Earnings Call Transcript
COHERENT CORP. (COHR)
Earnings Call Transcript - COHR Q1 2025
Operator, Operator
Good day, and thank you for standing by. Welcome to the Coherent Corp. FY '25 First Quarter Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Paul Silverstein, Senior Vice President, Investor Relations and Corporate Communications. Please go ahead.
Paul Silverstein, Senior Vice President, Investor Relations and Corporate Communications
Thank you, Operator, and good afternoon, everyone. With me today are Jim Anderson, Coherent's CEO; and Sherri Luther, Coherent's CFO. During today's call, we will provide a financial and business review of the first quarter of fiscal 2025, and the business outlook for the second quarter of fiscal 2025. Our earnings press release can be found in the Investor Relations section of our company website at coherent.com. I would like to remind everyone that during our conference call today, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements or predictions are based on information that is currently available and that actual results may differ materially. We refer you to the documents that the company files with the SEC, including our 10-Ks, 10-Qs, and 8-Ks. These documents contain and identify important risk factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements. This call includes and constitutes the company's official guidance for the second quarter of fiscal 2025. If at any time after this call, we communicate any material changes to this guidance, we intend that such updates will be done using a public forum such as a press release or publicly announced conference call. We'll refer to both GAAP and non-GAAP financial measures during this call. By disclosing certain non-GAAP information, management intends to provide investors with additional information to permit further analysis of the company's performance and underlying trends. For historical periods, we provided reconciliations of these non-GAAP financial measures to GAAP financial measures that can be found on the Investor Relations section of our website at coherent.com. Let me now turn the call over to Jim Anderson, our CEO.
Jim Anderson, CEO
Thank you, Paul, and thank you everyone for joining today's call. I'd like to begin by welcoming Sherri Luther back to Coherent as our new CFO. Sherri and I previously worked together at Lattice Semiconductor for almost six years, where Sherri did an outstanding job as the CFO. Prior to Lattice, Sherri worked for 16 years in various finance roles at legacy Coherent before its acquisition. Sherri's proven track record as the CFO, combined with her long history with the company, has allowed her to hit the ground running, and we're very pleased to have her join our team. I also want to thank Rich Martucci for serving as our Interim CFO, prior to Sherri's arrival. Rich's leadership and dedication have been a tremendous help to me and the company. And I'm deeply grateful for his commitment and continued dedication to Coherent. Now that Sherri is onboard, I'm pleased to announce that we'll host an Investor and Analyst Day, in New York, on May 28 of next year. At that event, we'll outline our overall strategy, including our end market growth opportunities, product and technology roadmap, and long-term financial model. We look forward to the event and sharing more details about our plans to create value for our shareholders. Before I discuss our first quarter results, I'd like to provide an update on the three key areas of improvement that I outlined at our last earnings call; culture, strategy, and execution. I believe improvements in these three areas will transform our extensive, innovative technology portfolio and our growing market opportunity into an engine of market-leading revenue growth, expanding profitability, and industry-leading shareholder value creation. First, regarding culture, I've now had the opportunity to visit more than 20 of our sites and meet with many of my teammates across the world. We have incredible depth and breadth of talent, and our employees' dedication is inspiring. My favorite part of our culture is our focus on innovation. And we will continue to nurture this fundamental part of our culture. Yes, as I noted at last quarter, there is also an opportunity to evolve our culture. We're building a faster and more agile company. We've already made numerous changes to simplify and strengthen our organizational structure, empower our leaders, streamline decision-making, and accelerate execution. Culture change always takes time, but I'm encouraged by our early progress in this area. Second, regarding strategy, we completed the strategic portfolio review that we initiated in June. This portfolio assessment will be the foundation for making organic and inorganic investment decisions moving forward. We applied a set of strategic and financial criteria to sort each of our product lines into one of four categories; Growth Engines, Profit Engines, Long-Term Bets, and Non-Strategic. We've now moved to the next phase, which is to drive actions based on the strategic assessment. For example, we've already shifted organic investment towards our Growth and Profit Engines, where we have conviction that we can drive strong long-term profit expansion for the company. For instance, we increased investment in new datacom platforms, such as next-generation transceivers, and our new Optical Circuit Switch. We've also started the process of divesting or shutting down product lines and assets that are non-strategic. For example, we recently announced the planned sale of our Newton Aycliffe facility, which was an underutilized and non-strategic asset. The proceeds from the sale of the facility were used to pay down our outstanding debt and reduce overhead costs. Another example is our recent announcement that we're exploring strategic options for our battery technology platform. Although our non-strategic businesses represent a relatively small portion of our revenue, they dilute the company's margin structure and absorb investment capital and focus that would be better deployed in our core businesses. As we optimize our portfolio over the coming quarters, we'll provide further updates, including at our upcoming Investor Day. Finally, the third area of focus for improvement is execution. Last quarter, I underscored the opportunity to significantly improve operational efficiency and effectiveness. We're tackling the greatest opportunities up front. For example, we've begun engaging our key customers and partners in a much more strategic manner. This approach has already uncovered new areas of long-term growth opportunity with our key customers and partners. Another example is our focus on gross margin expansion. We launched initiatives for pricing optimization and product cost reduction aimed at achieving our goal of operating at a consistent sustainable gross margin level above 40%. On operating expenses, we are shifting R&D investment to our growth and profit engines, and we are shutting down or divesting highly speculative projects that do not suit our long-term business model. Our go-forward R&D strategy will ensure that investments are focused, efficient, and offer high return. And on SG&A, we are focused on driving greater efficiency and leverage. Evolving our culture, optimizing our strategic portfolio, and improving our operational execution will put us on a path of sustained market-leading growth, enhanced profitability and cash generation, and a stronger balance sheet. I look forward to sharing more details at our upcoming investor meeting. I'll now switch gears and provide some brief comments on our fiscal first quarter results. Revenue in Q1 increased by approximately 3% sequentially and by 28% year-over-year, driven primarily by strong AI-related datacom transceiver revenue growth, along with improvements in our telecom revenue. Non-GAAP gross margin expanded by 49 basis points sequentially, and our non-GAAP EPS grew by 22% sequentially, and by well over 4x year-over-year. Let me summarize what we're seeing by our business by end market. In the communications market, Q1 revenue increased by 14% sequentially, and by 68% year-over-year. The sequential and year-over-year increases were driven by strong increases in both our datacom and our telecom revenue. Our Q1 datacom revenue grew by approximately 16% sequentially and by 89% year-over-year, due primarily to AI data center demand. We're very pleased with the continued ramp of our 800-gig transceivers and the adoption of those products across a broader set of customers. We also continue to make great progress on our 1.6T transceivers. Having delivered initial samples in the preceding quarter, we continue to expect to begin ramping sales of 1.6T datacom transceivers in calendar 2025. We're also investing in a broad portfolio of transceiver ingredient technologies that includes VCSELs, EMLs, and silicon photonics. The breadth of our extensive technology portfolio allows us to deploy the best technology solution for each customer and application. We showcased this capability at the European Conference on Optical Communications this past September, where we presented a multi-technology datacom transceiver demonstration at 200 gig per optical lane based on both our differential EML and our silicon photonics platforms. We also continue to make great progress on key enabling components such as 200 gig differential EMLs, 200 gig VCSELs, and CW lasers for our silicon photonics solutions. We also recently announced a family of high-efficiency lasers to power 1.6T optical transceivers based on silicon photonics. Beyond transceivers, our new datacom optical switch platform continues to progress well and is generating significant customer engagement. Our differentiated switch is based on our highly reliable solid-state liquid crystal technology and was recognized at ECOC '24 with the Best Product Award for data center innovation. We've shipped sample units to key strategic customers and we expect to begin ramping revenue in calendar 2025. Shifting to telecom, our revenue increased by 9% sequentially and by 17% year-over-year, although we continue to take a cautious view of the telecom market recovery, the sequential revenue growth in Q1 was a combination of end market improvement along with our ramp of new products, especially our new 100G ZR and 400G ZR ZR+ Coherent transceivers. We're in qualification with our high optical output power C-band 800G ZR ZR+ Coherent transceivers, and we recently announced an L-band version to double the capacity of existing fiber infrastructure. In our remaining markets, which are primarily industrial-related applications, aggregate revenue decreased 10% sequentially and decreased 3% year-over-year. Within these markets, ongoing strength in display capital equipment was more than offset by weakness in precision manufacturing and other sub-segments. Display strength is being driven by continued strong demand for our Excimer lasers for OLED screen manufacturing, which is driven by increased OLED adoption in new laptop and tablet computers. We also booked initial revenue for our new PYTHON annealing lasers that are being deployed in Gen-8 OLED display fabs. Across other industrial-related market subsegments, such as precision manufacturing, we experienced demand headwinds in Q1 that were consistent with broader industry trends. Overall, despite some near-term headwinds, we expect the industrial market to be a long-term growth driver for the company as the end markets recover and as our new products continue to ramp. In summary, after being on board for five months, I'm even more enthusiastic about the opportunity to unlock significant shareholder value based on the depth and breadth of our technology innovation, the size of the market opportunities we address, and the potential to improve our operational execution. We're expecting strong growth in our communications business over the coming quarters, and while some near-term softness persists in our other end markets, we continue to expect Fiscal 2025 overall to be a solid growth year for the company. I'll now turn the call over to our new CFO, Sherri Luther.
Sherri Luther, CFO
Thank you, Jim. Let me begin by saying how excited I am to rejoin Coherent, a company with a rich culture of innovation. I want to express my appreciation for the warm welcome I have received from my Coherent teammates. I also especially want to thank Rich Martucci, who has helped me to quickly come up to speed and ensure a smooth transition. As Jim noted, I spent 16 years at Coherent prior to its acquisition. What attracted me to rejoin Coherent was the opportunity to drive significant shareholder value expansion. The company has a solid foundation with its innovative technology and breadth of product portfolios. I see the opportunity to improve profitability in a number of areas. For example, I see opportunity for gross margin expansion, greater operational efficiency in the R&D investments we make, and opportunity for better SG&A efficiency. In addition, capital allocation is key, because we need to ensure that we are investing in the product portfolios that drive the highest return for the company, while also paying down debt to de-leverage our balance sheet as quickly as possible. I look forward to sharing additional thoughts with you at our investor and analyst event in May. Now, let me provide a summary of our results. Overall, in the first quarter, we drove continued sequential improvement in our financial results with solid revenue growth and gross margin expansion, driving strong profitability. With a strong focus on cash and capital allocation, we paid down $118 million of our debt, which reduced our net debt leverage ratio as defined in the credit agreement to 2.4 times. First quarter revenue was 1.35 billion, an increase of approximately 3% sequentially and 28% year-over-year. From a segment perspective, networking revenue increased 12% sequentially and 61% year-over-year due to AI data center demand. Laser segment revenue decreased 2% sequentially and increased 4% year-over-year, reflecting relatively stable end market demand. Material segment revenue decreased 15% sequentially and 3% year-over-year, primarily due to weak automotive end market demand. Our first quarter non-GAAP gross margin was 37.7%, an increase of 49 basis points compared to the prior quarter, and an increase of 293 basis points compared to the year-ago quarter. The improvements in gross margin were driven by higher revenue volume, favorable mix, and yield improvements. First quarter non-GAAP operating expenses were $276 million compared to $266 million in the prior quarter and $234 million in the year-ago quarter. The sequential and year-over-year increases were primarily driven by increased R&D investments in our product portfolio, as well as variable compensation. Looking ahead, we plan to continue to be disciplined in managing our SG&A expenses, while ensuring that we invest in our product portfolio. Our first quarter non-GAAP operating margin was 17.3% compared to 17% in the prior quarter, and 12.6% in the year-ago quarter. First quarter non-GAAP tax rate was 20.3%, compared to 25.9% in the prior quarter as a result of non-recurring one-time items. First quarter non-GAAP earnings per diluted share was $.074, compared to $0.61 in the prior quarter, and $0.16 in the year-ago quarter. We paid down $118 million in debt during the quarter using cash from operations and the proceeds of the sale of our Newton Aycliffe fabrication facility for incremental debt reduction. I will now turn to our guidance for the second quarter of fiscal 2025. Revenue is expected to be between $1.33 billion and $1.41 billion. Non-GAAP gross margin is expected to be between 36% and 38%. Total operating expenses are expected to be between $275 million and $295 million on a non-GAAP basis. Tax rate for the quarter is expected to be between 19% and 22% on a non-GAAP basis. EPS is expected to be between $0.61 and $0.77 on a non-GAAP basis. In summary, I'm very excited to return to Coherent. I see a bright future with significant opportunities to drive shareholder value expansion, transforming the company's strong foundation in technology and innovative products into a stronger operating model. That concludes my formal comment. Operator, please open the call for Q&A.
Operator, Operator
Thank you. Our first question comes from Samik Chatterjee with J.P. Morgan. Your line is open.
Samik Chatterjee, Analyst
Hi, and thanks for taking my questions, and maybe if we can start with one for Jim, and then I have a quick follow-up. Jim, I think you mentioned it's been now five months since you've joined the company. What's been the feedback that you've received from the customers or partners that you've talked to in terms of areas to focus on, areas that they really think Coherent is good at and/or even areas they think Coherent can improve on? And then I have a quick follow-up. Thank you.
Jim Anderson, CEO
Thank you for the question. It's a great topic to discuss. I have spent a significant amount of time with customers over the last five months, trying to meet as many as I can. We have strong existing relationships with our key strategic customers, including those in networking, data centers, and industrial sectors. Many of these relationships have a long and positive history. I see an opportunity to deepen our strategic engagements with these customers, shifting from immediate problem-solving to long-term, multigenerational innovations and partnerships. When discussing long-term strategies with our customers, two main areas resonate. First, our technology portfolio and roadmap can significantly support their innovation efforts. Second, the resiliency and depth of our supply chain are increasingly important. Take our AI data center customers, for example, where we're experiencing rapid revenue growth. They appreciate the comprehensive technology we offer, especially in optical networking, where we not only assemble modules but also create essential components like lasers and other ingredients. This broad technological capability positions us well for ongoing partnerships. Additionally, supply chain resilience is crucial for our strategic customers. Our diverse manufacturing footprint and vertically integrated structure give us a competitive edge, especially during periods of rapid growth, allowing us to meet demand reliably. These are key points that our customers find appealing, and I believe we have a significant opportunity to forge deeper strategic engagement with them moving forward. Our customers seem open to this approach, and it's an area we'll prioritize in the future.
Samik Chatterjee, Analyst
Got it. And for my follow-up, I'm just trying to think of the gross margin here, and what we should be tying it to the improvement in the gross margins and what we should be tying it to as we move through the year. You are guiding to sequentially a bit better revenue in the midpoint. Should we be tying those improvements to revenue improvement through the year or should we be thinking about some of the pricing that you've talked about, start to sort of agree to that, just trying to think about the gross margin trajectory for the rest of the year, I'm not looking essentially for guidance, but more how to think about what drives it from here on. Thank you.
Sherri Luther, CFO
Yes, hi, Samik. I'll take that question. I'll start with some context on Q1 and then discuss the guidance for Q2 and our long-term outlook. In Q1, we saw about a 50 basis point sequential improvement and a 290 basis point year-over-year improvement, which we are very pleased with. This improvement came from several factors. Higher revenue volume played a part, as did a favorable product mix, particularly in our Lasers segment, where demand for our excimer lasers used in OLED screen manufacturing remained strong. We also saw improvements in yield, notably in our datacom business, where we observed positive trends since we started that segment. Looking ahead to Q2, our guidance is a range of 36% to 38%. There can certainly be fluctuations in gross margin on a quarterly basis. Last quarter, Jim mentioned our gross margin expansion strategy, which includes optimizing product pricing and reducing product costs. We will focus on these areas as we aim for a long-term gross margin of over 40%. This is our target for long-term gross margin, and we are just beginning to implement this strategy. Rest assured, we are committed to achieving that greater than 40% goal. At our Investor Day in May next year, we will provide more insights on our model and its various components.
Samik Chatterjee, Analyst
Got it. Great, thank you. Thanks for taking my questions.
Operator, Operator
One moment for our next question. Our next question comes from Simon Leopold with Raymond James. Your line is open.
Simon Leopold, Analyst
Thank you for taking my question. I have two, one is more thematic and the other more reflective. First, I would like to hear from Sherri regarding priorities for the capital structure, specifically about weighing the options for delivering, investing in OpEx, and possibly making acquisitions. How are you approaching these decisions? As for my follow-up, concerning the strength of the datacom business, management had previously mentioned that products below 800 gig, particularly 400 gig and below, would be relatively flat for the year. I'm trying to understand where the surprising upside came from this quarter. Was it primarily from the 800 gig and above products, or was there also significant strength in the traditional products below 400 gig that contributed to the upside? Thank you.
Sherri Luther, CFO
Thank you, Simon. I'll take the first part of the question on capital allocation. I'll let Jim take the second part of that. So, from a capital allocation perspective, certainly lots of opportunity that I see in this area in joining the company. And really, the number one priority is in the organic growth of the company and making those investments that drive the highest ROI. Jim mentioned the strategic portfolio review that was undertaken and completed and we're really in the next phase there where we're shifting our R&D spend toward those programs that drive the highest ROI for the company in order to drive the long-term growth. So, that's the number one priority. The second priority, and it's a very close second priority, and that is in reducing our debt to deleverage the balance sheet and really overall strengthen the balance sheet. This also serves to reduce the debt service costs that hit our P&L as well. In Q1 of this 25, we paid down $118 million to reduce our debt and brought our debt leverage ratio down to 2.4 times as defined in the credit agreement. So, we're pleased with the sequential progress there. But in order to pay that down, we did use cash from operations, but took an incremental or component of that pay down was coming from the proceeds of the sale of our Newton Aycliffe facility, fabrication facility that we sold during the quarter. And so, the sale of that facility really gave us the opportunity to pay down additional debt to further deleverage. And so, I certainly have a history of aggressively paying down debt and that's something that's going to continue to be a focus area for me and a very close second priority.
Jim Anderson, CEO
And Simon, on the second part of your question around the datacom business, first of all, yes, we're really pleased with the performance of that part of our business. Just to reiterate, the datacom transceiver business was up 16% sequentially and it was up 89% year-over-year. And you're right, we didn't see growth as well in from a sequential basis in the 400-gig and below transceiver speeds. We did see sequential growth there. That was very nice to see. When you look across the customer base, customers are at different stages of adopting the different transceiver speeds. So, we still have customers that are doing significant volume on 400G and below as well. And so, it's really a mix of different transceiver speeds. And then, back on 800-gig, I would say, look, we're really pleased with the ramp, the overall ramp of our 800-gig transceivers. And then, the other color I would add is that one of the things I'm really pleased to see is the breadth of customers that we have. The number of customers that are ramping 800-gig has significantly increased. If I look like a year ago, it was only maybe a couple customers. Now, we have many customers ramping 800-gig. So, there's a much bigger diversity of revenue streams underneath that 800-gig ramp. And we do expect 800-gig to continue to grow over the coming quarters as well.
Simon Leopold, Analyst
Thank you very much.
Jim Anderson, CEO
Thanks, Simon.
Operator, Operator
One moment for our next question. Our next question comes from Thomas O'Malley with Barclays. Your line is open.
Thomas O'Malley, Analyst
Hey, guys. Thanks for having me on the call. And welcome, Sherri. It's great to have you. I just wanted to ask broadly into the out year, you guys have talked about some strategic alternatives that you guys are taking. You've reviewed the business. You've kind of said the review is concluded. You talked about the sales of the facility. You paid down some debt. And then, you pointed out specifically the battery business. But I was curious, is that all that you identified as non-strategic? Could there be additional sales on the way? And just any call you give, I honestly understand that there's an Analyst Day coming up. But is your intent to give more there? Or is that kind of the extent of the non-strategic thus far?
Jim Anderson, CEO
Yes. Thanks, Thomas, for the question. No, there are definitely other things that we're working on in the category of non-strategic. So, as we said, we completed that portfolio assessment. I think we wrapped up pretty much at the end of August. And then, we've since moved into execution mode. And there's a number of different things that we're looking at. Just the two examples that I gave in the prepared remarks were from an asset standpoint, the sale of the Newton Aycliffe facility. And then, from a product line standpoint, that battery technology platform, but there definitely are other things that we're working on within that non-strategic category, and we'll certainly share that with investors at the right time. It's a little premature to share some of that, but we will definitely share that at the right time. And then, certainly, we'll give a better picture at the Investor Day as well. But even between now and the Investor Day, we'll share any key milestones along the way. And then, I just want to reiterate what I said in the prepared remarks that even though the overall non-strategic category is a relatively small part of our revenue, again, it is dilutive to our operating margins. And more importantly, it draws away capital and focus from the management team. So, we are anxious to execute quickly on that, to improve focus, to improve where our assets and where our investments are focused. And then, beyond just the non-strategic category, in our other categories of, for instance, key growth drivers and key profit drivers, that's a place where we've been adding investment. And so, we've been shifting investment away from the non-strategic areas into the fast-growing areas. And the best example of that is the data center AI transceiver growth. And so, we have increased R&D investment in new technology platforms for datacom transceivers. So, these are new future technology platforms that we're really excited about, as well as the other example I would give would be the optical circuit switching, which we're excited about as well. So, we're also shifting organic investment towards those high-growth, high-profitability categories as well. So, that's certainly already happened or in process as well.
Thomas O'Malley, Analyst
Thank you, Jim. I have a follow-up question regarding the 1.6T transceivers. You mentioned that there will be a ramp-up in calendar year '25, but do you expect any contributions from the 1.6T this fourth quarter? Are you anticipating any revenue this year? Additionally, when do you predict the volume ramp for 1.6T to occur? Some companies in the industry have indicated there are constraints related to lasers and DSPs. Are you experiencing any of those limitations? Lastly, as the 1.6T ramp progresses, do you foresee a shift towards a silicon photonics approach or an EML approach? I apologize for the multiple questions, but I appreciate your insights.
Jim Anderson, CEO
Thank you, Thomas. I'll do my best to address all your questions. At this stage, we anticipate a ramp-up in production by calendar year 2025. Our focus, along with our customer, is to expedite the deployment of our solution. If there's an opportunity to ramp sooner, we will act as quickly as possible. I was pleased that the team delivered samples last quarter, and we are collaborating closely with our lead customers to move into production swiftly. For now, I will maintain the expectation of a ramp in calendar year 2025, and as we approach that revenue stage, we will provide more details about the timing of the ramp and its impact. Regarding our technology, one of our key strengths is our ability to offer a wide range of optical networking technologies. We aim to deploy the best technology suited to our customers' needs and applications. Whether that's EML, VCSEL, or silicon photonics, we are developing various options and will implement the strongest technologies to distinguish our products and benefit our customers. This broad range of technology options is a competitive advantage for us compared to our peers and competitors.
Operator, Operator
Thank you. One moment for our next question. Our next question comes from Meta Marshall with Morgan Stanley. Your line is open.
Meta Marshall, Analyst
Great. Thanks. Maybe a couple of questions for me, you mentioned some strengths out of telecom in the quarter. Just wondered, is that more Asia-based or U.S.-based? And then as a second question, you had mentioned kind of some increasing yields for reason for upside or gross margins in the quarter. I wanted to get a sense of, is that some of the kind of tailwinds from some of the yield disruptions we saw in fiscal Q3 earlier this year? Or is that just kind of additional improvements you guys have made to the business? Thanks.
Jim Anderson, CEO
Yes, thanks, Meta. On the first part of the question around telecom strength, so yes, telecom was a bit stronger than we had originally forecasted. Really pleased to see that. And it was, first of all, just to reiterate, it was a combination of two things. We saw end market improvement, but it was also due to some of the new products that we have ramping in telecom. And specifically on those new products, and I talked about this at last quarter's earnings, the 100 ZR and the 400-gig ZR, ZR+ that we had begun ramping. We continue to see good ramp contribution from those products. And so, that certainly benefited us. But we did see some improvement in the end market, specifically around DCI, data center interconnect, but also even in the traditional transport area, the traditional telecom transport area, we did see some strengthening there. We are still taking kind of a cautious view and cautious outlook on telecom recovery overall, but it was nice to see some good end market demand signals and strength in Q1. And then, with respect to Asia versus, I think you asked a question about Asia versus U.S. I'm actually not sure which market in particular, I believe we saw some improvement across both of those markets. And then, on the second part of your question on yield increase, yes, so Sherri mentioned in the Q1 sequential improvement from Q4 to Q1, there were three different factors. She highlighted yield being one of those. Yes, I wouldn't really characterize it as a tailwind. I would characterize it as new yield improvements. And this is actually something that I highlighted last earnings call. When I talked about the gross margin improvement initiative that we were putting in place, I said there were two components of it. There was a pricing component of it, but there's also a big focus on product costs. And I mentioned yields as one of the key areas we've been focusing on. And the team has definitely been focused on that over the past few months. In fact, some real-time information, Sherri and I were actually sitting in a review with the team this morning, the datacom transceiver team this morning, and we were reviewing yields and really pleased with the progress that that team has made on yield improvements over the past few months and really pleased with the plan that they're showing moving forward. Now, we're still in the early stages of the gross margin improvement strategy, and we have a lot more work in front of us. But I want to say thanks to the team for the initial good work that they've done and for the plan that they have moving forward. So, yes, yields will continue to be a key area of focus for us.
Meta Marshall, Analyst
Great. Thanks so much.
Operator, Operator
Thank you. One moment for our next question. Our next question comes from Karl Ackerman with BNP Paribas. Your line is open.
Karl Ackerman, Analyst
Yes, thank you. Jim, I was hoping you could discuss whether you are seeing data center customers reallocating procurement of optical transceivers to U.S.-domiciled suppliers like Coherent. And then, second, are you able to quantify your expanding TAM opportunity as AI clusters now have the option of being disaggregated into white-box components that seem to benefit yourself? Thank you.
Jim Anderson, CEO
Thank you, Karl. You raised two important questions. First, regarding data center customers, I've briefly mentioned this before, but supply chain resiliency is crucial for them. We often highlight two key aspects: our technology roadmap, which showcases our innovative capabilities, and the significant focus on supply chain resiliency. This has become increasingly important to our customers, who recognize the value and differentiation that Coherent offers in this area. Our resiliency is built on two main factors. First, we have extensive geographic diversity in our production platforms where our devices and modules are produced and assembled, benefiting our customers. Second, we focus on verticalization. For instance, we don't just assemble transceivers; we manufacture many essential components ourselves, such as VCSEL lasers, EMLs, isolators, and even the garnet materials used in isolators. While we sometimes utilize external suppliers when beneficial, our verticalization significantly enhances our supply chain resiliency, which our data center customers appreciate and find increasingly important. Regarding your second question about our expanding total addressable market, I can confirm that it is indeed growing for the reasons you mentioned. Although I don't have specific numbers to share right now, we plan to discuss this further during our Investor Day in May, where we'll elaborate on the broader market opportunities we see ahead, including the data center transceiver market and the growth of our total addressable market.
Karl Ackerman, Analyst
Great. Thank you.
Jim Anderson, CEO
Thanks, Karl.
Operator, Operator
One moment for our next question. Our next question comes from Ruben Roy with Stifel. Your line is open.
Ruben Roy, Analyst
Thank you. Jim, I had a question similar to the last one regarding the components that go into transceivers. Last quarter, you mentioned build versus buy, and earlier this year, the company discussed expanding the six-inch wafer fab and five-fab. I'm curious if that's an area you could potentially accelerate, and if so, how you view build versus buy and the insourcing of some of these components, especially on the EML side, considering the constraints you've mentioned, as you plan for 2025 and 2026.
Jim Anderson, CEO
Thank you, Ruben. First, regarding our overall philosophy on whether to build or buy or develop internally versus using external resources, we aim to direct our R&D funds towards areas where we can truly stand out. If we believe we can offer significant differentiation for our customers, which provides them with benefits unavailable in the broader market, that's how we should use our R&D dollars. This differentiation can manifest as either a technological edge or a favorable cost structure. Therefore, if we can deliver real differentiation, we will pursue that. Conversely, if we cannot provide a substantial advantage, we should consider external solutions. This principle also applies to our supply chain; if we can create a technical advantage, cost efficiency, or improve supply chain resilience for our customers, we should focus on that. However, if we can't achieve a true advantage, we will look to external resources. Sometimes we decide to build those components in-house, and at other times we opt to collaborate with external suppliers. As we move ahead, we will be more strategic and intentional in our decisions than we may have been previously, which encapsulates our general philosophy.
Ruben Roy, Analyst
Very helpful, thanks, Jim. Just a quick follow-up, I might have missed this, but on the telecom commentary last quarter, you had a little bit more of a muted outlook on telco, nice surprise here to the upside. Was that mostly driven by DCI or were some of the traditional telecom products also a little bit better than you had thought? Thank you.
Jim Anderson, CEO
Thanks, Ruben. It was a combination of both. The end market was a bit stronger, and that was a combination of DCI, but also traditional telecom transport as well. We saw an uptick in end market demand there too. And as I mentioned earlier, we're still taking a cautious approach to the telecom market. I'd like to see a couple more quarters of improvement before we're positive that the market is fully recovering, right, but some good positive signs so far.
Ruben Roy, Analyst
Appreciate it. Thank you.
Operator, Operator
One moment for our next question. Our next question comes from Christopher Rolland with Susquehanna. Your line is open.
Christopher Rolland, Analyst
Hey, guys. Thanks for the question. And I guess, firstly, welcome, and also welcome back, Sherri. My question, I guess, first is a follow-up to Ruben's on EMLs. Are you guys going to be commercially shipping your own EMLs into either 800 and 1.6 next year? And additionally, are you concerned at all about data center capacity constraints for you guys into what could be a pretty robust 2025? And this is either for transceiver assembly or light source.
Jim Anderson, CEO
Thank you, Chris. To address the first part of your question regarding EML usage in 800-gig and 1.6T, we utilize a mix of our internally developed EMLs and those from strong external partners. As mentioned earlier, we believe in providing benefits for our customers through internal solutions when advantageous, and we also leverage external resources as needed. I expect us to continue this approach for both 800-gig and 1.6T. Additionally, we adopt a multi-technology strategy, meaning we not only rely on EML but will also pursue VCSEL or silicon photonic solutions as suitable. Our goal is to choose the best technology path that maximizes benefits for our customers. Our expertise lies in effectively manipulating photons for data transmission, whether through EML, VCSEL, or silicon photonics, to drive innovation. Regarding the second part of your question about capacity constraints as we scale our data center AI operations, I want to express my gratitude to my production and engineering teams for their exceptional work in supporting the growth of our data center AI business. They have done an excellent job meeting our customers' needs, despite some minor constraints. Our focus moving forward is on continuing to increase and ramp up our internal capacity for transceiver assembly and the various components involved, such as isolators, VCSELs, and EMLs. We are committed to ensuring we have the appropriate capacity to meet the expected demand from our customers.
Christopher Rolland, Analyst
Excellent. And then, perhaps a follow-up, Jim, now that you've had some time to kind of look under the hood, some of the pushback that I get is around margin expansion opportunities in data center, particularly on the transceiver, your old Finisar business, as you look to your path for greater than 40% total company GMs. And what I'm getting at here is, there seems to be a balance here between upside from surging units obviously, driven by AI versus what I think are fairly aggressive capacity expansion plans for guys particularly out of Asia, but in the science, but you have Cloud Light, you have some other transceiver guys here as well. So, when you balance those together, do you think there is sizable room here to expand margins on the transceiver side, which is a big chunk of your data comp business?
Jim Anderson, CEO
Thank you, Chris. I'll start by discussing the company as a whole before diving into data center transceivers. To put it simply, we are committed to reaching our goal of a 40% gross margin. We have identified two significant initiatives: one focusing on pricing and the other on product cost. The pricing optimization we can implement is likely more applicable to our industrial sectors, where we have numerous product lines and various sub-markets. I see a great opportunity to enhance our pricing strategy to better reflect the value of the technology and innovation we offer in these industrial markets. However, in the datacom transceiver area, there seems to be less potential for pricing adjustments, but there is certainly room for cost improvements. As mentioned earlier, one example is the product costs associated with transceivers. I highlighted that enhancing yields is a key opportunity, and Sherri and I recently conducted an operational review to discuss yield improvements that have been achieved in the past months, as well as what further enhancements we need to see going forward. This is a primary focus for us. So, regarding your question about datacom transceivers, while we may not find as much opportunity with pricing, we are definitely concentrating on reducing costs.
Christopher Rolland, Analyst
Great answer. Thanks, Jim.
Operator, Operator
One moment for our next question. Our next question comes from Jack Egan with Charter Equity Research. Your line is open.
Jack Egan, Analyst
Great. Thanks for taking the questions. So, I didn't hear or see anything about segment operating margins, but through June, the networking segment had been kind of range-bound in the mid-teens despite being at record revenue. So, I was just wondering, are you seeing the margin benefit from a higher mix of 800-gig transceivers today? And if not, just when exactly does that impact kind of kick in?
Jim Anderson, CEO
Yes, Jack, I’ll address that question. Sherri can join in if she wants. To answer your question, when considering the data center or communication segment, which mainly involves data center AI, it’s true that as we adopt new technologies, the newer speed grades for the transceivers generally provide higher margins. Consequently, as we rapidly increase production of these advanced, higher-speed transceivers, we typically see an improvement in gross margins. Therefore, as we scale up these higher speeds, we can anticipate an enhancement in margins.
Sherri Luther, CFO
Yes, I'll just add that if you look into our queue, you'll see, Jack, that we do show a segment profit, and on the networking side of the business, we did see higher segment profits sequentially. So, you will see that in there when you dig in.
Jack Egan, Analyst
Okay, great. I appreciate that. And then, my follow-up is a bit of a kind of a higher-level question. So, it was good to see a rebound in telecom, but we've seen this prolonged slowdown in that market after the carrier spent quite a bit on 5G spectrum licenses at first, and then obviously on the 5G equipment build-out itself. But when you look at some of the commentary kind of across the telecom supply chain, it's been pretty difficult to monetize 5G. So, the carrier might not have much incentive to keep spending and adding new capabilities. So, that being said, I'm just kind of curious on your long-term growth outlook for telecom and whether it may be challenged in the long-term just because those newer, more advanced generations like 5G, advanced or 6G are just difficult to monetize?
Jim Anderson, CEO
Yes, thanks, Jack. And that's exactly why we're taking a more cautious view on telecom in the near term. That's why last quarter I said we're taking a cautious view, and the same applies to this quarter as well. Until we see a dramatic pickup in telecom operator CapEx, I think that market may be challenged in terms of recovery. Now, that said, we did see in Q1 some strong positive signs as I said earlier. And I think the clear area of growth is around data center interconnect. We are definitely seeing strong demand signals in DCI, right? And obviously, that's only a portion of the telecom market, but we are seeing very strong demand signals there. And then, as I mentioned before, we did see a little bit of recovery in traditional telecom transport as well. But we agree in the near term, we're definitely taking a more cautious view of the telecom recovery. Now, over the long-term, we still do believe that telecom over the long-term will continue to grow and we believe that's a great growth area for the company. We've got a lot of new products that are ramping in that segment. And then, we'll paint a more complete picture of what we see as a long-term opportunity as part of our Investor Day in May.
Jack Egan, Analyst
Great. Thank you, guys.
Operator, Operator
One moment for our next question. Our next question comes from Richard Shannon with Craig-Hallam Capital Group. Your line is open.
Richard Shannon, Analyst
Great. Thanks, everyone, for allowing me to ask a couple of questions here. Jim, I guess maybe a quick two-parter related to datacom here. When I look at 1.6T, how are you thinking about Coherent tying to market relative to your competitors? And do you also expect to ramp at a breadth of customer base more like what you have now in 800-gig or kind of what you saw in the earlier phase of 800-gig where, as you just know today, the customer base has expanded nicely here over this period.
Jim Anderson, CEO
Yes, thank you, Richard. Just to reiterate, we delivered samples last quarter and are working closely with our customers to expedite production. We anticipate revenue to start increasing in 2025. As we approach that ramp, we will provide more details. We are eager to move into production as quickly as possible. Regarding the second part of your question about the customer base, I expect it to be similar to what we experienced at the beginning of the 800-gig ramp. It may be slightly different, but will be of comparable scale in terms of the number of customers.
Richard Shannon, Analyst
Okay. Fair enough for that, Jim. My quick follow-on question here is just following up on the last couple of recent questions related to your telecom business. You just noted in response to the last one here about seeing some really nice growth in DCI versus traditional telecom transport. Anyway, give us a sense of how big each of those buckets are, I know it's not easy to necessarily know where it goes, but is DCI relatively close to traditional telecom or a small portion, or just help us out a little bit there, please.
Jim Anderson, CEO
Yes, we don't really break out to that level of granularity, but DCI was a smaller portion, but is a rapidly growing portion of that revenue base, right? And so we do expect DCI to become a bigger component of that overall telecom TAM, as well as our revenue base over the coming quarters. It's certainly faster growing than kind of the rest of that part of the market.
Richard Shannon, Analyst
Okay. Appreciate the comment, Jim, that's all for now.
Jim Anderson, CEO
Thanks, Richard.
Operator, Operator
Thank you, ladies and gentlemen. This concludes today's question-and-answer session. I'd like to turn the call back over to Jim Anderson for any closing remarks.
Jim Anderson, CEO
Thank you, everyone, for joining us on our call today. I want to once again thank Sherri for joining the team as well. It's good to have her sitting at the table here with me again. And just in closing, I want to thank all my Coherent teammates for all their hard work and dedication. I'm really proud, really proud of them and proud to be on the same team as them. And we thank you for all of your support and look forward to updating you on our progress and operator that concludes today's call.
Operator, Operator
Thank you, ladies and gentlemen. This concludes today's presentation. You may now disconnect and have a wonderful day.