Coherent is a stock that will test investors as the company has near-perfect positioning, yet the timing is taking longer than what growth investors typically look for. If I had to describe this earnings report, I would use the word “visibility” as the headline numbers will fail to impress, yet I believe the stock price will march upward as the equation of what Coherent offers + where the demand is = will eventually materialize (in 2026).
The data center and communications segment revenue grew by 33% YoY and 11% QoQ in FQ2, accelerating from 26% YoY growth and 7% QoQ growth in FQ1 driven by strong AI demand. The Communications segment grew 44% YoY and 9% QoQ, although this was down from 11% QoQ growth and 55% YoY reported last quarter. However, the data center segment accelerated meaningfully to 14% QoQ and 36% YoY, up from 4% QoQ growth and 23% YoY last quarter. As of this quarter, data center and communications segment represents 70% of revenue.
The company offered strong visibility metrics, such as stating book-to-bill ratio is 4X, meaning they are booking orders 4X faster than they can ship. Much of Coherent’s timing hinges on indium phosphide capacity as the company has been working to increase this capacity by moving from 3-inch wafers to 6-inch wafers, which will produce 4X the amount of chips at half the cost. The words “second half" came up frequently with management emphasizing an incoming inflection: “We expect 1.6T to ramp significantly over the coming quarters, with the early phase of the ramp driven by our EML and silicon photonics-based transceivers, followed by our 200G VCSEL-based 1.6T transceivers ramping in the second half of this calendar year.”
In addition to the transition toward 1.6T being a catalyst, optical circuit switches (OCS) and co-packaged optics (CPO) represent additional catalysts as we move look into 2027. Although in the future, an area where Coherent could stand out is CW lasers for the incoming CPO wave in AI networking. According to management, they secured a large order from a hyperscaler. Management also emphasized their non-mechanical liquid crystal technology for OCS provides an edge, with an update on the call they currently have 10 customers in their pipeline.
Book-to-Bill at 4X offers Important Visibility
Coherent’s management team went to great strides to offer visibility, which helped the price stabilize after hours. In particular, the comment their data center bookings have a bill-to-book ratio of 4X was helpful: “In Q2, we experienced another step function increase in our data center bookings, with a book-to-bill ratio that exceeded 4x, as customer demand continues to increase and customers place orders further out in time, which provides us with strong visibility for the coming quarters.”
This was asked about in the Q&A with management emphasizing again the line of sight they currently have: “I was really pleased with the acceleration of our sequential growth rate, 14% sequential growth. And then we also saw, as I mentioned in the prepared remarks, over 4x book-to-bill ratio. So just seeing incredibly strong demand, and we’re seeing bookings go further out in time than we would have in the past, which is great for us for visibility.”
Coherent also noted that some large customers are booking 2-3 years out with long-term agreements, which guarantee customers a defined level of supply while offering a stronger growth outlook than optical networking companies have seen in the past.
Per management: “Then the third thing I would mention with respect to visibility is, number of long-term supply agreements that we’ve either signed with customers or in the process of signing, where, you know, the LTA will provide, a guarantee to our customers for a certain amount of, supply, and in exchange, they give us a guarantee on a certain amount of demand. There’s often, some sort of financial commitment from our customers, like investment for CapEx, et cetera. I would say all those things combined, the visibility of the business is, the best it’s ever been, which gives us just kind of great confidence in terms of the go-forward growth that we’re seeing.”
Pros/Cons of Internal Sourcing versus External Sourcing
Coherent’s slower growth compared to peers is due to sourcing the substrates and wafers internally rather than rely heavily on external suppliers. Although this results in higher margins over time, it results in a slower near-term ramp. This manufacturing strategy could ultimately pay off given Coherent can yield more at fixed costs.
Inevitably this is discussed at length on earnings calls given it’s a competitive differentiation versus other optical networking peers. In the opening remarks, Coherent explained they are on track to increase internal capacity by the end of the year: “For example, we significantly increased our indium phosphide production capacity in Q2, and we are executing on track to our plan to double our internal indium phosphide production capacity by the fourth quarter of this calendar year.”
During the Q&A, management described the advantages of sourcing internally in the following way: “Another way to look at it is, any time the kind of market price of Indium Phosphide goes up, it makes our internally sourced Indium Phosphide that much more valuable, right, in terms of a differential. And then, you know, I would say in terms of our own pricing, you know, we continue to see, you know, the ability to continue to optimize pricing. I think Sherry mentioned in her prepared remarks that, some of our gross margin improvement last quarter was based on pricing optimization. We continue to see opportunity to optimize pricing, especially in a environment where, where we’re, where demand is very strong.”
Financials
By Royston Roche
Organic Revenue Growth of 22%
Coherent’s FQ2 ending December 2025 revenue grew by 17.5% YoY and 6.6% QoQ to $1.69 billion, beating estimates by 2.7%. On a pro forma basis, excluding revenue from the divested Aerospace and Defense business, which the company sold in FQ1, revenue grew by 9% QoQ and 22% YoY primarily driven by AI Datacenter & Communications demand.
Management guided FQ3 revenue of $1.70 billion to $1.84 billion, implying a YoY growth of 18.2% and 5% QoQ at the midpoint, beating estimates by 3.5%. As per our internal proforma estimate, it implies a YoY growth of 23.8% and 6.3% QoQ in FQ3 after excluding Aerospace and Defense business revenue from the prior year quarter and also the recently sold product division based in Munich. The product business in Munich had averaged $25 million quarterly revenue and had a gross margin well below the company’s corporate gross margin.
Management expects continued strong growth in the second half of fiscal year 2026 and throughout fiscal year 2027 based on strong datacenter and communications demand and the continued production capacity expansion along with improving demand in the Industrial segment.
The company’s CEO and President, James Anderson said in the earnings call, “In particular, we expect continued strong sequential revenue growth in both our March and June quarters, and we expect our fiscal '27 revenue growth rate to exceed our fiscal '26 growth rate. The key growth drivers that we see over the coming quarters are growth in both 800 gig and 1.6T transceivers, growth from the ramps of new products such as OCS and CPO solutions and ongoing exceptionally strong demand in our products for DCI and scale across.”
Segments
Data Center and Communications Segment Revenue Growth of 33%
The company’s data center and communications segment revenue grew by 33% YoY and 11% QoQ to $1.21 billion. Revenue growth accelerated from 26% YoY and 7% QoQ growth in FQ1 driven by strong AI demand.
FQ2 data Center segment revenue grew by 36% YoY and 14% QoQ, accelerating from 23% YoY and 4% QoQ growth reported in FQ1. The FQ2 data center revenue growth was driven by growth in both 800 gig and 1.6T transceivers. The company is witnessing very strong AI demand and is also rapidly expanding capacity, and management expects double-digit sequential growth in data center segment in both FQ3 and FQ4.
Management expects revenue growth in the current quarter to be driven by a combination of growth in both 1.6T and 800 gig transceivers as well as growth in the OCS systems. Coherent is witnessing strong demand for the 1.6T transceivers across multiple customers and continue to expect both 800 gig and 1.6T to grow significantly in calendar 2026.
Coherent expects OCS revenue to grow sequentially in the coming quarters as they ramp production capacity as fast as possible to meet the rapidly growing demand. Management estimates over $2 billion of addressable OCS market in the coming years.
Communications segment FQ2 revenue grew by 9% QoQ and 44% YoY driven by growth in data center interconnects products and in traditional telecom applications. Management expects the communications business to grow sequentially in FQ3 and FQ4.
Industrial segment revenue was down (10%) YoY and down (3%) QoQ. On a pro forma basis, excluding the divested aerospace and defense business revenue grew by grew 4% QoQ and was flat YoY. Sequential growth in FQ2 was driven by industrial lasers and engineered materials product lines. Management expects the Industrial segment to be roughly flat sequentially in FQ3 on a pro forma basis. Looking ahead, they expect improving demand as they witnessed significant increase in orders in FQ2 from the semi-cap customers, which they expect to translate into sequential growth for the industrial business in the June quarter and the remainder of this calendar year.
Margins
The company’s margins are improving driven by reductions in product costs, manufacturing efficiency gains, and operating leverage.
- FQ2 gross profits grew by 22.3% YoY to $622.8 million. Adjusted gross profits grew by 20% YoY to $657.4 million with an adjusted gross margin of 39%, up 80 basis points YoY and 30 basis points sequentially and was in-line with the guide. The improvement in gross margin was driven by reductions in product input costs, efficiency gains from improved cycle times in the manufacturing process, as well as yield improvements. Pricing optimization also continued to contribute meaningfully to the gross margin expansion. The management FQ3 guide is 39.5%.
- FQ2 operating income grew by 34.3% YoY to $184 million. Adjusted operating income grew by 26.8% YoY to $336 million with an adjusted operating margin of 19.9%, up 140 basis points YoY and up 40 basis points QoQ and was in-line with the guide. The operating margin improvement was due to operating leverage and operational efficiencies. The management FQ3 guide is 20.9%.
- Net income grew by 41.9% YoY to $146.7 million with a net profit margin of 8.7% compared to 7.2% in the same period last year. Adjusted net income grew by 34.2% YoY to $248.2 million with an adjusted net profit margin of 14.7% compared to 12.9% in the same period last year.
Adjusted EPS grew by 36% YoY
FQ2 GAAP EPS grew by 72.7% YoY to $0.76, beating estimates by 10.1%. Adjusted EPS grew by 35.8% YoY to $1.29, beating estimates by 7%.
Management has guided adjusted EPS of $1.28 to $1.48 for FQ3, implying a YoY growth of 51.6% at the midpoint and beating estimates by 4.5%. Analysts expect FQ4 adjusted EPS to grow 43.2% YoY to $1.43 and 31.3% YoY to $1.52 in FQ1.
Cash Flow and Balance Sheet
Coherent’s balance sheet is beginning to improve, with the company using proceeds from the divestment to pay down debt, though debt to cash remains upside down. Operating cash flow margins were also thin and free cash outflows increased due to high capex to support the strong AI demand.
- FQ2 operating cash flow was $57.9 million or 3.4% of revenue, down from $187.4 million in the same period last year and up from $46 million in the previous quarter.
- FQ2 free cash outflow was ($95.7 million) or (5.7% of revenue), down from $81.7 million or 5.7% of revenue in the same period last year. FQ2 capex grew by 45.3% YoY to $154 million to support the strong AI demand. Management expects capex to increase in the coming quarters to support strong expected demand in the data center and communications segments.
- The company had debt of $3.35 billion and cash of $863.7 million at the end of the December quarter. While the debt is high, the company has taken steps to streamline its portfolio, with the $400 million sale of its Aerospace and Defense unit in early September, which it used to pay down its debt. Thereby, reducing the debt leverage ratio from 2.4x in the September 2024 quarter to the current 1.7x. The company further plans to pay down its debt by using the proceeds from the recently sold Munich product division, which should also reduce interest expenses and lower the debt leverage ratio.
Conclusion:
Data center revenue is accelerating with a 4X book-to-bill ratio and the 6-inch wafer supply is already at 80% of target capacity. In addition, optical circuit switches are moving now and co-packaged optics are on the way – two solutions that Coherent maintains they have significant IP compared to its competitors.
Coherent hurries for nobody, and that discipline is evident even as the emerging 1.6T cycle is arriving earlier than expected and will be margin accretive. The company clearly has a plan given its pivot to 6-inch wafers; that plan happens to be more gradual than the market prefers to see. However, when strong visibility intersects with an in-line earnings report; strong visibility tends to win out.
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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