Coherent saw positive price action following its FQ2 earnings report with record revenue that beat consensus and EPS growth of 256% YoY. The top line revenue growth of 26.8% does not tell the full AI story, with the company’s AI-related networking segment up 56% YoY and 7% QoQ. When breaking it down by end markets, Datacom within Communications grew 79% YoY and was up 4% QoQ. There are additional AI-related components helping to drive sequential growth in the telecom segment, which was up sequentially for two quarters at 16% YoY growth and 11% QoQ growth.
To refresh your memory, Coherent supplies components for datacom transceivers and for optical interconnects. Transceivers and optical interconnects convert electrical signals into optical signals for fiber optic networks within the data center. Traditionally, optical links have been used for compute and storage servers, yet AI/ML servers are driving an increase in demand for the optical interconnects and transceivers that Coherent supplies.
As we look at larger AI systems ramping this year, there is some evidence that issues around single-rack Blackwell systems have been resolved yet multi-rack interconnects continue to see issues with overheating. Even though Nvidia has stated they are on schedule with Blackwell, the B300s and next generation Rubin will very likely require more fine-tuning.
Co-packaged optics (CPOs) are gaining widespread attention as a possible solution with rumors Nvidia will announce a CPO switch at the upcoming GTC conference. Although a bit early still, Coherent would be a strong contender in partnering on co-packaged optics. We take a look at this and the company’s strong financial performance in the report below.
Revenue Hits a New Record in FQ2
Coherent refined its methodology to report non-GAAP means starting in FQ2 2025 and recast the prior quarter’s non-GAAP numbers. The updated figures were used in this analysis.
FQ2 revenue grew by 26.8% YoY and 6.4% QoQ to a record $1.44 billion, beating consensus estimates for $1.37 billion by 5.11. Revenue strength was attributed to robust AI-related data center demand and growth in its telecom business, which offset weakness in its industrial segment.
- Management FQ3 guide is $1.39B to $1.48B, representing YoY growth of 18.7% and flat QoQ, beating estimates by 2.9%. Management FQ3 adjusted EPS guide is $0.85 at the midpoint, representing 123.7% YoY growth and beating estimates by 11.8%.
- Last quarter, revenue growth was up 28% YoY and up 3% QoQ to $1.35 billion. This beat consensus estimates for $1.32 billion by 2.4%.
When asked about the flat QoQ revenue on the call, the CEO stated it was not due to the AI-related segments: “It's pretty straightforward. We expect datacom and telecom to be up sequentially. And we expect the rest of our industrial related businesses to be down sequentially. And that net at the midpoint to be flat.”
Margins Expands for Fourth Consecutive Quarter
Disciplined operating expense management helped to drive strong improvement in operating margin.
- FQ2 Non-GAAP gross margin rose 363 bps YoY to 38.2%, compared to 34.6% in the same period last year. Non-GAAP gross profit rose for the fifth consecutive quarter to $548 million.
- Management guided FQ3 non-GAAP gross margin between 37% to 39%, mid-point of 38%, on non-GAAP gross profit of $545.3 million.
- Non-GAAP operating margin was 18.5%, up from 13.5% in FQ2 2024 with FQ2 marking the fourth consecutive quarter of expanding margins.
- The non-GAAP operating margin guide for the next quarter is 17.4%. Management is making progress towards its goal of achieving above 40% non-GAAP gross margin, driven by pricing optimization and product cost improvements.
The goal is to see 40% gross margin as pointed out in our Coherent writeup, and was reiterated in the opening remarks:
“And if you recall back when we — several quarters ago, when we put out our long-term gross margin targets of greater than 40%, we talked about our gross margin expansion strategy and the elements that comprise that. Product cost or cost reductions rather are part of that, but also pricing optimization. And so, you know, those areas continue to be, you know, areas of focus for us as we drive toward the long-term model of greater than 40%. And so pleased to see the results in Q2 and, you know, and we'll continue to focus on that going forward.”
Non-GAAP EPS Grows 256% YoY, Newly GAAP Profitable
FQ2 non-GAAP EPS rose 256% YoY to $0.96, beating consensus estimates for $0.67 by 41.8%. Coherent also generated its first GAAP profit of $0.44 in five quarters.
Management FQ3 adjusted EPS guide is $0.85 at the midpoint, representing 123.7% YoY growth and beating estimates by 11.8%.
Our previous analysis pointed out that Jeffries believes by driving more efficiencies, that Coherent can double adjusted EPS from about $3.00 to $6.40 annual EPS as soon as 2026.
Steady Cash Flow Growth and Chipping Away Debt
FQ2’s operating cash flow hit a five-quarter high of $187.42 million as the operating cash flow percentage rose steadily for the fifth consecutive quarter to 13.10%.
Free cash hit its highest levels for the fifth straight quarter at $81.7 million, and the free cash flow percentage also improved for the fifth consecutive quarter, hitting a high of 5.7%.
Cash flow growth has been consistent. Coherent closed the quarter with $917.8 million in cash and cash equivalents. Debt has been consistently shrinking for the fifth consecutive quarter as the company has paid down $132 million to $3.86 billion.
Please note, Coherent is looking to divest or shut-down non-strategic product lines and assets, which will help margins and to help reduce debt. Read more here.more here.
Key Metrics/Segments
The data center and communications market has grown 58% YoY and now comprises 57% of total revenues, which offsets the softer industrial market which was flat YoY and accounts for 31% of total revenues. Instrumentation at 7% and electronics round out the smallest market at 5%.
Coherent has three key revenue segments.
Networking segment revenues rose 56% YoY and 7% QoQ to $815.9 million, compared to 61% YoY and 12%QoQ growth to $763 million in the previous quarter. Ongoing AI data center demand and continued recovery in telecom were the key drivers. This segment generates 49% of total revenue.
Lasers segment revenues rose 6% YoY and 8% QoQ to $375.3 million, compared to 4% YoY growth and (2%) QoQ drop to $348 million in the previous quarter. Excimer annealing lasers in the display capital equipment business were the main driver. This segment generates 29% of total revenue.
Materials segment revenues fell (4%) YoY and grew 3% QoQ to $243.5 million, compared to (15%) YoY and (3% ) QoQ drop to $237 million in the previous quarter. The weak automotive and market demand was responsible for the drop. This segment generates 22% of total revenue.
End Markets:
Communications – Datacom:
Communications across both datacom and telecom had growth of 58% YoY and 6% QoQ to $823M. Per the opening remarks: “The sequential and year-over-year increases were driven by another strong quarter of growth in our datacom revenue and a second quarter of sequential growth in our telecom revenue.“
CEO Jim Anderson noted Coherent’s record FQ2 datacom revenue rose 79% YoY and 4% sequentially, driven by ongoing strong data center demand. Management continues to see an expanding number of customers adopting and ramping up its 800G transceivers, and 400G and below transceivers remain strong. Coherent remains on track to ramp up sales in 2025 of its 1.6T datacom transceivers as customer engagements continue to expand. They are developing 3.2T transceivers and have the deepest portfolio of photonic technologies.
Communications – Telecom:
Telecom revenue grew 11% YoY and 16% QoQ, driven by data center interconnect, with some improvement in the traditional transport market, too. Continued ramp of new products, including 100G, 400G and 800G ZR and ZR+ Coherent transceivers, are expected to continue to ramp in the coming quarters.
CEO Anderson stated they are moving from cautious to cautiously optimistic, with their telecom market up 16% QoQ and 11% YoY in FQ2, marking its second consecutive quarter of growth, “And we are expecting the telecom revenue to be up again sequentially in our fiscal Q3. So given all of that, we are cautiously optimistic that we've moved beyond the bottom of the valley in terms of the telecom recovery and demand, and we're on the upslope within that market.” New products and 100G, 400G, and 800G ZR/ZR+ Coherent transceivers drove growth.
Industrial:
Industrial end markets was up 7% YoY and up 3% QoQ to $437M, including display capital equipment and Excimer lasers for OLED screen manufacturing. Expanding OLED adoption in smartphones and adoption in larger format devices like laptops, tablets and computers is driving display strength.
Instrumentation and Electronics were both down YoY but up nominally QoQ. These are small segments >$100 million in revenue.
Valuation
Coherent trades at forward price-earnings (P/E) of 29.86.
The price/sales (P/S) ratio is 2.75, forward P/S is 2.51.
Earnings Call:
AI Datacom Transceivers and Co-Packaged Optics (CPO):
Coherent offers a range of datacom transceivers, and this is one of the company’s key advantages as AI networking is in flux, and Coherent can serve any request whereas other competitors specialize in only one transceiver technology. These transceiver technologies include VSCELs, EMLs, and CW lasers for silicon photonics.
Along the lines of what we’ve been discussing in our Q1 webinar, Coherent is in agreement that the importance of key networking technologies is going to increase as AI clusters grow in size.
Here is what was stated on the call:
“And we believe pluggable transceivers will continue to grow especially in the scale out domain over the coming years. And so we believe we're well positioned to grow not just, because the TAM is expanding, but because we believe we're well positioned for share gain as well.”
Looking beyond traditional pluggable optics, there is an increasing amount of discussion around co-packaged optics (CPOs), which places the optical transceivers directly on the chip package, rather than using separate optical modules. This results in faster data transmission, reduced latency and higher bandwidth. This may be the best of both worlds: the performance of optical yet with reduced power consumption. Tracking this is especially important as since we last covered copper/Semtech, there have been reports that copper is “causing concurrent issues with overheating and glitching” with rumors Nvidia will launch a CPO switch at the upcoming GTC. That could mean Coherent will be a lead supplier for the anticipated CPO switch – we will be monitoring this closely.
Here is what was stated on the call:
“But the second effect that we think that we're expecting, and this is kind of where CPO plays into, is we're expecting there to be a greater proportion of those interconnects between the computing nodes that switch from what are today electrical connections towards optical connections moving forward. And so think about it as the proportion of electrical versus optical, the proportion of optical connections, we believe increases over the coming years.
And the reason for that is if you look at the bandwidth that's required to support the connections between these computing nodes, and those computing nodes could be GPUs, CPUs, or XPUs, some sort of accelerators, the bandwidth is ramping up significantly. And optical connections can provide a much higher level of bandwidth than an electrical connection. And we think CPO is one of those enabling technologies. There'll be other enabling technologies that help enable the TAM expansion or the replacement of electrical connections with optical connections. And we see this CPO primarily, we believe the biggest sort of area of application for it over the long-term is in scale up. So within the rack or within the box connections between the computing nodes is where we believe we'll see the most prevalence over the long-term. And so the net is we believe CPO is a net accelerator of the overall TAM for optical networking and the data center. “
Here was another quote regarding the importance of CPOs and how Coherent will participate:
“But the second effect that we think that we're expecting, and this is kind of where CPO plays into, is we're expecting there to be a greater proportion of those interconnects between the computing nodes that switch from what are today electrical connections towards optical connections moving forward. And so think about it as the proportion of electrical versus optical, the proportion of optical connections, we believe increases over the coming years.”
Optical Switch Platform
The new data center Optical Circuit Switch (OCS) platform is progressing well, and Coherent has secured its first customer order in FQ2, significantly expanding its addressable market in data centers. Unlike other mechanical MEMS-based solutions, their platform uses field-proven digital liquid crystal technology that provides tremendous advantages for customers. Initial OCS revenue is expected in the calendar of 2025, yet will not be a significant contributor until 2026/2027.
“On the revenue ramp, we remain, our view remains that the revenue, we should start to see first revenue in this current calendar year. We'll probably get better, you know, quantification of that as we move throughout the year, but I think given that we would start to see revenue this year would be more of a contributor in calendar ‘26 and ‘27 and beyond”
Indium Phosphide Capacity Triples
Coherent emphasizes its ability to build many of its components yet also source when needed. They reiterate their supply chain resiliency on earnings calls to stand out against competitors who run into sourcing issues. FQ2 indium phosphide production grew 300% YoY, enabling rapid YoY growth of its 800G transceivers, as it’s the key technology behind EML (electro-absorption modulated laser) and CW (continuous wave) lasers. The U.S. CHIPS Act funding will help the expansion of the in-house indium phosphide platform at the Sherman, Texas facility.
Coherent is one of the few photonics companies with significant vertical integration. The Company grows its crystals and has had an in-house indium phosphide platform for two decades, which it is expanding.
Semiconductor capital equipment saw healthy sequential YoY growth where Coherent’s lasers and advanced materials are critical enabling technologies.
According to management, there were no significant impacts are expected from tariffs in FQ3, and the guidance already factors in any anticipated effects. Additionally, the company's robust and resilient supply chain further supports its ability to mitigate potential tariff challenges. There wasn’t and pull forward of demand from customers to stockpile ahead of tariffs.
Conclusion:
As you know, we’ve covered big tech capex for four years now to help us cement our AI positions. Although in years past, we positioned with the larger design companies, we are keen to position for the smaller networking component suppliers this year.
Our Members should note that this is all in a state of flux, so we will keep you informed as we go along, yet our goal at the I/O Fund is to strategically participate in Nvidia’s AI dominance throughout 2025. You can expect our portfolio to remain agile as we track these twists and turns. According to Trend Force, co-packaged optics could ship in “mass production” as soon as August. In the meantime, Coherent is putting up strong AI-related growth at exactly the right time, and we will not hesitate to buy more of this quality company with a management team that tripled EPS, has plans to reduce debt, and has transparent discussions on their plans increase their margins.
Jea Yu, Equity Analyst at the I/O Fund, contributed to this article.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
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