Earnings Call Transcript
COHERENT CORP. (COHR)
Earnings Call Transcript - COHR Q4 2023
Operator, Operator
Good day and thank you for standing by. Welcome to the Coherent Corp. FY23 Fourth Quarter Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Paul Silverstein. Please go ahead.
Paul Silverstein, Speaker
Thank you, Kevin, and good morning, everyone. Thank you for joining our fourth quarter fiscal 2023 earnings call. Today on the call, we have Chairman and CEO, Dr. Chuck Mattera; Chief Financial Officer, Mary Jane Raymond; Chief Strategy Officer and President of Materials Segment, Dr. Giovanni Barbarossa; and Laser Segment, President, Dr. Mark Sobey. As a reminder, yesterday after the market closed, Coherent posted a shareholder letter along with an updated investor presentation. They can both be found in the Investor Relations section of our website. Before I turn the call over to Chuck for his opening remarks, I want to call everyone’s attention to our shareholder letter and accompanying change in format of this morning’s call. The shareholder letter contains the traditional financial statements that were previously set forth in our earnings press releases, along with additional color around our operating performance, key trends and outlook. Given the additional disclosures in the letter, we plan to devote the bulk of this morning’s call to answering questions from the financial community. We’ve undertaken this change with the goal of providing greater insight and clarity for our quarterly earnings release. We welcome your feedback. I also want to remind everyone on this call that we will refer to forward-looking statements, including all statements the Company will make about its future financial and operating performance, growth strategy and market outlook, and that actual results may differ materially from those contemplated by these forward-looking statements. Risk factors that could cause actual results and trends to differ materially are set forth in the shareholder letter and the annual and quarterly reports filed with the SEC. Coherent assumes no obligation to update any forward-looking statements which speak only as of their respective dates. In addition, during this call, we may discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in the shareholder letter. Unless otherwise stated, all financial information referenced in this call will be non-GAAP. Our discussion will be limited to those non-GAAP financial measures that are reconciled in the shareholder letter. Today’s conference call will be available for webcast replay in the Investor Relations section of our website for one year. With that, it is my pleasure to turn the call over to Chuck. Chuck, please go ahead.
Dr. Chuck Mattera, CEO
Thank you, Paul. I hope those of you listening in have had the opportunity to read our new shareholder letter. In the fourth quarter, the Coherent team did a good job executing in the midst of a challenging macroeconomic environment. Our revenue of $1.205 billion was above the high end of our guidance and non-GAAP EPS of $0.41 was toward the high end of our guidance. Operating cash flow was $182 million, which marked sequential and year-over-year improvement. We invested $93 million in capital equipment, and we retired $121 million of debt. When I look back on fiscal year ‘23, legacy Coherent contributed to our resilient business model. In addition, our track record following our acquisition of Finisar once again speaks to our ability to successfully effect strategic acquisitions, and thereby create shareholder value. Two major highlights in fiscal year ‘23 were related to our acquisition of Finisar. We demonstrated our unique scale while generating nearly 20% of our FY23 revenues from just two customers, one in Communications and one in Electronics. These are good examples of the strength of our vertically integrated platforms which enable breakthrough solutions, and our differentiated ability to scale to meet sudden increases in market demand like those that we are now seeing in AI. And while we experienced a surge in orders in Q4 in Communications for AI, the macroeconomic uncertainty that affected some of the industrial and instrumentation businesses, slower-than-forecasted recovery in China, and a post-COVID deceleration in the Communications markets, drove the conservative fourth quarter order patterns for some of our customers’ legacy products. Recently, some of those customers have taken actions, including reducing orders of legacy products in the face of lower demand and reducing their inventory levels while slowing their planned investments in CapEx. This setup presents the ongoing challenge of managing through a retooling in fiscal ‘24, and so we got busy during Q4 to align our costs with market reality. We view this temporary slowdown in demand as an opportunity to strengthen our foundations. We remain bullish about the future because many of our largest customers are also resetting their strategies and accelerating their investments in new products that depend on our innovations and our ability to manufacture at scale. The largest opportunity in FY24 that we are addressing is for 800G Datacom transceivers for planned artificial intelligence and machine learning build-outs. That demand should help offset the anticipated declines in demand from our traditional data center and hyperscale customers in data communications in fiscal ‘24. In addition, we continue our review of strategic alternatives for our silicon carbide business, another one of our major growth opportunities. Thanks to our strategy of diversification, we believe that we are well positioned to benefit from any improvement in the macroeconomic environment, though our outlook assumes that we will not see meaningful signs of recovery before the end of fiscal ‘24. So, in short, we are prepared for a reset year, and we consider these challenges as a temporary interruption of otherwise powerful secular trends. Our guidance for the first quarter of fiscal ‘24 is revenue of approximately $1 billion to $1.1 billion and non-GAAP EPS of approximately $0.05 to $0.20 on 153 million shares. Regarding full year fiscal ‘24 guidance, revenue of approximately $4.5 billion to $4.7 billion and non-GAAP EPS of approximately $1 to $1.50 on 153 million shares. With that, I’ll turn the call back over to Paul.
Paul Silverstein, Speaker
Kevin, if you could open it up for questions. Thank you.
Operator, Operator
Thank you. Our first question comes from Samik Chatterjee with JPMorgan.
Samik Chatterjee, Analyst
Good morning. I appreciate the opportunity to ask questions and the detailed information in the shareholder letter, which was very helpful. I would like to clarify something regarding AI and machine learning, specifically whether these elements are included in your guidance or if you decided not to include them. Can you explain if we should understand that there are no AI/ML orders factored into the fiscal '24 guidance, or is there a portion included based on your current capacity and visibility? You mentioned capacity ramp as one of the challenges in the shareholder letter in relation to fiscal '24, so could you elaborate on the capacity challenges you're facing and what milestones you need to achieve in order to include these elements in your guidance moving forward? I also have a quick follow-up.
Dr. Chuck Mattera, CEO
Okay. Thank you, Samik. I’ll take that. Maybe three points are helpful. The first one is that the Q4 bookings that we had a surge that we reported, that surge was all about AI. That’s number one. Number two, we have revenue for 800G transceivers contemplated inside our guidance in the $4.5 billion to $4.7 billion. There’s meaningful revenue for a delivery of 800G transceivers. Those have already started. In the first half of the year, we will see a ramp from Q1 to Q2, but the substantial amount of revenue we will deliver, it will be in the second half of the year. And what’s in front of that is managing our scale and especially managing our supply chain, and so we see the opportunity for over and above what we have in our plan. But that opportunity will require quite a few more synchronizations, including in the supply chain. As we work our way through in the next few months through the first and second quarter, we’ll have our eyes set as we work to compete for the greater opportunity that may come inside this fiscal year.
Samik Chatterjee, Analyst
Thank you for your presentation. You mentioned three distinct opportunities in AI/ML related to EMLs, your DFB laser, and VCSELs. Could you share your insights on which of these areas you believe has the highest potential for success and where the current demand for these orders is being generated?
Dr. Chuck Mattera, CEO
Okay. Well, I’ll start out and then I’ll ask Giovanni to finish it off, Samik. As you know, we’re a vertically integrated supplier. And in addition to selling both VCSEL-based and EML-based transceivers for this application, we are also a supplier to the merchant market. And having said that, our ability to scale both at high performance and high volume and high quality to be able to meet this ramp is partly the basis on which we’re going to continue to win both new orders and to be able to ship. Giovanni, please elaborate.
Dr. Giovanni Barbarossa, CSO
So Samik, I would say that approximately one-third will be short reach and short wavelength, while two-thirds will be long reach and long wavelength, and we can support both with our internal devices. We expect that ratio to vary in terms of volume because of price differences, likely resulting in a 50-50 split. This ratio is expected to remain consistent for the next five years, specifically regarding AI, including the 800G and possibly even the 1.6T in the future. This ratio should hold steady in the coming years as well.
Operator, Operator
Our next question comes from Simon Leopold with Raymond James.
Simon Leopold, Analyst
Great. I appreciate you taking the question and providing all the detail last night. It gave us a little bit of time to try to digest this. So, maybe a couple of aspects around the exclusion of the AI-related Datacom from the guidance. Could you help us understand the rationale for backing the AI-related business, which you described as worth several hundred millions, out of the guidance? And help us understand as well, if we wanted to include this in our own estimates, what do you think the impact would be on the EPS? Just as a very, very quick follow-up to this question, what assumption do you have in terms of your market share of 800 gig and above transceivers? Thank you.
Dr. Chuck Mattera, CEO
Okay, Simon. Let me clarify and repeat my response to Samik’s question. Our revenue guidance for the full year, especially for the first quarter, includes a significant amount of revenue from shipping 800G transceivers. I want to emphasize that our plan anticipates a substantial number of shipments. I believe there could be additional upside, potentially as much as $200 million. However, in order to confidently incorporate that into our plan, we need to manage several aspects of our ramp effectively, and we are committed to doing that. I cannot guarantee that everything will align in time to confidently add that $200 million or more, but we are focused on it. If we have more to share in 90 days, we will. Regarding your second question, we believe we hold a leadership position in a competitive market. We have strengths that we will continue to utilize in this generation. Those strengths were evident in FY23, with a significant year-over-year increase in Datacom transceivers from 2021 to 2022 to 2023. We possess the capability to scale and the necessary components for both the current generations and the upcoming 1.6T. Therefore, I believe we are just at the beginning. It is challenging to assess what will happen later on in the game as everyone is just starting, and we are well positioned to surpass our own aspirations for leadership in this market.
Simon Leopold, Analyst
That’s very helpful. And just to sort of paraphrase it to make sure it’s crystal clear, that the exclusion is because of the risk of ramping the production capacity shipping. It is not because you believe this is sort of a one-time flash in the pan kind of project, this is the beginning of a cycle. Correct?
Dr. Chuck Mattera, CEO
This is the first inning of the game. It’s the start of something significant, and we believe there’s much more to come. In 90 days, I hope to provide an update regarding the potential for additional revenue that we can incorporate into our guidance, as we work to operationalize it. This is just the beginning, and we think that as we move into 2024 and into 2025, our growth will continue.
Operator, Operator
Our next question comes from Meta Marshall with Morgan Stanley.
Meta Marshall, Analyst
Great. Thanks. Maybe just outside of the transceiver business for now. You had noted that visibility increased during the quarter. I just wanted to get a sense of whether that visibility increased anywhere outside of Datacom transceivers? And then, just as you look at recovery of the business, either late in the second half of the fiscal year or into fiscal ‘25, just what segments are most likely to kind of recover first outside of Datacom? Thanks.
Dr. Chuck Mattera, CEO
The Telecom business, based on our strong portfolio and relationships with Telecom customers, is expected to perform better in the second half of the year compared to the first half. I anticipate we will see signs of recovery before the end of this calendar year, which should lead to new orders that align with the launch of new products, such as our pluggable DCO modules. We believe this will enable us to significantly grow our market share starting in the second half of next year. In addition, the industrial market is diverse, and while I hesitate to say we have hit the bottom, I expect any significant increase in macroeconomic activity will be reflected in higher laser utilization, our service business, and further adoption of laser technology, like in EV battery welding. Our silicon carbide substrate business is growing well, and I foresee this trend continuing into 2024. I'll stop here and you may follow up, Meta, if you’d like.
Meta Marshall, Analyst
Yes. No. Just as a follow-up, I mean, just to come back to Datacom transceivers, when you talk about this kind of additional $200 million, is the majority of the gating item your capacity, or are there other gating items to kind of recognition of that?
Dr. Chuck Mattera, CEO
Every manufacturing line has a primary constraint, and when that is resolved, another constraint typically follows. Our expertise lies in managing multiple constraints simultaneously. In terms of supply, we rely on critical components, and for the past six months, that supply chain has been gradually tapering off while demand has been rising. The rapid increase in demand at the outset of this phase caught many in the industry off guard. Thus, we need to navigate specific supply chain challenges. While operations are ongoing, enhancing the speed of our supply chain would allow us to take on more work, and we certainly have the capability and ambition to expand. I believe our customers share this expectation. In the coming months, we will persist in urgently managing our overall manufacturing capacity, and we plan to provide an update in 90 days.
Operator, Operator
Our next question comes from Vivek Arya with Bank of America.
Vivek Arya, Analyst
Thanks. One more on Datacom. For fiscal ‘23, what was your total Datacom transceiver sales, and how much was that in AI/ML? And I’m curious, how are you drawing that line. Is it anything about 200 gig? And so, that’s my first question.
Dr. Chuck Mattera, CEO
Our Datacom transceiver sales in 2023 accounted for about 20% of our consolidated revenues. Regarding AI, while there are some applications and sockets operating at data rates below 800, our focus is primarily on 800, and we plan to discuss our roadmap for 1.6. However, in fiscal year 2023, the contribution was not significant. We started shipping in the third quarter, and we expect a notable increase in 2024.
Vivek Arya, Analyst
And for my follow-up, I was hoping if you or Mary Jane could provide the bridge between the sales guidance and then the earnings guidance. What are you assuming for gross margins in fiscal ‘24 and the exit OpEx rate in fiscal ‘24?
Dr. Chuck Mattera, CEO
Okay. Thank you, Vivek. Mary Jane?
Mary Jane Raymond, CFO
So, I think with respect to the whole year, we’re widening our gross margin range to 37% to 42%. And at lower revenues similar to what we have in the guidance, given the importance of volume, the margins may not be at 40% every quarter, so that’s the first thing. The second thing is, similarly, at the same level of revenue that we’re talking about for the full year guidance, the OpEx tends to be a little bit higher percentage of sales, not because the dollar value of the OpEx is going up but because the revenue was lower. So it’s probably in the neighborhood of about 22% or 23%, which is the high end of our range of 20% to 23%. So that’s the way we’re looking at it. I do think that as the year goes on, we will probably see the margins improve as the volume picks up, especially if some of the outlook that we have that we think covers somewhere between the next two to four quarters starts to recover in the back half of the year.
Vivek Arya, Analyst
But Mary Jane, how do we reconcile that you're guiding sales down by about 11% at the midpoint and earnings down almost 58% at the midpoint? What drives that larger decline? It seems like gross margins are expected to remain similar to fiscal '23, unless I'm mistaken. What are the missing pieces contributing to this disparity? Is it the share count? What is causing earnings to decline at such a faster rate?
Mary Jane Raymond, CFO
Compared to 2023, the revenue alone is $0.91, with the revenue declining significantly impacting the earnings. Additionally, taxes influence the results, and dividends fluctuate. Despite the share count changing with the Series A, the in-kind dividends are increasing due to capitalization. These are likely the main factors, but the primary driver is that revenue is below 2023.
Operator, Operator
Our next question comes from Tom O’Malley with Barclays.
Tom O’Malley, Analyst
I just wanted to see what silicon carbide was as a percentage of total revenue in the June quarter. In the prepared remarks, you talked about the continued supply constraints just from not being able to scale, but you also said it grew nicely. Could you just give it for the June quarter?
Dr. Chuck Mattera, CEO
Yes. Good morning, Tom. Just give us a second. Yes.
Mary Jane Raymond, CFO
The whole of the Wide-Bandgap product line was about 6% of revenue.
Tom O’Malley, Analyst
Okay. Thank you. And then, I just wanted to ask just a technical question, maybe this is in Giovanni’s camp. So, in terms of AI connections that you’re seeing today, I thought it was interesting in your slide deck, you showed that the biggest growing opportunity between ‘23 and ‘28 is the silicon photonics portion where you have it going from like $800 million to $4.6 billion. Where are you guys playing in silicon photonics? And why is that growing so fast in that period of time? Thank you.
Dr. Giovanni Barbarossa, CSO
There are solutions that are better suited for silicon photonics in terms of power consumption and performance. However, a laser is still necessary for these solutions. We observe a division in silicon photonics that is not currently detailed in our slide, which does not differentiate between short reach and long reach. I would estimate that this division is approximately one-third short reach and two-thirds long reach, both linked to the AI ramp we mentioned. This segment is experiencing rapid growth, and aside from that, there's also a VCSEL segment that is growing quickly and is independent of the silicon photonics sector. Specifically regarding silicon photonics, the division remains one-third short reach and two-thirds long reach, all related to AI.
Operator, Operator
Our next question comes from Jed Dorsheimer with William Blair.
Jed Dorsheimer, Analyst
Just to clarify my understanding regarding silicon carbide, if I examine the Wide-Bandgap market and exclude indium phosphide, is it accurate to say that silicon carbide represents about 70% of that market? Additionally, is there anything else I should be aware of regarding this sector?
Dr. Chuck Mattera, CEO
Jed, can you repeat your question? Which set of…
Jed Dorsheimer, Analyst
What I'm trying to understand is the growth of silicon carbide. Previously, you mentioned that it accounted for 3% of sales, and now Wide-Bandgap totals 6%. Within Wide-Bandgap, the other significant component is indium phosphide, which seems to only make up about 20% to 30%, so most of it is silicon carbide. Is there anything else that should be considered to get back to that silicon carbide figure? I want to clarify the year-over-year growth of that business.
Dr. Chuck Mattera, CEO
In our Wide-Bandgap electronics platform, most of the sales come from silicon carbide substrates. There are no sales from indium phosphide or gallium arsenide, nor from any other compound semiconductors. However, we do offer ion implantation services, which involve providing ion implant services for silicon carbide to our customers who operate fabrication facilities. The focus of our Wide-Bandgap electronics platform is on silicon carbide, and it is experiencing growth that surpasses the Company's overall growth.
Mary Jane Raymond, CFO
And it’s been 4% to 5% for the last several quarters, Jed.
Jed Dorsheimer, Analyst
Got it. Okay. You mentioned in the shareholder letter that 40% of the CapEx was allocated to this business unit. Last quarter, you noted that you were considering a strategic review of this unit. That's a significant amount of CapEx for something relatively small, although it is growing. How should we interpret that percentage in the '24 guidance? Do you anticipate linear growth, or do you expect that this capital intensity for expansion will lead to nonlinear growth?
Dr. Chuck Mattera, CEO
No, I’m expecting that in FY24 and planning that about 40% to 50% of our capital will be invested in silicon carbide to fuel the growth.
Jed Dorsheimer, Analyst
Sure. What I was getting at, Chuck, is that in a business undergoing a strategic review, which could take various forms, you are investing a significant amount of capital expenditure. Are you anticipating nonlinear growth in that segment? In other words, if you are currently at 6%, do you expect that to double? That's what I'm asking to justify the capital expenditure in that business unit.
Dr. Chuck Mattera, CEO
Mary Jane, would you like to?
Mary Jane Raymond, CFO
Certainly, as we've discussed in previous quarters, as traditional vehicle manufacturers transition to electric vehicles, we anticipate an upward shift in this market, and we believe we are only witnessing the initial stages of that change. Growth was robust in the fourth quarter and also strong in the third quarter, and we expect this trend to persist. Fortunately, this segment of the business operates with a bit more rationality compared to others. However, it is crucial to ensure that capacity is available for manufacturers to commit to converting half or more of their entire vehicle lines.
Dr. Chuck Mattera, CEO
It’s Giovanni’s segment. Giovanni, would you like to add?
Dr. Giovanni Barbarossa, CSO
So Jed, I’ll give you a number. For fiscal years 2023 and 2024, we expect growth of at least 40%.
Operator, Operator
Our next question comes from Christopher Rolland with Susquehanna.
Christopher Rolland, Analyst
Yes. I was wondering if you guys might be able to talk about any kind of nontraditional engagements. Have you guys had any engagements for optical or lasers into things like AI systems or servers or cards? And perhaps if you could talk a little bit more broadly about the economics for AI just in your transceiver business, how margins compare to corporate, what the OpEx needs are to support that business, et cetera?
Dr. Chuck Mattera, CEO
Chris, could you repeat the first part of your question? The nonfinancial part?
Christopher Rolland, Analyst
Yes. Your competitor has begun discussing custom AI designs that are being integrated into systems beyond just transceivers. Have any hyperscalers or AI-specific companies collaborated with you on custom designs?
Dr. Chuck Mattera, CEO
Giovanni, would you take that?
Dr. Giovanni Barbarossa, CSO
Let me begin by discussing our strength in device technology. We should currently sell more devices than we actually use internally. Many of our competitors are also our customers, as you likely know. Our broad-based laser and receiver technology platforms work for both short and long wavelengths. We are involved in some nonstandard designs with end customers, and despite these customizations, ensuring interoperability will eventually require standardization. I don't believe there is a significant change in the standardization process we've experienced in the past 20 years in the Datacom space. While there are efforts to improve performance and cost of ownership, any internal custom solutions still revolve around 100G optical lanes at the core, despite the upcoming 200G electrical and optical lanes. Thus, while we have some level of customization, it does not alter our competitive edge, which remains significantly stronger than most of our competitors due to our vertical integration. This not only enhances our capability to meet demand but also allows us to differentiate at the internal design level of transceivers. We are actively involved in customized solutions for some AI players from this perspective.
Dr. Chuck Mattera, CEO
Mary Jane, would you…
Mary Jane Raymond, CFO
With respect to the margins. So, generally speaking, you’ll remember that the communications entire end market, the margins tend to be below the corporate average. Having said that, the higher data rate and typically more technologically complex products that deliver a greater value, tend to have margins that are above the average within communications to a pretty decent extent.
Christopher Rolland, Analyst
Great. Thank you very much. For my second question here, I know it’s hard to figure this out and inventory at your customers, and I know it’s going to take a few more quarters here to work through. But is there any way to kind of quantify what this inventory burn is? What you think normalization would have been at your customers? How much more would you have shipped if you’re shipping in line with demand? Any thoughts on that? And then, any thoughts on perhaps the linearity of how this inventory dynamic plays out? Thanks.
Dr. Chuck Mattera, CEO
I cannot speculate on what it could have been as it is too complex and uncertain. However, 90 days ago, I mentioned that I expected the moderation to continue at least until the end of this calendar year and possibly longer. It's still difficult to provide a clearer forecast than what I previously stated. Regarding Telecom, which is a primary market for us, I remain hopeful and am actively engaged in discussions with customers. I don't anticipate a turnaround before the second half of the year, but I believe we may start to see some signs of improvement by then.
Operator, Operator
Our next question comes from Ananda Baruah with Loop Capital.
Ananda Baruah, Analyst
I guess two, if I could. In the shareholder letter, you guys also talk about sort of AI exposures being more than just AI transceivers. And I think there is mention made of AI active and passive components, high-speed lasers. And I was wondering if you could drill down on that. I think you gave some context at OFC on this as well, but would love to get context on that. Any updated way you’re thinking about that? And then I have a quick follow-up. Thanks.
Dr. Chuck Mattera, CEO
Giovanni, maybe just talk about VCSELs, EMLs and optics.
Dr. Giovanni Barbarossa, CSO
Yes. Ananda, you're asking about the significant revenue growth we anticipate this year due to a surprising surge in demand. While the magnitude and timing were unexpected, we did foresee this market trend eventually occurring, which caught us somewhat off guard. Thankfully, we have our 800G platform ready. The key challenge now lies in logistics and supply chain management as we ramp up production. Regarding the revenue split, we expect that the transceiver will account for about 90% of our total revenue in the next 12 months during fiscal year 2024, with a rough distribution among modules and devices, including lasers, photodiodes, and some integrated circuits.
Ananda Baruah, Analyst
Thank you, Giovanni, for the information. As a follow-up, I appreciate the details on the AI transceiver total addressable market in the slide deck and the outlook moving forward. Could you share your thoughts on your market share in the different categories you've outlined? Looking at the bigger picture, do you believe you're positioned to capture more market share in the future? Any additional insights on this would be appreciated. Thank you.
Dr. Chuck Mattera, CEO
Ananda, we are the largest transceiver maker in the marketplace. And as it relates to this 800G opportunity and more broadly AI, including the generations to come, our goal is to be the market leader. It’s early as a starting point, but even though it’s early, we’ve gotten busy. I believe that in ‘24, what we have baked into our plan is already a super exciting ramp, and I believe that there will be a possible upside of several hundreds of millions, even in ‘24, in the back half of ‘24. And I believe that our ability to address the market, to serve the market, to scale in the market is going to be critical for us to be able to win. Our goal is to be the market leader.
Ananda Baruah, Analyst
Chuck, is there anything about your technology portfolio that could enhance your competitive advantage in the market for 800G, 1.6T, and so on, compared to your current position as a leader?
Dr. Chuck Mattera, CEO
Yes, absolutely. Let me repeat. Our laser-based technology, both short wavelength and long wavelength, and the demands on that laser technology, including for 800 but especially for 1.6, will separate us even further from the other players in the marketplace because we are the only vertically integrated company that has a road map to support well beyond 800G. And I believe that those are among the very strong value propositions that we present to a customer.
Operator, Operator
Our next question comes from Ruben Roy with Stifel.
Ruben Roy, Analyst
Chuck, if I can ask you to put a little bit of a finer point on the AI/ML transceiver momentum you’re seeing. How much do you characterize the relative strength today, at least in sort of optics going into InfiniBand AI training clusters versus Ethernet? And really, what I’m trying to get to is if you can give us a sense of timing and qualification cycles for Ethernet deployments, say, 800 gig and then eventually 1.6T would be helpful.
Dr. Chuck Mattera, CEO
Okay. Ruben, I’ll ask Giovanni to address both.
Dr. Giovanni Barbarossa, CSO
We are completely neutral regarding the switch architecture of our customers. If we look at the market demand, there may be a stronger preference for InfiniBand compared to Ethernet, but from a hardware perspective, it really makes no difference to us.
Ruben Roy, Analyst
Okay, Giovanni. Are you qualified for some of the cloud service providers that are discussing moving to new Ethernet switches, 51.2 terabit, etc.? Will you be ready as those switches are phased in during 2024?
Dr. Giovanni Barbarossa, CSO
Yes, absolutely.
Ruben Roy, Analyst
Okay. And then, I guess, one last question then for Chuck or Giovanni. You mentioned the 20% of consolidated revenue in fiscal ‘23 related to what you would consider AI/ML. That leaves a pretty big portion of sort of how I would consider legacy transceivers, 200 gig, maybe even lower. How do you think that plays out? Do you think the AI/ML stuff is going to ramp faster than legacy falls off or legacy sort of hangs in there? How are you considering that?
Dr. Chuck Mattera, CEO
Ruben, let me clarify. My earlier comment was about 20% of our consolidated FY23 sales were in Datacom transceivers. So, let me ask if you have any question about that.
Ruben Roy, Analyst
Okay. No. I messed that up, then. Thank you, Chuck.
Dr. Chuck Mattera, CEO
I’m glad we’re having this discussion. As mentioned in the shareholder letter, we had a significant customer in the data communications sector. I pointed out earlier the dwindling demand for some legacy products from our customers. We anticipate that this demand will diminish in fiscal year 2024 as planned. I also expect that during this fiscal year, we will be able to replace it with at least 800G AI transceivers, and we are striving to exceed that target. Is that clear?
Ruben Roy, Analyst
Absolutely. I appreciate the detail, Chuck. Thank you.
Dr. Chuck Mattera, CEO
You’re welcome, Ruben.
Operator, Operator
Our next question comes from Dave Kang with B. Riley.
Dave Kang, Analyst
My first question is regarding your transceiver revenues. What was the split between different speeds, like 100 gig, 400 gig last year? And now, with 800 gig ramping, what do you think that mix will be this fiscal year? And what’s the margin differential between 100 gig versus 400 gig and 800 gig?
Dr. Chuck Mattera, CEO
Giovanni, do you want to…?
Dr. Giovanni Barbarossa, CSO
I would say that 200 gig and above accounted for about 30% of the total, with the remainder being 200 gig and below. However, let me clarify the split the other way around.
Dave Kang, Analyst
So Giovanni, so 200 gig and above was 70%? Just wanted to make clear.
Dr. Giovanni Barbarossa, CSO
Yes. Yes. The significant change in our revenue distribution has been that, in the past, we indicated a breakdown where one-third came from hyperscalers, one-third from the top 20 cloud providers, and one-third from enterprises and others. Due to the transition to AI and changes in inventory over fiscal year 2023, that ratio has shifted. For fiscal year 2024, approximately two-thirds of our revenue will come from AI, primarily driven by 800G and 200G products. The remaining portion will come from smaller cloud providers and enterprises, signifying that hyperscalers will represent a much larger share of total revenue compared to fiscal year 2023.
Dave Kang, Analyst
And how does that transition, that shift impact the margins?
Mary Jane Raymond, CFO
As I mentioned earlier, the margins on higher data rate and more technologically advanced products are generally higher than average within a specific category. In the case of transceivers, those exceeding 200G, especially 800G, will have margins that are above average. However, for products around 100G and lower, we are becoming exceptionally efficient in their production. Consequently, the lower-margin products tend to retain their value, especially since we are nearly the sole manufacturer of these items. Overall, that’s the perspective on how the margin structure operates.
Dave Kang, Analyst
Got it. And maybe, Mary Jane, my last question is about your backlog of $2.7 billion. Could you share the breakdown between your three divisions? Additionally, I know you provided operating margins for those divisions; I'm wondering if you could also provide the gross margins for them.
Mary Jane Raymond, CFO
The backlog for the Materials segment is approximately $650 million out of the total $2.7 billion. For the Networking segment, it's about $1.2 billion, with the remainder in Lasers. We typically do not disclose gross margins for the segments. However, you can assume that they align closely with the operating margins, noting that grown materials and laser diodes have the highest margins in the company, along with most industrial products. Laser systems generally exceed the corporate average, while communications margins tend to fall below the corporate average.
Operator, Operator
The next question comes from Jim Ricchiuti with Needham & Company.
Jim Ricchiuti, Analyst
Mary Jane, could you share any targets for debt reduction? In fiscal '24, perhaps at the midpoint of your full year guidance, how should we be thinking about that? I have a follow-up as well.
Mary Jane Raymond, CFO
We haven't previously discussed specific targets for debt reduction. We aim to exceed $200 million in that effort. Reducing debt is a very high priority for us, so although capital expenditures are the primary focus for our capital structure, we have been proactive in managing those expenditures, especially since they tend to decrease during periods of lower revenue.
Jim Ricchiuti, Analyst
I'm curious about the comments you made in the shareholder letter regarding the display side of the business. Are you anticipating any seasonal increase in utilization that could boost that segment in the first half, especially considering feedback from one of the suppliers of OLED materials for the handset market? Additionally, regarding the systems side, you mentioned an uptick in orders from China. Will those deliveries be for fiscal '24, or will most of them occur in fiscal '25? Thank you.
Dr. Mark Sobey, President, Laser Segment
Thanks, Chuck. Hi, Jim. Yes, we definitely expect service utilization to pick up in the first half of our fiscal year, so over the next six months. As you know, we get a batch of new smartphone releases from various manufacturers typically in the September, October period. And we’ve certainly got visibility into having expectations that that would drive our service revenue. And the bookings that we mentioned on our new OLED capital equipment, and the shipments are in FY24. So, those shipments are within the fiscal year.
Jim Ricchiuti, Analyst
Okay. But Mark, how does that compare with past investment cycles you’ve seen in this part of the business?
Dr. Mark Sobey, President, Laser Segment
That's a great question. I think it's pretty similar. We would love for this business to be more linear, but it’s not. It tends to be linked to fab build-outs, and we have a limited number of major customers, around 6 to 8, primarily split between China and Korea. It typically goes in phases, with each phase usually consisting of three to four systems. So, the recent orders we collected were in that range. We would also expect additional phases to develop, including expectations for Generation 8 fab build-outs, especially in China. Therefore, we see this as reasonably typical.
Operator, Operator
Our next question comes from Tim Savageaux with Northland Capital Markets.
Tim Savageaux, Analyst
A couple of questions here and maybe they’re related, which is, specifically, I wanted to focus on trends in the Telecom business from a demand standpoint, and you probably have some inventory issues there as well. But, as you look through to end demand, what can you tell us about what’s happening there? And kind of related to that, if we look at the September quarter guide going down something on the order of $150 million, if you look across your segments, what are the main kind of drivers there in terms of puts and takes from a sequential standpoint? Thanks.
Dr. Chuck Mattera, CEO
Okay. Thank you, Tim. We had very strong shipments in communications in the fourth quarter. I think that will be down into the first quarter. I think that’s the number one driver in the change from Q4 to Q1. That accounts for maybe more than half or two-thirds of the variation and the rest of it is spread across the other markets or across the other segments and markets. What was the second part of your question?
Tim Savageaux, Analyst
I understand. Regarding the comps being half to two-thirds of the decline, I was trying to clarify the comparison between Telecom and Datacom.
Dr. Chuck Mattera, CEO
It’s a combination, and the moderation that we saw in the March quarter in the Telecom market persisted in Q4 and will likely continue into at least Q1 as well. It’s a significant part of it.
Operator, Operator
Our next question comes from Mike Genovese with Rosenblatt Securities.
Mike Genovese, Analyst
I have a few clarifications. First, regarding the second customer, which accounts for nearly 10% of the Datacom customer base. I would like to confirm if that customer is indeed a hyperscaler. Additionally, when you mention transceivers, are you also including cables, such as active optical cables and electrical cables, as transceivers? I want to ensure that the term "transceivers" is used correctly in this context. Thank you.
Dr. Chuck Mattera, CEO
Giovanni, why don’t you take it?
Dr. Giovanni Barbarossa, CSO
Thank you for the questions, Mike. Yes, we always include cables, but just to be clear, we do not have electrical cables in our portfolio, so everything is optical. We definitely include cables. Regarding your first question, we couldn’t hear you very well, but I believe you were asking about the two-thirds I mentioned, which refers to hyperscalers. I think that addresses your query.
Mike Genovese, Analyst
Sorry, if I could clarify that question. You said you had two large customers where orders were expected to go down and one is, obviously, the consumer electronics customer. I just wanted to check the second one, the Datacom customer, that that is, in fact, a hyperscaler?
Dr. Giovanni Barbarossa, CSO
Well, one was really consumer electronics and the communication was Datacom. It was a large customer of ours. Okay. My next question is about the 200G lasers. When do we expect those to generate shipping revenue within your transceivers or for external customers? Right now, we are focusing on our internal customers for anything 200G. However, we have gained design wins with some of our transceiver competitors. This will become significant only in the second half of the fiscal year.
Operator, Operator
One moment for our next question.
Dr. Chuck Mattera, CEO
Kevin, we’re going to wrap the call.
Operator, Operator
Okay. Ladies and gentlemen, this does conclude today’s presentation. We thank you for your participation. You may now disconnect, and have a wonderful day.
Dr. Chuck Mattera, CEO
Thank you.
Mary Jane Raymond, CFO
Thank you.