, but that is how I would rank order them.
The next question comes from Karl Ackerman with BNP Paribas. Please go ahead.
Yes, thank you. Jim, you spoke about how customers are beginning to book out to calendar 2028 that gives you confidence in your growth forecast. At the same time, there is investor concern about the financing and permitting of data centers here in the U.S. In light of this, how does the team align its laser production capacity plans with your major customers, and has the team considered customer prepayments for additional laser production capacity? Thank you.
Yeah. Thanks, Karl. The answer to the last part of the question is yes, definitely. Maybe I'll start with the end of the question. We've signed a number of LTAs over the past quarters. The one public LTA is the one with NVIDIA that we signed back in March, but we've signed a number of other LTAs. The LTAs all follow a general pattern, and one part of the LTA is typically some sort of upfront payment from the customer. It could be either prepayment or NRE. There's different forms of payment, but there's some sort of upfront payment from the customer. What we do that for is for two reasons. Number one is it makes sure that the customers have skin in the game. But number two is we use that upfront payment to help fund the CapEx to build the capacity for that customer, right?
We think it's important that if we're going to go build the capacity, that the customers either fund that or help co-fund that. So far, we've had customers be very willing to do that, and I think that's worked really well for us. So, I would say almost every LTA that we've signed has that general pattern. So, that certainly gives us better confidence and helps offset the risk in terms of our own capital deployment. But I guess on the first part of your question, we certainly work very, very closely with our customers on planning out the demand. I think one thing to keep in mind with indium phosphide capacity is, remember that it's not just being driven by data center demand. There's two things driving optics, in general, optics demand, right?
Number one is data center growth, but number two is, in the case of integrated optics, it is the conversion of the copper links to optical over time. That is a technology trend that, in my view, is independent of the market demand. That is a technology trend that will happen regardless of the data center demand, because that is necessitated by the ability to achieve the bandwidth and the link speeds that we need to achieve in the scale-up domain or chip-to-chip, is we have to switch to optics over time. That is an independent technology trend, and that is certainly part of what is driving the indium phosphide capacity demand over the long term.
The next question comes from Meta Marshall with Morgan Stanley. Please go ahead.
Great. Thanks. Maybe just a question on substrate availability. I think there had been some concern in the market around availability of six-inch versus three-inch. I know you noted in the prepared remarks that you had gotten capacity, but maybe if you could just speak about kind of the six-inch versus three-inch substrate availability and how that is impacting expansion plans. Thanks.
Yeah. Thanks, Meta. We have over, on six-inch in particular, but three-inch as well, we do continue to buy three-inch wafers. We do still have three-inch production, but all of our expansion is mostly on six-inch moving forward. We have over five different suppliers of substrates. We have signed long-term agreements with a number of those suppliers, and when I look at our next step of more than doubling the capacity by the end of calendar 2027, we believe we have secured the necessary substrates for that capacity expansion. We have certainly, we have plans in place to further expand capacity beyond 2027, and we are certainly working with or already have in place substrate capacity for that as well. I think the summary is we have multiple different suppliers, and we have made sure that we have the substrate capacity for the expansion.
The next question comes from Sean O'Loughlin with TD Cowen. Please go ahead.
Great. Thanks for squeezing me in. I'll make it quick. Jim, can you just talk about how fungible your capital installed base is across indium phosphide versus gallium arsenide if maybe we end up in a world that is more VCSEL or multi-core VCSEL heavy than it is ultra-high power CW? Thanks for getting the question. Thanks.
Sure. I would say there's some fungibility, but it's not like you can easily switch a line from indium phosphide to gallium arsenide or vice versa. I will note that we have a tremendous amount of gallium arsenide capacity. One of the stats that we shared at the PhotonLink launch is that today we have capacity to produce over 1 billion VCSEL arrays annually. We have a tremendous amount of capacity that we could deploy. To the extent that we saw a broad-based adoption and rapid ramp of VCSEL technology, I don't think there's probably anybody else in the industry that's better positioned to source or to supply that demand than Coherent is. We feel really well-positioned on gallium arsenide VCSEL technology and/or capacity. On indium phosphide, obviously, we're ramping that very, very quickly.
I think on both, we're on a good path.
Our last question today comes from Ananda Baruah with Loop Capital. Please go ahead.
Hey. Thanks, guys. Really appreciate it. Yeah, congrats on the progress here. I guess, Jim, let me just ask you a capacity question, supply capacity, supply question from the other direction. Yeah, there's also been a conversation just in the financial community about, at an industry level, excess InP/EML capacity at some point in calendar 2028. Now you're also talking about sort of contract agreements going sort of well into that timeframe. So, would love to get your opinion on sort of how you view the potential for an oversupply situation at an industry level going through 2028. Thanks.
Yeah, I think through 2027 and into 2028, I don't see that as a risk, given that, given not just the demand that pluggable transceivers is creating, but also the demand that integrated optics is going to create for lasers, as well as there's quite a bit of indium phosphide that's also used in some of the DCI applications too. So when I look across all of that, I don't see an oversupply risk through calendar 2028. I also think for us, because most of our indium phosphide gets used in our, well, I guess today, all of it. Today, all of our indium phosphide gets used in our own products, and we don't even produce enough today to meet all the demand of our own products. For us, that's not a primary concern for us.
I think if there were more supply externally, that may affect us if we were supplying indium phosphide lasers externally, but we're not. I think our plan is to, over time, to start to use more of our internal indium phosphide production to change, to increase the mix towards internal over time. Yeah, I guess the short answer to your question is we don't see any big oversupply situation into 2028.
This concludes our question-and-answer session. I would like to turn the conference back over for any closing remarks.
Thanks, operator, and thanks, everybody, for joining us on the call today. We certainly enter the remainder of the year with great momentum, exceptional customer demand, and as we were just talking about, rapidly expanding capacity. Just want to say thanks to, especially to all of our employees, our customers, our partners, and of course, our shareholders for the continued support. We look forward to updating you again next quarter. Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.