Earnings Call Transcript - COHR Q4 2025

Operator, Operator

Greetings, and welcome to Coherent's Fourth Quarter and Full Fiscal Year 2025 Earnings Webcast. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Paul Silverstein, Senior Vice President of Investor Relations for Coherent. Please go ahead.

Paul Jonas Silverstein, Senior Vice President of Investor Relations

Thank you, operator, and good afternoon, everyone. With me today are Jim Anderson, Coherent's CEO; and Sherri Luther, Coherent's CFO. During today's call, we will provide a financial and business review of the fourth quarter fiscal 2025 and full year fiscal 2025 and the business outlook for the first quarter of fiscal 2026. Our earnings press release can be found in the Investor Relations section of our company website at coherent.com. I would like to remind everyone that during our conference call today, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions based on information that is currently available and that actual results may differ materially. We refer you to the documents that the company files with the SEC, including our 10-Ks, 10-Qs, and 8-Ks. These documents contain and identify important risk factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements. This call includes and constitutes the company's official guidance for the first quarter of fiscal 2026. If at any time after this call, we communicate any material changes to this guidance, we intend that such updates will be done using a public forum such as a press release or publicly announced conference call. Additionally, we will refer to both GAAP and non-GAAP financial measures during this call. By disclosing certain non-GAAP information, management intends to provide investors with additional information to permit further analysis of the company's performance and underlying trends. For historical periods, we provided reconciliations of these non-GAAP financial measures to GAAP financial measures in our earnings release and investor presentation that can be found on the Investor Relations section of our website at coherent.com. Let me now turn the call over to our CEO, Jim Anderson.

James Robert Anderson, CEO

Thank you, Paul, and thank you, everyone, for joining today's call. Our fiscal 2025 was an outstanding year for Coherent as full year revenue increased by approximately 23% year-over-year to a record $5.81 billion, driven by strong growth in our data center and communications business. Our revenue growth, combined with gross margin expansion of 358 basis points led to an approximately 3x increase in our non-GAAP EPS over the prior year. In addition, Q4 marked a strong end to the year with revenue increasing 16% year-over-year to a new record and non-GAAP EPS approximately doubling year-over-year to $1 per share. Having completed my first year with Coherent, I'd like to take the opportunity to thank my Coherent teammates for their outstanding focus and execution over the last year and their help in positioning the company for continued long-term growth. At Coherent, almost everything we do touches a photon in some way. We believe there is no other company with a broader and deeper portfolio of photonic technology, expertise, and innovation. Photonics is becoming increasingly critical to many applications, including AI datacenter communications and a wide range of industrial applications, and Coherent is well positioned to take full advantage of this opportunity. We're excited about the future, and I couldn't be more proud to be part of such an incredible team. Let me provide some market and product updates from the past quarter. In our data center and communications market, revenue grew by 51% in fiscal '25. In Q4, revenue grew 5% sequentially and 39% year-over-year. For fiscal Q4 and full year, we saw strong growth in both AI datacenter and communications. In the data center market, full year revenue increased by 61%. For Q4, we again achieved record quarterly revenue with data center revenue growth of 3% sequentially and 38% year-over-year. We continue to see strong bookings and demand forecasts across our data center customers as they continue to invest in AI datacenter capacity expansion. In fiscal Q4, we were pleased to see initial revenue shipments of our new 1.6T Transceivers, and we continue to expect 1.6T volumes to ramp throughout the balance of this calendar year with more meaningful revenue contribution in calendar '26. In the meantime, demand continued to grow in Q4 for our Transceivers with data rates below 1.6T. Beyond 1.6T, we continued to make solid progress on the development of our 3.2T Transceiver products and technologies, which will support a range of optical data transmission form factors. Our 400-gig per lane differential EML, which we demonstrated earlier this year and is the foundation of 3.2T Transceivers, is recognized by our customers as a key advantage of Coherent's technology roadmap. We also continue to make progress on CPO-related products and technologies, with strong engagements across a wide range of customers. For example, one of the key technologies behind CPO applications is CW lasers. We have a long history of producing CW lasers, and we drove a significant increase both sequentially and year-over-year in our CW laser production in Q4, and we expect to continue to rapidly ramp CW laser volume over the coming quarters. To meet the rising demand for our optical networking solutions that use EML or CW lasers, we continue to ramp internal production of indium phosphide, which is the key technology behind EML and CW lasers used in both pluggable transceivers and CPO applications. As a reminder, we've had indium phosphide capability in-house for over 20 years, and indium phosphide-based transceivers account for a majority of our Datacom Transceiver revenue, with the majority of our EML-based transceivers utilizing our internally manufactured EMLs. We've tripled indium phosphide capacity year-over-year and expect to continue to expand capacity over the coming quarters to support the strong demand signals from our customers. For example, I'm pleased to announce that we will begin production this month of our new 6-inch indium phosphide line in Coherent's Sherman, Texas facility. This is the world's first 6-inch indium phosphide production platform and is expected to provide us significant advantages in terms of both lower cost and higher volume production, and it will further enhance our industry-leading supply chain resiliency. In addition to indium phosphide, our Sherman, Texas facility is also a site for VCSEL production on gallium arsenide technology. As mentioned in a recent Apple announcement regarding their American manufacturing program, we've entered into a new multiyear agreement with Apple for a new generation of VCSEL products that support Apple's iPhone and iPad products. We expect revenue from this expanded partnership with Apple to begin in the second half of calendar '26. The VCSELs for Apple are manufactured in our Sherman, Texas facility and will help support the long-term growth and utilization of the site. I want to thank Apple, which has been a long-standing customer for this important multiyear agreement. This agreement highlights the importance of our supply chain resiliency and flexibility, including our significant U.S. manufacturing footprint. In fiscal Q4, we also began initial revenue shipments of our new Optical Circuit Switch. As a reminder, this new product represents a $2 billion expansion of our addressable market opportunity. The underlying technology in our OCS has tremendous benefits versus mechanical MEMS-based solutions offered by others as our solution is non-mechanical and is based on field-proven digital liquid-crystal technology that's been deployed for many years in demand telecom applications. Customer engagements on this new product continue to grow, and we expect revenue to ramp through the remainder of this calendar year and to contribute more meaningfully in calendar '26. We also delivered strong growth for both full year fiscal '25 and Q4 in our communications business. This business is comprised of both traditional telecom as well as data center interconnect. Communications revenue increased 23% for fiscal '25. For Q4, we saw accelerated growth in this segment as communications grew 11% sequentially and 42% year-over-year. Growth was driven by robust demand for our ZR/ZR+, DCI-focused new product introductions and ongoing recovery in end demand in the traditional transport market. We saw continued growth in the ramp of our new products, including our 100-gig, 400-gig, and 800-gig ZR/ZR+ Coherent transceivers and expect these products to increase their revenue contribution throughout fiscal '26 and beyond. In particular, our 100-gig ZR product family is ramping rapidly. Driven by strong customer traction for this uniquely differentiated solution, we productized multiple variants and have several more in development across multiple applications. We believe both AI datacenters as well as communications will be strong long-term growth drivers for the company given the exceptional breadth and depth of our photonic technology. Turning to our industrial-related end markets. Revenue decreased 2% for the year. For our fiscal Q4, revenue decreased 2% sequentially and 8% year-over-year. For the full year, we delivered above-market growth in our industrial laser products and services, which were offset by a decline in our silicon carbide business, which was consistent with softer end market demand in the automotive segment. In our industrial laser products, where we lead the industry with the widest and deepest portfolio of industrial lasers, fiscal 2025 growth was driven by growth in both product sales as well as growth in our recurring services revenue stream. Year-over-year growth was driven primarily by display capital equipment and semi cap equipment markets. In particular, display capital equipment growth was driven by growing demand for our laser systems and services that are used to support the capacity expansion of OLED fabs. As OLED screen adoption continues to grow and total OLED surface area is expected to double over the coming years. Across our industrial laser products, our recurring services revenue stream grew faster than product sales. As we discussed at our Investor Day, we continue to expand the installed base of our industrial lasers, and we expect the recurring service revenue stream to continue to become a larger component of our overall industrial revenue over time, which is a tailwind for our gross margin. For our materials products, fiscal '25 revenue, excluding silicon carbide, was flat year-over-year as demand remained stable. During fiscal '25, we experienced a drop in silicon carbide demand, which was a headwind to our overall industrial revenue. However, over the past months, silicon carbide demand has stabilized, and we do not expect this to be a headwind for us in fiscal '26. We continue to see our industrial products and end markets as a strong long-term revenue growth and gross margin expansion opportunity for the company given our leadership portfolio of hardware and software products and services. On the topic of our investment strategy and our portfolio optimization initiative, as discussed over the past quarters and at our recent Investor Day, we've been driving a series of actions to streamline our portfolio and concentrate our investments in the areas of greatest long-term growth and profitability. As part of our portfolio optimization, today, we announced an agreement to sell our Aerospace and Defense business for $400 million. We expect to close this transaction this quarter. Upon closing, we plan to use the proceeds of the sale to pay down additional debt, and we expect the sale to be accretive to our EPS. We made the decision to sell our A&D business because it was not aligned with our long-term strategic focus areas, and it did not support our long-term financial targets. I'd like to thank all of the A&D employees for their tremendous contributions to Coherent over the past years and wish them all the best moving forward. We will continue to look for ways to streamline and strengthen our portfolio moving forward and ensure that our investments are concentrated in the areas of greatest shareholder value creation. Regarding the current tariff policy environment, unchanged from last quarter, we do not expect significant impact from tariffs this quarter. Though we do not have full details yet, we believe President Trump's recent announcement regarding semiconductor tariffs may present a competitive advantage for our business. Many of our products such as transceivers are today covered by the semiconductor exemption. And as a company with significant U.S. manufacturing operations today and new investments planned for our Sherman, Texas, Eastern Pennsylvania, and other U.S. facilities, we believe we would avoid the semiconductor tariff. Our extensive U.S. manufacturing footprint is a key part of our overall supply chain resiliency, and we believe this is an important competitive advantage for us. Over the past months, you've heard me stress the importance of Coherent's dynamic, flexible global manufacturing footprint as a competitive advantage and a hedge against geopolitical risk. Our U.S. footprint is a key part of that strategy. Coherent has a long and proud history of advanced manufacturing in the United States, leading U.S. manufacturing innovation since our founding more than 50 years ago, beginning with the company's first manufacturing site in Saxonburg, Pennsylvania, which remains our company headquarters. Today, our U.S. manufacturing footprint extends across more than 20 U.S. manufacturing locations in 13 states. Across those U.S. manufacturing locations, we employ thousands of people. These sites lead the industry in technical innovation and manufacturing, and we continue to invest in our U.S. manufacturing footprint. In summary, I'm very pleased with the progress we made during our fiscal 2025. We expect fiscal '26 to be another growth year for the company and believe we are well positioned for continued long-term growth as we drive market-leading photonic innovation across our core markets and continue to progress toward the financial targets we provided at our Investor Day. Once again, I want to thank the Coherent team for all their hard work and dedication. I couldn't be more proud of my teammates and their laser focus on unlocking the full potential of the company. I'll now turn the call over to our CFO, Sherri Luther.

Sherri R. Luther, CFO

Thank you, Jim. We are pleased with our full year 2025 results. We drove strong double-digit revenue growth, significant gross margin expansion, and improved profitability. We increased our cash from operations, enabling us to significantly pay down our outstanding debt and further strengthen our balance sheet. Let me now provide a summary of our results. Fourth quarter revenue was a record $1.53 billion, up 2% sequentially from the third quarter and up 16% year-over-year, driven by growth in AI datacenter demand, coupled with the continuing recovery in telecom. Full year 2025 revenue was a record $5.81 billion, up 23% from 2024. Revenue growth for the full year 2025 was driven by growth in both AI datacenter demand as well as telecom. Our Q4 non-GAAP gross margin was 38.1%, down 43 basis points compared to the prior quarter and was up 220 basis points compared to the year ago quarter. The sequential decline in gross margin was primarily driven by unfavorable foreign exchange in Q4, which was partially offset by benefits from our gross margin expansion strategy with improvements in both pricing optimization as well as cost reductions. Our non-GAAP gross margin for the full year 2025 was 37.9%, up 358 basis points from 2024. The improvements in non-GAAP gross margin for the full year 2025 were driven by our gross margin expansion strategy, where we saw improvements in both pricing optimization as well as cost reductions, offset somewhat by unfavorable mix and foreign exchange. Cost reductions included lower manufacturing costs as well as yield improvements. Fourth quarter non-GAAP operating expenses were $307 million compared to $297 million in the prior quarter and $269 million in the year ago quarter. The increases were primarily in R&D, driven by increased investments in our product portfolio, in particular, in data center and communications. We continue to focus on investing our R&D in those projects with the highest ROI while driving efficiency and greater leverage in SG&A. Non-GAAP operating expenses for the full year 2025 increased to $1.17 billion from $998 million in 2024, primarily driven by increased investments in our product portfolio as well as variable compensation. Our fourth quarter non-GAAP operating margin was 18% compared to 18.6% in the prior quarter and 15.4% in the year ago quarter. Our non-GAAP operating margin for the full year 2025 was 17.8%, up 472 basis points from 2024. Fourth quarter non-GAAP earnings per diluted share was $1 compared to $0.91 in the prior quarter and $0.51 in the year ago quarter. Non-GAAP diluted earnings per share for the full year 2025 was $3.53 compared to $1.21 for the full year 2024. This represents a 191% year-over-year growth. We paid down $51 million in debt during the quarter using cash from operations. This brings our fiscal 2025 total debt payments to $437 million, nearly 2x the amount of debt payments made in fiscal 2024. This significant increase in debt payments has reduced our debt leverage ratio to 2x, down from 2.5x as defined in the credit agreement at the end of 2024. As Jim noted, we plan to use the proceeds from the sale of the Aerospace and Defense business to further reduce our interest expense by paying down additional debt, which will be immediately accretive to our EPS. For reference, this sale will result in Coherent's exit from 10 sites and will reduce our employee count by approximately 550 employees who will remain with the A&D business. Over the past 4 quarters, this business contributed average quarterly revenue of approximately $50 million with a gross margin below Coherent's average gross margin. We view this sale as a very positive outcome for shareholders as exiting this business will meaningfully streamline our portfolio, allow us to accelerate the paydown of our debt, increase our profitability and focus our investments in the areas that enhance shareholder value. I will now turn to our guidance for the first quarter of fiscal 2026. We expect the sale of our Aerospace and Defense business to close this quarter. As a result, our outlook excludes approximately $20 million in Aerospace and defense revenue that we expect will occur after we close the sale. We expect revenue to be between $1.46 billion and $1.6 billion. We expect non-GAAP gross margin to be between 37.5% and 39.5%. We expect total operating expenses of between $290 million and $310 million on a non-GAAP basis. We expect the tax rate for the quarter to be between 18% and 22% on a non-GAAP basis. We expect EPS of between $0.93 and $1.13 on a non-GAAP basis. In summary, I'm very pleased with the progress we have made in Q4 and throughout fiscal 2025. We are excited about the year ahead and remain focused on executing to our financial target model that we laid out at our Investor Day earlier this year. That concludes my formal comments. Operator, please open the call for Q&A.

Operator, Operator

Our first question comes from Samik Chatterjee with JPMorgan.

Samik Chatterjee, Analyst

Jim, I can start by discussing the data center side. Based on your new segmentation, you achieved impressive results in the fourth quarter with 40% year-over-year revenue growth. What is your outlook for growth in the next fiscal year? We've noticed that all the hyperscalers have increased their capital spending plans as well. Can you provide any insights on growth rates or your perspective on the data center business outlook for fiscal '26? I also have a follow-up question.

Richard Cutts Shannon, Analyst

Thank you for the question, Samik. Reflecting on fiscal '25, I'm very pleased with the growth we experienced in data center and communications, which includes both our traditional business and DCI. We achieved over 50% growth for the full year, and in the latest quarter, specifically the June quarter, we recorded a 5% sequential growth and nearly 40% year-over-year growth. The data center segment was the fastest-growing, exceeding 60% growth for the year, and I want to express my gratitude to the team for their excellent execution over the past year. Looking ahead, we continue to observe strong demand indicators, supported by our backlog, current ordering activity, and customers' long-term forecasts. The demand outlook remains robust, and we expect data center and communications to show sequential growth again this quarter. While we're not providing specific guidance for the current quarter, we do anticipate sequential growth. Additionally, several factors are contributing to our growth trajectory. First, our 800-gig transceivers are gaining momentum, and we expect continued growth in this area through this calendar year and into the next. We're also excited about the initial revenue from our 1.6T transceivers, which began shipping in the previous quarter and is expected to ramp up through this year and next. Furthermore, we started seeing revenue from our optical circuit switch last quarter, and we anticipate that will also continue to grow. We noted accelerated growth in the communications segment, with double-digit sequential growth in the most recent quarter, particularly in data center interconnect driven by strong demand for our ZR/ZR+ products. We have a robust lineup in that category. Overall, there are numerous growth opportunities ahead, and we're enthusiastic about our prospects for the upcoming year. We're also focused on expanding our capacity to meet the anticipated demand, including assembly, testing capacity, and essential components like indium phosphide. We're genuinely excited about the growth potential in data center and communications.

Samik Chatterjee, Analyst

Got it. For my follow-up, I wanted to ask about your progress on the 6-inch indium phosphide platform in Sherman, Texas. Can you provide an update on how the ramp is going? What feedback are you receiving from customers regarding interest in U.S. manufacturing? Specifically, what does the announcement with Apple indicate in terms of additional revenue or opportunities? Any insights on that would be helpful.

James Robert Anderson, CEO

Thank you, Samik. I'll begin with the 6-inch indium phosphide and our facility in Sherman. We see this as a significant milestone. In August, we started production on the new 6-inch indium phosphide line in Sherman, which we believe is the first of its kind in the world. Production will commence this quarter and increase over the next few quarters. This development offers us two major advantages: increased capacity due to the larger wafer size and a favorable cost structure. As we fully ramp up this capacity, we will not only achieve higher volume but also lower costs, which is a substantial benefit. We are truly excited about this and looking forward to the ramp-up. Regarding our U.S. manufacturing footprint, this is definitely part of our overall strategy to invest in domestic manufacturing. Over the past few years, the company has made significant strides in enhancing our supply chain resilience and flexibility, emphasizing geographic diversity and the strategic vertical integration of essential components. A key aspect of this geographic diversity is our strong presence in U.S. manufacturing, with over 20 sites across 13 states employing thousands of people. We continue to invest in U.S. manufacturing because we see it as a competitive advantage. Our top strategic customers frequently acknowledge that our supply chain resilience and U.S. manufacturing footprint are vital elements of our competitiveness. A recent example of this is our partnership with Apple, which underscores the strategic advantage of our U.S. manufacturing presence, particularly at the Sherman facility. We are excited about the expansion of our partnership with Apple. As for revenue, we anticipate that the financial benefits from this extended partnership will materialize in the second half of next calendar year. This situation highlights the strength of our U.S. manufacturing presence and our ongoing commitment to enhancing our supply chain resilience.

Operator, Operator

Our next question comes from Simon Leopold with Raymond James.

Simon Matthew Leopold, Analyst

First thing I wanted to see if I could get an understanding of what product categories or segments might be down sequentially at the midpoint of your guidance. And I appreciate you've highlighted the $20 million for the aerospace sale. But apart from that, it sounds like there's a number of things going well. So I'm trying to make sure I capture what might be down sequentially from the June quarter? And then I've got a quick follow-up. I'll ask now, is you talked about generating some revenue from the OCS, could you tell us a little bit about your pipeline and the thoughts on the trajectory for that product line?

James Robert Anderson, CEO

Yes. Thanks, Simon. On the first part of the question, so as you mentioned, we expect data center and communications to be up sequentially. We expect our industrial-related markets to be down sequentially. Part of that is the $20 million that Sherri mentioned that we took out of the guidance, assuming the transaction closes sometime during this quarter. If you set that aside sort of on a pro forma basis, I would say we expect Industrial to be flat to down sequentially. We're taking a bit of a cautious view on the broad-based industrial market. Just given the macro economy uncertainty around tariffs, we're just a little bit more of a cautious view of that business and that end market. Now that said, that's a very near-term comment. Over the long term, we still believe that the industrial segments represent a really good growth opportunity for the company. And I would highlight that if you look at last year fiscal '25, our industrial segment, if you set aside the silicon carbide headwind that we had last year, we saw some nice growth in our industrial segment, especially in our industrial lasers. So over the long term, we expect industrial to continue to be a good growth area for the company across things like semi cap equipment, display capital equipment. But near term more of a cautious view on that market. And then the second part of the question, I think, was on OCS pipeline. Yes, I would say the OCS pipeline is very healthy. We are really pleased with the initial revenue generation in the prior quarter. The customer engagement, I would call very strong across multiple customers. And we're very excited about the ramp of this product. We are adding capacity to support the ramp of this product as fast as we can based on the demand outlook that we're getting and the orders that we're getting from our customers.

Operator, Operator

The next question comes from George Notter with Wolfe Research.

George Charles Notter, Analyst

I guess I wanted to come back to the Apple relationship. I'm just curious how much incremental revenue is in the offering from that relationship. Yes. If I look back, obviously, there was a step-down in the Apple business going back a couple of years ago, it was pretty significant for the company. I guess I'm wondering if you've been able to kind of build in anything contractually that gives you more certainty of that run rate on a go-forward basis?

James Robert Anderson, CEO

Yes, we are very optimistic about the expansion of our partnership with Apple. This involves a new generation of VCSELs for their iPads and iPhones, which we expect will positively impact our revenue starting in the second half of 2026. We believe this is a long-term collaboration, and we value our strong history with Apple. It is encouraging to see this partnership grow. Additionally, these VCSELs are produced at our plant in Sherman, Texas, which not only helps in maximizing the utilization of that facility but also supports our overall business there, especially as we increase production of other products like the indium phosphide capacity I mentioned earlier. This highlights the significance of our manufacturing presence in the U.S.

George Charles Notter, Analyst

Just as a quick follow-up. Is there any sense for what your market share would look like in Apple on a 3D sensing basis? And then also, do you have to make capital investments in Sherman? Is that something that Apple would help you with? Or is that fully on Coherent?

James Robert Anderson, CEO

Yes. On the first, we do have a sense of the share. We'll probably share more details about that as we just get closer to the ramp. So I would say stay tuned on that, and we'll provide sort of more thoughts on the size and the rate and the pace of that ramp as we get closer to the second half of '26. And then on capital, I think there's a little bit of incremental capital that we would be providing, but to support that business.

Operator, Operator

The next question comes from Blayne Curtis with Jefferies.

Unidentified Analyst, Analyst

Ezra Weener on for Blayne. I guess the first one would be on the OCS competitive landscape. I know you guys talked about the liquid crystal versus mechanical. Can you talk a little bit about what that is from a performance benefit and what that means for cost for your customer?

James Robert Anderson, CEO

Yes. Thanks, Ezra. Yes, first of all, let me just describe the technology difference. So if you look at what's been deployed sort of historically around optical circuit switching, it's been based on MEMS technology, which is an inherently mechanical technology. Our technology is digital liquid crystal, and this is a technology that we've used for years in our telecom business. So what we've done is we've taken that technology and repurposed it for optical circuit switching. And because it's a non-mechanical technology, it has a much, much higher reliability. And as you can imagine, in a data center and AI datacenter, reliability is an incredibly important attribute to our customers. So it has much higher reliability. And the performance is very good. The performance is meeting the specs of our customers and so that's why we're seeing, I would say, again, very strong engagement across multiple customers, and we're really excited about the ramp of this product.

Unidentified Analyst, Analyst

Got it. And then the second one would be, you talked about initial 1.6T shipments and that 800G is going to ramp this year and next year. Can you talk a little bit more about what you're seeing, a, from a supply-demand perspective on that as your capacity ramps and also a little bit more about what you're internally sourcing from a laser perspective versus externally sourcing?

James Robert Anderson, CEO

Okay. Regarding the first part of the discussion, the 800-gig ramp is clearly increasing this calendar year compared to the previous one. We expect this growth to continue into next year, and it is ramping up rapidly. Additionally, we believe that the 1.6T will begin to ramp alongside the 800-gig growth. We saw initial revenue from this in the previous quarter, and we anticipate that this revenue will increase in the upcoming quarters. For a model of how these transitions and ramp-ups occur over time, I recommend looking back at our Investor Day in May, where we presented a multiyear model illustrating these transitions and the layering of different speeds and their impact on overall growth. To summarize, you should consider the 800-gig to continue its ramp into next year, with the 1.6T ramping additionally on top of that. On the second part of your question regarding capacity and laser, we are certainly increasing our capacity to fulfill the demand we are observing for both 800-gig and 1.6T. This involves enhancing our assembly and testing processes as well as ramping up the internal components needed for the transceiver, such as laser capacity, specifically indium phosphide. This is why I highlighted in my prepared remarks that achieving production of indium phosphide 6-inch this August is a significant milestone, and we are continuing to ramp this from now on. Regarding the mix of internal versus external lasers, we currently utilize a combination of both. I expect this to continue. Currently, more than half of our transceivers are equipped with EML lasers, with over half of those EML-based transceivers being sourced internally. This gives you a rough idea of the distribution. We believe we will maintain a mix of both internally sourced and externally sourced lasers.

Operator, Operator

The next question comes from Vivek Arya with Bank of America Securities.

Vivek Arya, Analyst

So the first one, Jim, I realized this is a little bit more short-term oriented. But when I look at your data center and communications segment, sequential growth rate has gone from 9% in March to 5% in June, and I think your September implied is probably at or somewhat below this number, even though you're starting to ramp 1.6T and OCS. So what is the right way to interpret, right, this kind of somewhat slowdown because when I look at the deployment of AI clusters, they seem to be accelerating in the back half and one of your closest peers guided to double-digit sequential growth. So how would you address that pushback and do you think the sequential growth rates can start to reaccelerate at some point?

James Robert Anderson, CEO

Thank you, Vivek. The sequential growth rates can vary from quarter to quarter due to fluctuations in customer demand or supply and capacity issues. However, when looking at the entire fiscal year of '25, I'm quite satisfied with our growth in the data center sector, achieving over 60% overall growth and even higher growth in the higher speed data rates. We believe we gained market share during that year, and we feel optimistic about the fiscal '25 results. Moving into this current fiscal year, we anticipate very strong demand driven by several growth factors, including 800-gig and 1.6T. We have also noted robust demand in our DCI segment. Therefore, we are confident about our future growth and are ensuring we have the necessary capacity in place to meet this demand.

Vivek Arya, Analyst

And for my follow-up, maybe one on gross margins. I think Sherri you mentioned there were some FX headwinds in Q4, if you could perhaps quantify how much that impacted gross margin? Are you assuming any headwind in Q1? And then as we look out into fiscal '26 and you look at the ramp you might have with that Apple and just obviously, the continued growth in transceivers. Do you think that there is a chance that Coherent gets toward that 40% gross margin that many have been expecting for a while? Or is there a different mix that we should keep in mind as we model gross margins for the fiscal year?

Sherri R. Luther, CFO

Vivek, I'll address that question. The decline in gross margin we saw this quarter was primarily due to unfavorable foreign exchange rates, although we did mitigate some of that through our gross margin expansion strategy, including cost reductions and pricing optimization. I'm quite satisfied with the advancements we've made in these areas. In fact, were it not for the challenges posed by foreign exchange, our gross margin would have surpassed the upper limit of our guidance for the quarter. I'm genuinely pleased with the progress on our gross margin initiatives. To elaborate on cost reductions, we experienced yield improvements and enhancements in our manufacturing processes that provided benefits. Regarding pricing optimization, we noted positive results in both our lasers and datacom segments. This has led to promising outcomes. Regarding your question about our Q1 guidance related to foreign exchange, it's derived from the most current information available. I don't foresee a significant impact, but it is based on what we know at this time. It seems the foreign exchange challenges from the last quarter stem from historic weaknesses of the U.S. dollar against several currencies, which is a rarity in recent years. Therefore, I don't expect this to significantly affect the next quarter. You also inquired about Apple and its effect on our gross margin. I anticipate that partnership will positively impact our gross margin. I'm very satisfied with our arrangement with Apple, and I believe it will enhance our gross margin in the future. Finally, regarding whether we can reach our long-term target of greater than 42%, I am confident we will achieve this model. The improvements we've seen in Q4 and throughout the 2025 fiscal year, where our gross margin increased by 360 basis points, are quite encouraging. I view this as just the beginning of our initiative, which will continue. The timing of when we see the impacts or benefits may fluctuate quarterly, but I feel very optimistic about our long-term target model.

Operator, Operator

The next question comes from Meta Marshall with Morgan Stanley.

Meta A. Marshall, Analyst

Maybe a couple for me. Just on the industrial lasers business, is there any geographic concentration to where the customers are that perhaps kind of make you a little bit more cautious? Or do kind of general caution in industrial production? And then maybe just a second question on datacom. Is there any lumpiness maybe you mentioned lumpiness as a factor there, but just any design changes or things to be mindful of, even if they're kind of staying with you overall as a customer, just to be mindful that could kind of cause some of that lumpiness.

James Robert Anderson, CEO

Thank you, Meta. Regarding the first part of your question about industrial lasers, I wouldn’t say we have any unexpected issues with customer concentration. We have a diverse customer base that includes a large number of clients in Europe, many in Asia, and some in North America as well. Our cautious stance on that sector stems from the high cost of capital and ongoing tariff uncertainties, which lead us to take a more conservative outlook for the near term. While we could be mistaken and the situation might improve, we prefer to be cautious at this moment. Looking at fiscal '25 for our overall industrial business, excluding the significant headwinds from silicon carbide, I was quite satisfied with the rest of the performance. Our industrial lasers experienced year-over-year growth, with the service and recurring revenue component exceeding the growth of our product sales, which is encouraging. This remains a key strategic focus for us and supports our gross margins positively. While we are adopting a more cautious view for the near term, we still believe this is a promising growth area for the company in the long run. As for the second question about data centers and the fluctuations in growth rates quarter-to-quarter, we have historically observed these variations, and we do not find them unusual for this business. The transition some customers are making from 400-gig to mainly 800-gig, which is related to the 800-gig ramp you mentioned, involves expected changes that we categorize as normal.

Operator, Operator

The next question comes from Papa Sylla with Citibank.

Papa Talla Sylla, Analyst

So I guess for my first question is on DCI. You seem to be kind of seeing a very strong growth there. Can you maybe touch a little bit on the nature of your customers or any visibility on the underlying factor there? Is the growth kind of primarily coming from multi-data center training or is it more inference? And maybe part of that question is kind of any color at this point on how we should think about DCI sales versus traditional telco?

James Robert Anderson, CEO

Thank you, Papa. To address your first question, yes, we are experiencing robust demand in DCI. When looking at the communications segment of our business, which includes both traditional telecom and DCI, we noted an overall sequential increase of about 11% in the latest quarter. However, DCI showed even stronger growth. This can be attributed to our range of products, such as the ZR/ZR+ 100-gig, 400-gig, and 800-gig coherent transceivers, which are ramping up effectively. We have a competitive lineup of products, and we are encouraged by the growth. We continue to observe strong demand signals moving forward. In response to your second question regarding customers, in DCI, we utilize two routes to market. We sell coherent transceivers and related systems, and we also supply components to other vendors. Thus, we have both product sales and component sales, both of which are experiencing strong demand. Regarding the nature of demand, it is largely driven by multi-data center workloads requiring interconnectivity between multiple data centers, although there is still some demand for inference. I believe I have addressed all aspects of your question.

Papa Talla Sylla, Analyst

Yes, absolutely. You got them all. I'll make sure my follow-up will be a little bit shorter. I guess I was hoping on the datacom sequential growth, you can pass through a little bit. Obviously, 800-gig plus AI was very strong. But just any sense of the sub-400 gig kind of demand this quarter and then moving forward?

James Robert Anderson, CEO

Yes, we expect the demand for 800-gig to keep increasing this quarter. Demand for 400-gig and lower remains relatively strong, with several customers using significant amounts. We anticipate this demand to stay robust in the near term, while the market shifts towards 800-gig. Additionally, we are beginning to see revenue related to 1.6T. During our Investor Day in May, we shared insights on market growth and the transition from 400-gig to 800-gig and eventually to 1.6T, and even projected 3.2T. Our perspective on this remains consistent with what we presented in May, and I recommend referring back to the Investor Day for a detailed view of the expected transitions.

Operator, Operator

The next question comes from Christopher Rolland with Susquehanna.

Christopher Adam Jackson Rolland, Analyst

My questions are really around transceiver. There has been outstanding growth in transceivers, but I have some questions about the Chinese dynamic with companies like Optilink growing at rates of 60% and 150% this year. How do you perceive Coherent's market share as we move toward 800 and eventually 1.6 with the pricing pressures from this Chinese dynamic? What are your specific plans for increasing transceiver capacity in 2026 and beyond?

James Robert Anderson, CEO

Thank you, Chris. Regarding the first part of your question on market share, we believe we gained share in fiscal '25 based on third-party independent data. It's crucial to examine trends over multiple quarters rather than just one, and we feel we have improved our market position overall, specifically in the higher data rate transceivers. We're committed to further increasing our share. We believe we are competitively well-positioned for two main reasons: our technology roadmap and our supply chain resiliency and strategy. On the technology front, we offer a strong lineup of 800-gig transceivers. Earlier this year at OFC, we showcased three different versions of 1.6T transceivers using different laser technologies: VCSELs, EMLs, and silicon photonics. Our technological capabilities make us feel confident in our position. Regarding our supply chain, we have a robust and resilient network thanks to our geographically diverse U.S. manufacturing, vertical integration, and our internal supply of vital components like indium phosphide and EMLs. This resilience is a significant advantage that customers recognize, which enables us to continue gaining market share. Concerning pricing pressure, we have seen pricing develop as expected, without any unusual fluctuations. As for capacity, we are ramping it up as swiftly as possible, which includes both assembly and test capacity, as well as an increase in key ingredient production like indium phosphide and EMLs. We have tripled our indium phosphide capacity year-over-year and have also boosted CW laser production sequentially and year-over-year. We are focused on expanding capacity given the strong demand signals and forecasts from our major data center customers.

Christopher Adam Jackson Rolland, Analyst

Very helpful, Jim. I also read an article suggesting that you guys inaugurated a new facility in Vietnam. This article suggested there were multiple products there, including expanding capacity for silicon carbide. I don't know if all the facts in this article were correct or not. But could you talk about that Vietnam facility and your plans for silicon carbide as well moving forward?

James Robert Anderson, CEO

Yes. Thanks. We did inaugurate a new facility in Vietnam. This is part of our strategy around geographic diversity, and then this facility is focused on a number of our materials-related businesses and silicon carbide being one of them. And so yes, we're really pleased with the opening of that facility that will help us drive some additional flexibility, capacity, and cost structure advantages. On the silicon carbide business, in general, if you remember, we recently stopped the investment in the devices and modules portion of the silicon carbide business. That was pre-revenue investment. And so we shut down that and concentrated the investment on the wafers and the epi that we supply silicon carbide last year in fiscal year that was a headwind for us. We did see a significant drop in silicon carbide demand. But more recently, that has now stabilized, and we've started to see demand pick back up. We don't expect that silicon carbide business to be a headwind for us in fiscal '26. And so yes, certainly expecting a bit of growth from silicon carbide this fiscal year.

Operator, Operator

The next one comes from Karl Ackerman with PNB Paribas.

Karl Ackerman, Analyst

I have 2 questions, if I may. First, do you believe you can be in a position to service all or nearly all of your EML laser needs internally by the end of this calendar year? As 6-inch comes online? And I have a follow-up.

James Robert Anderson, CEO

Yes. On the first part of the question, we're certainly ramping 6-inch capacity as quickly as we can. It's not, Karl, just to make sure I correct, it's not just about EMLs indium phosphide is used in a lot of different products. E-mails is one, also CW lasers. CW lasers are used in both silicon photonics as well as CPO applications. And so we're also ramping that indium phosphide to support those applications. They're also used for photodiodes and other products. So there's actually quite a number of products. But in terms of our insource versus outsource strategy, I believe we'll continue to use a mix for EMLs. In particular, we'll continue to use a mix of both internal supply and external as well. I think that gives us really good supply chain resiliency and optionality, and so I would see that we continue to have a mix in the foreseeable future.

Karl Ackerman, Analyst

Helpful. And then you certainly gave comments around datacom around in the September quarter. But just risen rising CapEx forecast by several key data center customers, do you believe that you can now grow or at least grow in line with your datacom growth rates that you've outlaid during your most recent Analyst Day?

James Robert Anderson, CEO

Yes, that's certainly our target is to grow within that range that we provided in the May Investor Day or certainly, we will target growing faster if we can. We're certainly adding capacity, as I mentioned a couple of times during the call, to support that growth. We see strong demand signals from our customers, and we're certainly adding the capacity to meet that demand. Does that answer your question, Karl?

Operator, Operator

Thank you. Ladies and gentlemen, this concludes the question-and-answer session. I would now like to hand the conference over to the CEO, Jim Anderson, for any closing comments.

James Robert Anderson, CEO

Yes. Thanks, everybody, for joining the call today. I just want to take the opportunity to once again thank my Coherent teammates for the great results in fiscal '25. And also for helping position Coherent for another strong growth year ahead of us as we kick off our fiscal '26. Thanks again for the support. Operator, that concludes our call.

Operator, Operator

Thank you. Ladies and gentlemen, the conference of Coherent Corp has now concluded. Thank you for participation. You may now disconnect your lines.