Coherent reported a double beat in Q3 with revenue growth of 24% and EPS growth of 141% YoY. The top line beat was driven by Data Center and Communications revenue growing 46% YoY. While this growth moderated slightly from the prior quarter, Nvidia suppliers should see a meaningful acceleration in the second half of the year.
Analysts have yet to fully factor in this acceleration, but as NVIDIA ramps Blackwell-based systems and scales out its Spectrum-X Ethernet and Quantum-X Infiniband platforms, suppliers of high-speed optical interconnects are likely to see an increase in demand. Coherent, as a key ecosystem partner to NVIDIA in silicon photonics and co-packaged optics (CPO), is well positioned to benefit as hyperscalers upgrade to 800G, 1.6T, and eventually 3.2T.
To refresh your memory, Coherent has many products that participate in the AI-driven datacom transceiver and optical interconnects market. Primarily, the growth story centers around supplying Nvidia with pluggable optical transceivers (400G, 800G, 1.6T) including EML lasers, VSCEL lasers and CW lasers, and emerging CPO technologies for next-generation switches and interconnects.
Coherent is certainly not without competitors, and this is the main risk the company faces. Management is tasked with executing flawlessly in an environment where components may see supply disruptions and must also move quickly to make sure they are first to market to support higher bandwidths. Optical transceivers are at risk of being commoditized as reflected in Coherent’s low margins.
Revenue
Coherent delivered another quarter of record revenue driven by strong AI data center demand, with revenue rising 4.4% QoQ and 23.9% YoY to $1.50 billion. This beat the consensus estimate for $1.44 billion by more than 4%, and marks a third straight quarter of >20% revenue growth.
For Q4, management guided a wide range for revenue, forecasting $1.425 to $1.575 billion. At the $1.5 billion midpoint, this represents flat QoQ and 14.5% YoY growth, slightly ahead of estimates for 12.1% growth. Revenue growth estimates for the next two quarters have moved higher since our last Q2 report, from the mid-9% range to double-digit growth through FQ1 2026.
Industrial is weighing on the growth while Datacom is expected to grow: “Yes, if you look at the midpoint of the guidance that Sherri provided on revenue, roughly flat at the midpoint sequentially. But within that, what I would say is we're expecting data center and communications to be sequentially up in the current quarter and then our industrial-related end markets to be sequentially down.”
Key Segments & End Markets
Networking remains the primary driver of Coherent’s growth as the company continues to release new optical networking solutions, including the industry’s first 400G electro-modulated laser (EML) to pave the way for 3.2T optical transceivers, as well as VCSEL-based CPO solutions.
Networking revenue increased 46% YoY and 10% QoQ to $897 million, or ~60% of revenue. Though growth continues to decelerate from Q1’s 61% print, the segment’s growth is much stronger this year compared to last. For the first nine months, networking revenue was $2.48 billion, up 53% YoY.
Lasers revenue softened, rising 4% YoY but dipping (3%) QoQ to $363.9M. This compares to 6% YoY and 8% QoQ growth last quarter to $375.3 million. Lasers accounted for 24% of revenue, down from 26% in the prior quarter as networking gained share.
Materials revenue remained soft, recording a YoY decline for the third consecutive quarter in Q3, though it lessened to just (1%) to $236.7 million. Of Coherent’s three revenue segments, Materials is the only to see a YoY decline for the first nine months of the year. Materials accounted for 16% of revenue.
By end markets, data center and communications continues to expand its revenue share, now accounting for 60% of revenue in Q3, up from 57% in Q2, helping offset softer growth in Industrial, Implementation and Electronics.
Data Center and Communications revenue increased 46% YoY and 9% QoQ to $897 million, slowing from 58% growth last quarter.
Within Communications, Telecom grew 2% QoQ and 21% YoY driven by data center interconnects. We’ve covered the DCI opportunity previously here, which could evolve to become a significant opportunity.
Industrial revenue increased 5% YoY and 1% QoQ to $440 million, accounting for just over 29% of revenue.
Implementation revenue was down (2%) YoY but flat QoQ to $96 million, accounting for over 6% of revenue. Electronics revenue declined (11%) YoY and (15%) QoQ to $66 million, accounting for less than 5% of revenue.
Margins
Coherent’s gross margin was at the higher end of management’s forecasted range and operating margin was more than 1 point ahead of its guide. Margins are expected to expand in Q4, although overall, margins are lower than a stock like Astera for example – which affects valuation.
The company recently restructured the business to divest the silicon carbide portion, which is also contributing to better margins for next quarter: “So I think you're referring to some of the restructuring that we've taken and the portfolio actions associated with it. And so what I would say is that the actions that were taken in terms of an underutilized assets or underutilized businesses, that benefit is — certainly will contribute to our financials from a gross margin and OpEx perspective, depending on the nature of the actual divestiture.”
- Q3 GAAP gross margin was 35.2%, expanding nearly 5 points YoY. Adjusted gross margin was 38.5%, at the higher end of the 37-39% guided range, expanding nearly 5 points YoY and slightly sequentially.
- GAAP operating margin was 4.8%, up 3 points YoY. Adjusted operating margin was 18.6%, up 6 points YoY and well ahead of the 17.4% guided figure. This highlighted some improvement in operating leverage for Coherent, expanding faster than adjusted gross margins.
For Q4, management is holding adjusted gross margin guidance steady at 37-39%, while guiding for an 18% adjusted operating margin. Coherent is beginning to close in on its long-term gross margin targets of 40% over the last two quarters, though it still needs to make some considerable progress or drive faster growth in higher-margin products to reach this threshold in fiscal 2026.
EPS
Coherent reported a 5.8% EPS beat in Q3 as it benefited from strong margins down the line, reporting $0.91 in EPS. This represented growth of 141% YoY, decelerating from 256% YoY growth in Q1.
For Q4, management offered a wide range for $0.81 to $1.01 in adjusted EPS, with the $0.91 midpoint in-line with estimates. For FY25, Coherent is currently expected to record more than 107% YoY growth to $3.46, though growth is expected to slow to 26.2% YoY to $4.37 in FY26. While the dollar figure for FY26’s EPS has not changed over the past three months, the growth figure is technically 17 points slower due to the higher base it’s growing from in FY25, at $3.46 estimated versus $3.02 three months ago.
Cash Flows and Balance Sheet
Cash flow margins expanded slightly YoY, with operating cash flow margin remaining in the double-digits, though just barely. Inventories ticked slightly higher, and accounts receivable rose rather quickly sequentially in Q3, with Coherent likely preparing for AI data center products such as Nvidia’s Blackwell to ramp in the back half of the year.
- Operating cash flow was $162.9 million for a 10.9% margin, expanding from a 9.7% margin a year ago. This was the fourth consecutive quarter of a double-digit OCF margin.
- Free cash flow was $51.1 million for a 3.4% margin, expanding from a 2% margin a year ago.
- Inventories ticked nearly 4% higher QoQ to $1.39 billion, though accounts receivable showed a much larger jump at more than 13% QoQ to $1.01 billion.
- Cash and equivalents totaled $890.3 million, while debt decreased slightly to $3.73 billion as Coherent paid down $136 million of debt in the quarter.
According to the CFO, the company has paid down $386M total for 2.1X debt leverage: “We paid down $136 million in debt during the quarter using cash from operations. This brings our fiscal year-to-date total debt payments to $386 million, reducing our debt leverage to 2.1x as defined in the credit agreement.”
When asked about inventory building, management stated they would not guide beyond one quarter yet see Datacom segment growing: “Yes. We don't guide beyond the current quarter, but what I would say is in datacom, we continue to see strong demand signals from our customers, both kind of shorter-term demand signals, which would be purchase orders and backlog, but also longer-term demand signals like the forecast that they'll give us a 12- or 18-month forecast. And so we continue to see strong demand from the data center customers. So we're expecting that business to continue to grow.”
Earnings Call Q&A
Upcoming 1.6T Shipments are a Major Catalyst
As discussed in our previous writeup on Coherent, the company supplies EML Lasers, VSCEL Lasers and CW Lasers for silicon photonics. While 100G per lane for 400G and 800G optical transceivers is what is supporting the growth now, it’s expected that 200G per lane and even 400G per lane for 1.6T optical transceivers is what will drive growth in H2 of this year.
Per the earnings call:
“So obviously, for the industry, the next — for the data center, the next big transition in terms of data rate is 1.6T, and we showed 3 different versions, one that was based on our 200G EML technology, one that was based on our 200G VCSEL and then another one based on our silicon photonics […] and then timing of impact would be on 1.6T, we continue to view the 1.6T ramp as we've said in past quarters. We expect 1.6T revenue to start in this current calendar year.”
The CEO also called out the importance of being early (and perhaps first) to release 400G per lane 3.2T in the future: “And then my other one that I really liked was we demonstrated 400G differential EML. And the reason that one is important is because that's really the foundation laser technology for 3.2T transceivers. So we're deep into the development of our portfolio of 3.2T transceivers and demonstrating that key laser capability of 400G is a really important milestone.”
According to a press release in March, Coherent was the first to release a 400G per lane EML for 1.6T, showing Coherent is working hard to remain a supplier of choice in a highly competitive market. According to Cignal AI, 400G and 800G modules grew 4X in 2023 and were expected to continue growing significantly in 2024 with Coherent noted as one of the leaders in the space.
To some extent, indium phosphide capacity is the limiting factor for these technologies, with Coherent stating they expanded capacity rapidly in the current quarter: “In Q3, we once again expanded our capacity both sequentially and year-over-year with year-over-year capacity growing by over 3x.” You can read more about InP here.
Coherent stated half of their revenue comes from EMLs, which is the main growth story right now: “As I mentioned in the prepared remarks, if we look at our transceiver revenue, actually over half the revenue is based on EML. So over half of our transceiver revenue comes from EML-based transceivers.”
Co-Packaged Optics and Optical Circuit Switches (OCSs):
Co-packaged optics also represents a significant opportunity for Coherent with an announcement in March that the company is collaborating with Nvidia on co-packaged optics at the time of the GTC conference. We prepared our Members for this announcement last quarter by stating in our post-earnings write-up, which was focused on CPOs:
“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.”That could mean Coherent will be a lead supplier for the anticipated CPO switch – we will be monitoring this closely.”
CPOs will be a strong growth story for Coherent as we move into 2026, and we will be tracking this closely as we go along.
Another growth story for 2026 is optical circuit switches, which were covered in our original Coherent write-up. On the call, it was implied that COHR believes it can outmatch Lumentum on OCS technology (LITE is MEMS-based): “We also continue to make good progress with our new data center optical circuit switch or OCS platform, which drives a significant expansion in our data center addressable market opportunity. The underlying technology in our OCS switch is based on field-proven digital liquid crystal technology that has been deployed for many years in demanding telecom applications. Our technology has tremendous benefits versus the mechanical MEMS-based solutions offered by others, and our customer engagement and enthusiasm around our OCS platform continues to grow.”
We will also keep an eye on this and let you know when timing approaches for OCS to become a growth driver.
China Manufacturing is Minimal:
China was bound to come up and Coherent communicated their rather insulated from China comparatively speaking:
“Christopher Rolland Susquehanna Financial Group:
So perhaps first, a follow-up on your manufacturing footprint, specifically for transceivers. I guess I think you're in China and Malaysia with that manufacturing. Do you have the capacity to serve American customers via Malaysia? Or how is China involved in that?
And then perhaps if you could give us some color as to what percent of your business might actually end up in America. So yes, can you fully serve America out of Malaysia? And what percent goes to the U.S.
James Anderson CEO, President & Employee Director:
Yes. On the first part of the question, the answer is yes. In fact, today, if you look at our U.S.-based, for instance, customers like hyperscaler customers, those transceivers come from Malaysia. So yes, we're — today, we're supporting our U.S. customers almost entirely from Malaysia.
And then on the second part of the question, I think you were asking about like total revenue by geography, how much is North America based. I don't know.”
Conclusion:
NVIDIA’s Spectrum-X and its Quantum-X Infiniband systems require ultra-high bandwidth and low-latency optics, both of which align with Coherent’s product roadmap. Nvidia’s NVLink speeds are expected to double from the fourth generation to the fifth generation as Blackwell is released to support the high-speed data transmission from AI workloads. This is expected to drive outsized demand for the 800G and 1.6T laser designs that Coherent specializes in.
Coherent is a company with a vanilla management team that tends to keep mum about anything progressing in the pipeline; likely to avoid stepping on any toes with Nvidia. Although Coherent faces competitive risks with gross margins that reveal commoditized pricing pressure, this next year is likely the most important year in Coherent’s history as their positioning in the optical module market will be tested.
There are no major flags in this report and no major catalysts in this quarter. Due to the competitive risks, we are watching Lumentum quite closely as well as both are strong players with EML lasers going into the highly anticipated NVL systems launch in the second half of the year.
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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