The I/O Fund has been looking closely at the networking stack to position for 2025 due to the increased demand from the expanding role that optical networking will play in artificial intelligence clusters.

Lumentum is a strong candidate within the networking stack as the company supplies components for datacom transceivers and optical interconnects. We recently covered a close competitor Coherent, who is quite similar in terms of its products. As discussed in the Coherent writeup, 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.

AI models are driving an exponential increase in compute requirements, meanwhile the scaling of workloads is limited by the existing network. Although GPUs and AI accelerators capture the headlines, as we move into 2025, hyperscalers will become equally as focused (if not more so) on networking capabilities as GPUs and ASICs are reaching the upper limit of what networking components and interconnects are capable of.

In response, transceiver speeds have been increasing, as traditionally, the highest data rates ranged from 100G to 200G to 400G. AI servers are driving a market for 800G data rates, which are shipping in production now, and 1.6T rates, which are shipping in 2025. These interconnects help to meet demand for high-speed, low-power data transmission in data centers. Over the coming year, a transition to 200G lane speeds for 800G and 1.6T single-mode optics and InP (indium phosphide) laser transmitters will cause some of these little-known suppliers to reach a critical inflection point in revenue, margins and cash.

The high-speed optical transceiver market is expected to grow at a 30% CAGR to exceed $10B between now and 2028. Notably, discussions from Lumentum’s management team points toward a more noticeable inflection in the second half of 2025 due to EML-related products being capacity constrained, yet we think it’s prudent to start tracking these companies now in an effort to be early. 

Optical Networking Components for 800G and 1.6T Transceiver Applications:

Lumentum’s cloud and networking segment inflected in the September quarter with 11% QoQ growth and more sequential growth expected in the December quarter. This was driven by silicon-based optical and photonic products, such as lasers, optical and datacom transceivers, and 400G and 800G optical modules.

About a year ago, Lumentum acquired a company called Cloud Light for its 800G transceivers. At time of acquisition, over half of Cloud Light’s $200M in revenue was from 800G modules, resulting in a doubling of Lumentum’s cloud data center infrastructure revenue.

The acquisition allowed Lumentum to add Cloud Light’s SR transceiver to the 100G VSCELs to potentially supply 800G transceivers to Nvidia. Following the acquisition, Lumentum is expected to become a supplier to Nvidia in early 2025 pending a qualification process with the Thailand facility.

An analyst pointed out the growth in the AI-related segment is forecast to be about 20% QoQ, from $282.3 million this quarter with an additional $55 million in sequential growth guided. The CEO stated it was from a mix of datacom chips and datacom modules although datacom chips will see bigger growth in the coming quarters: “I'd say Datacom chip growth is not a lot until the next couple of quarters because the capacity comes in increments in chunks.”

200G EML Datacom Transceivers:

Transceiver technologies that Lumentum provides include VSCELs, CW lasers for silicon photonics and EML-based lasers. Of these, the 200G EMLs are what is expected to drive the H2 2025 inflection. Management stated in the August earnings call that the 200G lane speeds in the 1.6T optical transceivers “play to our strengths” and that “we anticipate being a key laser supplier in initial 1.6T transceiver deployments as we ramp up 200G EMLs later this fiscal year.”

Electro-absorption modulated lasers (EMLs) enable 200G per lane transmission, which is enabling the 1.6TBps data rates for AI servers. As pointed out in last week’s analysis, EMLs were traditionally used by telecom customers, yet became attractive for AI servers due to meeting the 200G per second speeds necessary for 1.6T optical modules to support AI models. These are called single mode optics, made of Indium Phosphide, which has been used instead of silicon for long-haul networking due being a superior choice for optical functions, such as enabling the laser, modulator, photodetector and amplifier. InP is more expensive at the component level as four EMLs are needed compared to two lower-cost CW lasers for silicon photonics modules, yet this difference at the component level can be made up for in data centers as InP reduces power consumption.

Lumentum is already a lead supplier for 100G EML transceivers, and is setting up to be in pole position for the 200G EML transceivers. Per the November earnings call: “our 100G EMLs are currently shipping in high volumes to a wide range of optical transceiver suppliers for use in leading edge single-mode 400G and more importantly, 800G optical transceivers. These customers are now designing our 200G EMLs into their next generation of transceivers, positioning us well for the upcoming transition to 200G per lane.”

200G per Lane to Ramp in 2025

Management is optimistic in capturing the transition to 200G lane speeds that is expected to drive the importance of single-mode optics and indium phosphide laser transmitters. The company’s indium phosphide 100G EMLs (Externally-Modulated Lasers) are being shipped and used in leading single-mode 400G and 800G optical transceivers. These customers are now designing the company’s 200G EMLs into their next generation of transceivers.

Management provided a few clues as to when to expect an impact in their revenue growth from the 200G per lane datacom transceivers. For the upcoming quarter, datacom transceiver shipments are expected to increase QoQ and will continue to grow throughout the calendar year 2025. 

Regarding the timing, it was stated: “And so we're going to participate at the component level, as I talked about in the script, with our 200-gig EMLs and that ramps really more towards the summer of next year. But we're in the qualification stages today and have received volume orders today as our capacity is quite constrained. But I'd say that by the end of next calendar year, 1.6T should be ramping in a significant way.”

There was some talk about pricing power on EMLs, with management stating: “I think that we're justified in looking at price optimization on EMLs is one area that we are looking at and have implemented some strategic pricing for those products.”

EML Fully Subscribed in 2025:

In the August earnings call, it was stated the Indium Phosphide capacity is fully subscribed “to at least the end of calendar 2025. And therefore, we can only meet this demand by growing capacity.”

To increase capacity, the company is investing in wafer fab facilities, with $43 million spent in FQ4. In Q1, $74 million was invested in Capex “primarily driven by investments in high-speed transceiver capacity additions at our Thailand manufacturing site as well as indium phosphide wafer production capacity.”

Due to strong demand, the company is working to increase the EML production capacity by 40% in Q4 FY2025 compared to the same period last year, and then implied higher capacity growth the following year (beginning in June) – reference Q&A transcript below.

The company’s Datacom transceiver capacity expansion in Thailand is progressing well. The first production line is operational and management expects to complete additional phases in the next 18 months to meet the strong demand. These expansions are part of the company’s plan to expand facilities outside China.

Future Transceiver Technologies:

Looking further out into 2026, Lumentum is working on higher speed optical links, including 400G per lane, and new architectures, such as co-packaged optics requiring ultra-high power lasers. Specifically, the company’s experience in InP long haul transceivers is being tapped as AI servers scale out, especially since InP reduces power consumption compared to silicon.

Optical Switching:

Optical switches are a new kind of switch for AI clusters that handles the switching optically instead of using transceivers to convert photons to electrons, and back again. There are many competitors within optical switching, with heavyweights Broadcom and Arista coming to mind, yet Lumentum believes their MEMS-Based technology can set them apart. Although the discussion around MEMS can get quite technical, the idea is that Lumentum is a smaller, (potentially) key supplier for customers putting optical circuit switches into their data centers. Another use case for using Lumentum is to rearchitect or write software to enable the optical circuit switching.

According to the most recent earnings call, Lumentum has “already shipped evaluation units to customers who have provided overwhelmingly positive feedback on our performance.” It was also stated that “more meaningful growth will probably be in calendar 2026” for the optical switching circuit products.

Data Center Interconnects:

For long-distance transmission, Lumentum offers tunable lasers for data center interconnects (DCIs). These transmissions are traditionally used for telecom purposes and can range up to hundreds of kilometers, yet are now seeing demand for data center buildouts. Per the call: “we're seeing dramatic strength in anything ZR, anything to connect data centers as data centers are being built out, and that can take the form of ZR modules. But given our share of tunable lasers that go into ZRs, that's where we're going to see a dramatic pickup in the telecom side.”

Three Hyperscaler Customers for 2025

Lumentum recently added a third hyperscaler customer for a total of three hyperscaler customers. According to the earnings call: “we expect to start shipping volume production against these new customer awards in the first half of calendar 2025, and they will ramp through the year, consistent with the revenue targets we set out previously.”

According to a Susquehanna analyst, this is the return of the primary CloudLight customer i.e., Google. This is in addition to the new customer added last quarter.

With that said, Lumentum is competing for the larger orders expected to be placed sometime in 2025: “And I think we're positioning ourselves very well. We're having the capacity in place, as I said, with clean rooms as well as equipment. So we're planning for success, but we still have to earn that. But that said, these are all very, very large customers that consume a lot of transceivers. And so getting in the door is step one and earning bigger share is really what we're striving to do now.”

FQ1 Revenue and 2025 Revenue Targets

This quarter, Lumentum reported QoQ growth in its primary AI-related segment, Cloud and Networking. Management also reiterated their goal of reaching quarterly revenue of $500 million by the end of the calendar year 2025 while expecting continued significant growth into 2026 and 2027.

The management team plans to achieve its goal of $500 million quarterly revenue from the current guide of $390 million for the December quarter by increasing the EML capacity by 40% by June, and tapping the transceivers and data center infrastructure opportunities discussed above. If the traditional telecom business recovers, the company is expected to reach their goal before the end of the year.

Chris Coldren, Senior VP, recently said at the Barclays conference that he feels a lot better about telecom, which is another positive catalyst as the company’s revenue has declined in the past due to the inventory corrections at its network equipment customers.

“So, I feel a lot better about telecom than we have been at least several quarters that we're starting to see things improve. And hopefully, history repeats as things tend to improve, then they tend to improve faster than you expect. And then when they get bad, they tend to get worse than you expect. And we'll let you know when that starts to happen, but it definitely feels good.”

• Q1 FY2025 revenue grew by 6.1% YoY to $336.9 million and set a new record for Datacom laser chip orders. The CEO, Alan Lowe, said in the earnings call, “In the first quarter, we exceeded the high end of our guidance for both revenue and earnings per share. We set a new record for Datacom laser chip orders, including 200-gig EML chips, reflecting strong demand from multiple customers, including an AI infrastructure customer.”
• Management has guided FQ2 revenue of $390 million, representing YoY growth of 6.3% and 15.8% QoQ growth at the midpoint. “As we previously forecasted, our datacom transceiver shipments are expected to increase sequentially this December quarter, and we expect our transceiver production to continue growing throughout calendar year 2025, driven by demand from multiple hyperscale cloud and AI customers.”

Looking further out, analysts expect FY2025 ending June revenue to grow 17% YoY to $1.59 billion and 28.4% YoY to $2.04 billion in FY2026.

Segments

Cloud and Networking

Q1 FY2025 Cloud and Networking revenue grew by 23% YoY and 11% QoQ to $282.3 million. Profit from this segment increased 13% sequentially and 13% YoY. Segment profit increased to 2.5 percentage points YoY to 12.9%.

Revenue accelerated from a decline of (-11.1%) YoY in FQ4. Management attributed the strong growth to setting “a new record for Datacom laser chip orders, including 200-gig EML chips, reflecting strong demand from multiple customers, including an AI infrastructure customer.”

Management expects strong sequential growth to continue in FQ2: “based on expanding cloud demand and improving trends in the broader networking market, we expect double-digit sequential revenue growth in the second quarter.” Per discussions in the Q&A portion of the call, the implied increase QoQ for FQ2 will be $50 million to $60 million or about 20% sequential growth versus the 15.3% guided QoQ growth for overall revenue.

Industrial Tech

Industrial Tech revenue declined by (-38%) YoY and up 2% QoQ to $54.6 million. Management expects FQ2 revenue “to be approximately flat sequentially due to an uptick in industrial lasers led by our ultrafast lasers, offset by a sequential decline in 3D sensing revenue.” Segment profit declined to 4% from 17.4% in the same period last year.

Margins

The company’s margins are recovering helped by cost controls. The management has set an ambitious goal to achieve an adjusted operating margin of 17% to 20% when the company’s quarterly revenue surpasses $600 million. Management plans to reach the target by better capacity utilization, cost controls, and synergies from prior acquisitions.

Looking further ahead to next year, management expects gross margins to increase while operating margins will come under pressure from increased R&D investments: “we’ll see gross margins tick up sequentially through the fiscal year, but we'll — it will be muted a little bit from an operating margin standpoint because of the increased R&D investment we're making just given the amount of customer pull we have.”

The overhead expenses are also expected to increase in the next couple of quarters due to additional capacities being added. These investments are expected to yield benefits in the middle of this year as production ramps up. The Street can be especially margin-sensitive with hardware companies, and thus, this is important to keep track of:

“No, it does have a little bit of overhead impact [to add capacity] because we're building out in our Thailand facility as we move more of our production of transceivers to Thailand. And so as we move that up and ramp that up, there will be a couple of quarters of overhead expenses associated with that. And so that's already contemplated in the sequential increases in margins. But then as that volume ramps up in the middle part of next calendar year, we'll be able to see the benefit of that moving through the quarter. So we'll explain more about that as the quarters happen, but thank you for asking about that.”

• Q1 FY2025 gross margin was 23.1% compared to 24.1% in the same period last year. Adjusted gross margin was 32.8% in both the periods. Management expects gross margins to improve sequentially throughout FY2025. “In future quarters, we anticipate company gross margins will sequentially increase as manufacturing utilization improves due to an improving telecom outlook as well as an increase in Datacom laser shipments.”
• Operating margin was (-24.5%) compared to (-25.4%) in the same period last year. Adjusted operating margin improved to 3% from 0.60% in the same period last year. The difference between GAAP and non-GAAP operating margin is due to the stock-based compensation expenses and amortization of acquired intangibles. Management expects the adjusted operating margin to improve to 6.5% in FQ2.
• Net margin was (-24.5%) or (-$82.4 million) compared to (-21.4%) or (-$67.9 million) in the same period last year. Adjusted net margin was 3.6% or $12.2 million compared to 5.1% or $16.1 million in the same period last year.
• Adjusted EBITDA was $37 million or 11% of revenue compared to $34.6 million or 10.9% in the same period last year.

EPS

The EPS is expected to rebound in the coming quarters, with adjusted EPS expected to almost double sequentially in the next quarter. Note the very strong, incoming rebound on adjusted EPS below.

• FQ1 adjusted EPS came in at $0.18, beating consensus estimates by 48.1%, helped by operating leverage and cost controls.
• Analysts expect FQ2 adjusted EPS to grow 9.6% YoY to $0.35 and 46% YoY to $0.42 in FQ3.
• Looking further out, analysts expect the adjusted EPS for FY2025 ending June to grow 56% YoY to $1.58 and 134.5% YoY to $3.70 in FY2026.

Cash Flow and Balance Sheet

The cash flows are improving, driven by the recovery in revenue. With management targeting an adjusted operating margin of 17% to 20% once quarterly revenue surpasses $600 million, cash flow generation should further strengthen in the coming quarters.

• Q1 FY2025 operating cash flow was $39.6 million or 11.8% of revenue compared to (-$2.3 million) or (-0.7%) of revenue in the same period last year.
• Free cash outflow was (-$34.5 million) or (-10.2%) of revenue compared to (-$63.1 million) or (-19.9%) of revenue in the same period last year. The company has been investing due to the strong demand for AI. The company’s CEO, Alan Lowe, said in the earnings call, “In Q1, we invested $74 million in CapEx, primarily driven by investments in high-speed transceiver capacity additions at our Thailand manufacturing site as well as indium phosphide wafer production capacity.”
• The company has cash & short-term investments of $916.1 million and debt of $2.58 billion compared to $887 million and $2.5 billion at the end of FQ4.

Earnings Call Q&A:

EMLs are Capacity Constrained

EML production capacity was the hot topic on the earnings call, with the discussions revealing quite a bit about Lumentum’s strategy as the company attempts to compete against companies like Coherent/Innolight, Eoptolink, and others. Essentially, the company is buying CW lasers while reserving capacity for EML production in-house.

Reserving capacity for EMLs:

Here is what was stated regarding why Lumentum is looking for more H2 2025 strength in both EML lasers and the company’s strategy when approaching limited capacity with what they can build in-house:

“So, we use a lot of CW lasers, not EML lasers yet in the products that we're shipping and released today. So we can buy those CW lasers externally or we can use our very critical EML capacity to add those CW lasers into our products.

We've done the math. There's a lot of good CW laser suppliers. It makes more sense for us to buy those CW lasers and free up that EML capacity to ship to our customers than it would be to convert that EML capacity to CW lasers, for example. So that's one of the things that's pushing off that integration of CW lasers into our products until the second half.

I'd say that we are working on EML-based designs, and those will come to market in the second half of the calendar year. We have to get qualified and go through that. But today, most of the products that we're producing are silicon photonic-based using CW lasers from our strategic supplier partners to keep that EML capacity for our customers.”

–End Quote

1.6T Transceivers Driving Demand for EMLs:

Lumentum’s call is decisively focused on EMLs compared to more broad product discussions on the VSCELs or CW lasers that Coherent’s call covers. When asked why EML is so critical to Lumentum’s strategy, the management team responded with:

“And I'd add that the real performance advantage of EML starts to come in as we talk about 1.6T and future generations of higher performance 1.6T. So, our natural road map also aligns with using more vertical integration where the technologies are much more differentiated at those speeds.” There was also a follow-up: “And as Chris said, a lot of the new next generation of 1.6T likes EMLs better, especially as you get into multi-wavelengths where EMLs can really play a key role there. So yes, we're absolutely going to do that. It probably makes more sense in the second half of the calendar year as we get into these more advanced 1.6T products.

And then we have next-generation 200-gig EMLs, which are really going to differentiate us from our competitors. And I think that really gives us the ability to drive incremental differentiation at the transceiver level and drive higher gross margins.”

It was also stated during this discussion that the goal is to increase EML production capacity by 40% between June of 2024 and June of 2025. There was a question as to why not increase it 100%, to which management relented they would increase by that much, if they could: “So a very good question. If I had the ability to add 100% between now and June, I would do it.”

Most importantly, management hinted there would be more than 40% capacity increases after June, pointing toward wafer capacity for EMLs coming online in Japan: “And so I think we're going to do well in the second half of the calendar year on that. But we are adding capacity beyond the 40% for sure after the June quarter. We're not sitting idle for sure.”

EMLs will Not Ship until Later this Year:

Quick note to say the 11% sequential growth last quarter and the expected 20% growth this quarter in the cloud and networking segment is not coming from EMLs yet.

Per the discussions: “And so these, in general, are transceivers that won't have our EMLs at initial launch, if you will, because these have been in development and designed over the past year or so.

Obviously, these accounts have other opportunities to Alan's point, as we succeed and execute with them, not only will there be more share, but there will be more SKUs and other types of transceivers where we can introduce more of our own content.”

Expanding Outside of China

There were discussions around China with management stating “we’re as tariff-free as you can get with respect to our future,” citing manufacturing in the United States, U.K., Thailand and Japan. Similar to Coherent, Lumentum sees this as a tailwind.

“And with our U.S. headquarter and manufacturing outside of China, I think there's a compelling reason for customers to come our way. So we expect to not only grow our datacom module business and EML chip business, but gain significant share through the next coming years.”

Conclusion:

It’s important to emphasize that it’s not clear who will win the networking wars, yet we think given our detailed process of tracking earnings reports for material inflections, combined with technicals that allow us to reduce risk while tracking breakouts, that we will be able to carefully add the correct winners to our portfolio for 2025.

To hear more on how we plan to position this year, plan to join me for a one-hour special webinar for Q1 2025 on January 14th at 4:30 pm EST.

That’s a wrap for 2024! Thank you for an amazing year, we look forward to continued outperformance in 2025.

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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The I/O Fund has been looking closely at the networking stack to position for 2025 due to the increased demand from the expanding role that optical networking will play in artificial intelligence clusters.

Lumentum is a strong candidate within the networking stack as the company supplies components for datacom transceivers and optical interconnects. We recently covered a close competitor Coherent, who is quite similar in terms of its products. As discussed in the Coherent writeup, 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.

AI models are driving an exponential increase in compute requirements, meanwhile the scaling of workloads is limited by the existing network. Although GPUs and AI accelerators capture the headlines, as we move into 2025, hyperscalers will become equally as focused (if not more so) on networking capabilities as GPUs and ASICs are reaching the upper limit of what networking components and interconnects are capable of.

In response, transceiver speeds have been increasing, as traditionally, the highest data rates ranged from 100G to 200G to 400G. AI servers are driving a market for 800G data rates, which are shipping in production now, and 1.6T rates, which are shipping in 2025. These interconnects help to meet demand for high-speed, low-power data transmission in data centers. Over the coming year, a transition to 200G lane speeds for 800G and 1.6T single-mode optics and InP (indium phosphide) laser transmitters will cause some of these little-known suppliers to reach a critical inflection point in revenue, margins and cash.

The high-speed optical transceiver market is expected to grow at a 30% CAGR to exceed $10B between now and 2028. Notably, discussions from Lumentum’s management team points toward a more noticeable inflection in the second half of 2025 due to EML-related products being capacity constrained, yet we think it’s prudent to start tracking these companies now in an effort to be early. 

Optical Networking Components for 800G and 1.6T Transceiver Applications:

Lumentum’s cloud and networking segment inflected in the September quarter with 11% QoQ growth and more sequential growth expected in the December quarter. This was driven by silicon-based optical and photonic products, such as lasers, optical and datacom transceivers, and 400G and 800G optical modules.

About a year ago, Lumentum acquired a company called Cloud Light for its 800G transceivers. At time of acquisition, over half of Cloud Light’s $200M in revenue was from 800G modules, resulting in a doubling of Lumentum’s cloud data center infrastructure revenue.

The acquisition allowed Lumentum to add Cloud Light’s SR transceiver to the 100G VSCELs to potentially supply 800G transceivers to Nvidia. Following the acquisition, Lumentum is expected to become a supplier to Nvidia in early 2025 pending a qualification process with the Thailand facility.

An analyst pointed out the growth in the AI-related segment is forecast to be about 20% QoQ, from $282.3 million this quarter with an additional $55 million in sequential growth guided. The CEO stated it was from a mix of datacom chips and datacom modules although datacom chips will see bigger growth in the coming quarters: “I'd say Datacom chip growth is not a lot until the next couple of quarters because the capacity comes in increments in chunks.”

200G EML Datacom Transceivers:

Transceiver technologies that Lumentum provides include VSCELs, CW lasers for silicon photonics and EML-based lasers. Of these, the 200G EMLs are what is expected to drive the H2 2025 inflection. Management stated in the August earnings call that the 200G lane speeds in the 1.6T optical transceivers “play to our strengths” and that “we anticipate being a key laser supplier in initial 1.6T transceiver deployments as we ramp up 200G EMLs later this fiscal year.”

Electro-absorption modulated lasers (EMLs) enable 200G per lane transmission, which is enabling the 1.6TBps data rates for AI servers. As pointed out in last week’s analysis, EMLs were traditionally used by telecom customers, yet became attractive for AI servers due to meeting the 200G per second speeds necessary for 1.6T optical modules to support AI models. These are called single mode optics, made of Indium Phosphide, which has been used instead of silicon for long-haul networking due being a superior choice for optical functions, such as enabling the laser, modulator, photodetector and amplifier. InP is more expensive at the component level as four EMLs are needed compared to two lower-cost CW lasers for silicon photonics modules, yet this difference at the component level can be made up for in data centers as InP reduces power consumption.

Lumentum is already a lead supplier for 100G EML transceivers, and is setting up to be in pole position for the 200G EML transceivers. Per the November earnings call: “our 100G EMLs are currently shipping in high volumes to a wide range of optical transceiver suppliers for use in leading edge single-mode 400G and more importantly, 800G optical transceivers. These customers are now designing our 200G EMLs into their next generation of transceivers, positioning us well for the upcoming transition to 200G per lane.”

200G per Lane to Ramp in 2025

Management is optimistic in capturing the transition to 200G lane speeds that is expected to drive the importance of single-mode optics and indium phosphide laser transmitters. The company’s indium phosphide 100G EMLs (Externally-Modulated Lasers) are being shipped and used in leading single-mode 400G and 800G optical transceivers. These customers are now designing the company’s 200G EMLs into their next generation of transceivers.

Management provided a few clues as to when to expect an impact in their revenue growth from the 200G per lane datacom transceivers. For the upcoming quarter, datacom transceiver shipments are expected to increase QoQ and will continue to grow throughout the calendar year 2025. 

Regarding the timing, it was stated: “And so we're going to participate at the component level, as I talked about in the script, with our 200-gig EMLs and that ramps really more towards the summer of next year. But we're in the qualification stages today and have received volume orders today as our capacity is quite constrained. But I'd say that by the end of next calendar year, 1.6T should be ramping in a significant way.”

There was some talk about pricing power on EMLs, with management stating: “I think that we're justified in looking at price optimization on EMLs is one area that we are looking at and have implemented some strategic pricing for those products.”

EML Fully Subscribed in 2025:

In the August earnings call, it was stated the Indium Phosphide capacity is fully subscribed “to at least the end of calendar 2025. And therefore, we can only meet this demand by growing capacity.”

To increase capacity, the company is investing in wafer fab facilities, with $43 million spent in FQ4. In Q1, $74 million was invested in Capex “primarily driven by investments in high-speed transceiver capacity additions at our Thailand manufacturing site as well as indium phosphide wafer production capacity.”

Due to strong demand, the company is working to increase the EML production capacity by 40% in Q4 FY2025 compared to the same period last year, and then implied higher capacity growth the following year (beginning in June) – reference Q&A transcript below.

The company’s Datacom transceiver capacity expansion in Thailand is progressing well. The first production line is operational and management expects to complete additional phases in the next 18 months to meet the strong demand. These expansions are part of the company’s plan to expand facilities outside China.

Future Transceiver Technologies:

Looking further out into 2026, Lumentum is working on higher speed optical links, including 400G per lane, and new architectures, such as co-packaged optics requiring ultra-high power lasers. Specifically, the company’s experience in InP long haul transceivers is being tapped as AI servers scale out, especially since InP reduces power consumption compared to silicon.

Optical Switching:

Optical switches are a new kind of switch for AI clusters that handles the switching optically instead of using transceivers to convert photons to electrons, and back again. There are many competitors within optical switching, with heavyweights Broadcom and Arista coming to mind, yet Lumentum believes their MEMS-Based technology can set them apart. Although the discussion around MEMS can get quite technical, the idea is that Lumentum is a smaller, (potentially) key supplier for customers putting optical circuit switches into their data centers. Another use case for using Lumentum is to rearchitect or write software to enable the optical circuit switching.

According to the most recent earnings call, Lumentum has “already shipped evaluation units to customers who have provided overwhelmingly positive feedback on our performance.” It was also stated that “more meaningful growth will probably be in calendar 2026” for the optical switching circuit products.

Data Center Interconnects:

For long-distance transmission, Lumentum offers tunable lasers for data center interconnects (DCIs). These transmissions are traditionally used for telecom purposes and can range up to hundreds of kilometers, yet are now seeing demand for data center buildouts. Per the call: “we're seeing dramatic strength in anything ZR, anything to connect data centers as data centers are being built out, and that can take the form of ZR modules. But given our share of tunable lasers that go into ZRs, that's where we're going to see a dramatic pickup in the telecom side.”

Three Hyperscaler Customers for 2025

Lumentum recently added a third hyperscaler customer for a total of three hyperscaler customers. According to the earnings call: “we expect to start shipping volume production against these new customer awards in the first half of calendar 2025, and they will ramp through the year, consistent with the revenue targets we set out previously.”

According to a Susquehanna analyst, this is the return of the primary CloudLight customer i.e., Google. This is in addition to the new customer added last quarter.

With that said, Lumentum is competing for the larger orders expected to be placed sometime in 2025: “And I think we're positioning ourselves very well. We're having the capacity in place, as I said, with clean rooms as well as equipment. So we're planning for success, but we still have to earn that. But that said, these are all very, very large customers that consume a lot of transceivers. And so getting in the door is step one and earning bigger share is really what we're striving to do now.”

FQ1 Revenue and 2025 Revenue Targets

This quarter, Lumentum reported QoQ growth in its primary AI-related segment, Cloud and Networking. Management also reiterated their goal of reaching quarterly revenue of $500 million by the end of the calendar year 2025 while expecting continued significant growth into 2026 and 2027.

The management team plans to achieve its goal of $500 million quarterly revenue from the current guide of $390 million for the December quarter by increasing the EML capacity by 40% by June, and tapping the transceivers and data center infrastructure opportunities discussed above. If the traditional telecom business recovers, the company is expected to reach their goal before the end of the year.

Chris Coldren, Senior VP, recently said at the Barclays conference that he feels a lot better about telecom, which is another positive catalyst as the company’s revenue has declined in the past due to the inventory corrections at its network equipment customers.

“So, I feel a lot better about telecom than we have been at least several quarters that we're starting to see things improve. And hopefully, history repeats as things tend to improve, then they tend to improve faster than you expect. And then when they get bad, they tend to get worse than you expect. And we'll let you know when that starts to happen, but it definitely feels good.”

• Q1 FY2025 revenue grew by 6.1% YoY to $336.9 million and set a new record for Datacom laser chip orders. The CEO, Alan Lowe, said in the earnings call, “In the first quarter, we exceeded the high end of our guidance for both revenue and earnings per share. We set a new record for Datacom laser chip orders, including 200-gig EML chips, reflecting strong demand from multiple customers, including an AI infrastructure customer.”
• Management has guided FQ2 revenue of $390 million, representing YoY growth of 6.3% and 15.8% QoQ growth at the midpoint. “As we previously forecasted, our datacom transceiver shipments are expected to increase sequentially this December quarter, and we expect our transceiver production to continue growing throughout calendar year 2025, driven by demand from multiple hyperscale cloud and AI customers.”

Looking further out, analysts expect FY2025 ending June revenue to grow 17% YoY to $1.59 billion and 28.4% YoY to $2.04 billion in FY2026.

Segments

Cloud and Networking

Q1 FY2025 Cloud and Networking revenue grew by 23% YoY and 11% QoQ to $282.3 million. Profit from this segment increased 13% sequentially and 13% YoY. Segment profit increased to 2.5 percentage points YoY to 12.9%.

Revenue accelerated from a decline of (-11.1%) YoY in FQ4. Management attributed the strong growth to setting “a new record for Datacom laser chip orders, including 200-gig EML chips, reflecting strong demand from multiple customers, including an AI infrastructure customer.”

Management expects strong sequential growth to continue in FQ2: “based on expanding cloud demand and improving trends in the broader networking market, we expect double-digit sequential revenue growth in the second quarter.” Per discussions in the Q&A portion of the call, the implied increase QoQ for FQ2 will be $50 million to $60 million or about 20% sequential growth versus the 15.3% guided QoQ growth for overall revenue.

Industrial Tech

Industrial Tech revenue declined by (-38%) YoY and up 2% QoQ to $54.6 million. Management expects FQ2 revenue “to be approximately flat sequentially due to an uptick in industrial lasers led by our ultrafast lasers, offset by a sequential decline in 3D sensing revenue.” Segment profit declined to 4% from 17.4% in the same period last year.

Margins

The company’s margins are recovering helped by cost controls. The management has set an ambitious goal to achieve an adjusted operating margin of 17% to 20% when the company’s quarterly revenue surpasses $600 million. Management plans to reach the target by better capacity utilization, cost controls, and synergies from prior acquisitions.

Looking further ahead to next year, management expects gross margins to increase while operating margins will come under pressure from increased R&D investments: “we’ll see gross margins tick up sequentially through the fiscal year, but we'll — it will be muted a little bit from an operating margin standpoint because of the increased R&D investment we're making just given the amount of customer pull we have.”

The overhead expenses are also expected to increase in the next couple of quarters due to additional capacities being added. These investments are expected to yield benefits in the middle of this year as production ramps up. The Street can be especially margin-sensitive with hardware companies, and thus, this is important to keep track of:

“No, it does have a little bit of overhead impact [to add capacity] because we're building out in our Thailand facility as we move more of our production of transceivers to Thailand. And so as we move that up and ramp that up, there will be a couple of quarters of overhead expenses associated with that. And so that's already contemplated in the sequential increases in margins. But then as that volume ramps up in the middle part of next calendar year, we'll be able to see the benefit of that moving through the quarter. So we'll explain more about that as the quarters happen, but thank you for asking about that.”

• Q1 FY2025 gross margin was 23.1% compared to 24.1% in the same period last year. Adjusted gross margin was 32.8% in both the periods. Management expects gross margins to improve sequentially throughout FY2025. “In future quarters, we anticipate company gross margins will sequentially increase as manufacturing utilization improves due to an improving telecom outlook as well as an increase in Datacom laser shipments.”
• Operating margin was (-24.5%) compared to (-25.4%) in the same period last year. Adjusted operating margin improved to 3% from 0.60% in the same period last year. The difference between GAAP and non-GAAP operating margin is due to the stock-based compensation expenses and amortization of acquired intangibles. Management expects the adjusted operating margin to improve to 6.5% in FQ2.
• Net margin was (-24.5%) or (-$82.4 million) compared to (-21.4%) or (-$67.9 million) in the same period last year. Adjusted net margin was 3.6% or $12.2 million compared to 5.1% or $16.1 million in the same period last year.
• Adjusted EBITDA was $37 million or 11% of revenue compared to $34.6 million or 10.9% in the same period last year.

EPS

The EPS is expected to rebound in the coming quarters, with adjusted EPS expected to almost double sequentially in the next quarter. Note the very strong, incoming rebound on adjusted EPS below.

• FQ1 adjusted EPS came in at $0.18, beating consensus estimates by 48.1%, helped by operating leverage and cost controls.
• Analysts expect FQ2 adjusted EPS to grow 9.6% YoY to $0.35 and 46% YoY to $0.42 in FQ3.
• Looking further out, analysts expect the adjusted EPS for FY2025 ending June to grow 56% YoY to $1.58 and 134.5% YoY to $3.70 in FY2026.

Cash Flow and Balance Sheet

The cash flows are improving, driven by the recovery in revenue. With management targeting an adjusted operating margin of 17% to 20% once quarterly revenue surpasses $600 million, cash flow generation should further strengthen in the coming quarters.

• Q1 FY2025 operating cash flow was $39.6 million or 11.8% of revenue compared to (-$2.3 million) or (-0.7%) of revenue in the same period last year.
• Free cash outflow was (-$34.5 million) or (-10.2%) of revenue compared to (-$63.1 million) or (-19.9%) of revenue in the same period last year. The company has been investing due to the strong demand for AI. The company’s CEO, Alan Lowe, said in the earnings call, “In Q1, we invested $74 million in CapEx, primarily driven by investments in high-speed transceiver capacity additions at our Thailand manufacturing site as well as indium phosphide wafer production capacity.”
• The company has cash & short-term investments of $916.1 million and debt of $2.58 billion compared to $887 million and $2.5 billion at the end of FQ4.

Earnings Call Q&A:

EMLs are Capacity Constrained

EML production capacity was the hot topic on the earnings call, with the discussions revealing quite a bit about Lumentum’s strategy as the company attempts to compete against companies like Coherent/Innolight, Eoptolink, and others. Essentially, the company is buying CW lasers while reserving capacity for EML production in-house.

Reserving capacity for EMLs:

Here is what was stated regarding why Lumentum is looking for more H2 2025 strength in both EML lasers and the company’s strategy when approaching limited capacity with what they can build in-house:

“So, we use a lot of CW lasers, not EML lasers yet in the products that we're shipping and released today. So we can buy those CW lasers externally or we can use our very critical EML capacity to add those CW lasers into our products.

We've done the math. There's a lot of good CW laser suppliers. It makes more sense for us to buy those CW lasers and free up that EML capacity to ship to our customers than it would be to convert that EML capacity to CW lasers, for example. So that's one of the things that's pushing off that integration of CW lasers into our products until the second half.

I'd say that we are working on EML-based designs, and those will come to market in the second half of the calendar year. We have to get qualified and go through that. But today, most of the products that we're producing are silicon photonic-based using CW lasers from our strategic supplier partners to keep that EML capacity for our customers.”

–End Quote

1.6T Transceivers Driving Demand for EMLs:

Lumentum’s call is decisively focused on EMLs compared to more broad product discussions on the VSCELs or CW lasers that Coherent’s call covers. When asked why EML is so critical to Lumentum’s strategy, the management team responded with:

“And I'd add that the real performance advantage of EML starts to come in as we talk about 1.6T and future generations of higher performance 1.6T. So, our natural road map also aligns with using more vertical integration where the technologies are much more differentiated at those speeds.” There was also a follow-up: “And as Chris said, a lot of the new next generation of 1.6T likes EMLs better, especially as you get into multi-wavelengths where EMLs can really play a key role there. So yes, we're absolutely going to do that. It probably makes more sense in the second half of the calendar year as we get into these more advanced 1.6T products.

And then we have next-generation 200-gig EMLs, which are really going to differentiate us from our competitors. And I think that really gives us the ability to drive incremental differentiation at the transceiver level and drive higher gross margins.”

It was also stated during this discussion that the goal is to increase EML production capacity by 40% between June of 2024 and June of 2025. There was a question as to why not increase it 100%, to which management relented they would increase by that much, if they could: “So a very good question. If I had the ability to add 100% between now and June, I would do it.”

Most importantly, management hinted there would be more than 40% capacity increases after June, pointing toward wafer capacity for EMLs coming online in Japan: “And so I think we're going to do well in the second half of the calendar year on that. But we are adding capacity beyond the 40% for sure after the June quarter. We're not sitting idle for sure.”

EMLs will Not Ship until Later this Year:

Quick note to say the 11% sequential growth last quarter and the expected 20% growth this quarter in the cloud and networking segment is not coming from EMLs yet.

Per the discussions: “And so these, in general, are transceivers that won't have our EMLs at initial launch, if you will, because these have been in development and designed over the past year or so.

Obviously, these accounts have other opportunities to Alan's point, as we succeed and execute with them, not only will there be more share, but there will be more SKUs and other types of transceivers where we can introduce more of our own content.”

Expanding Outside of China

There were discussions around China with management stating “we’re as tariff-free as you can get with respect to our future,” citing manufacturing in the United States, U.K., Thailand and Japan. Similar to Coherent, Lumentum sees this as a tailwind.

“And with our U.S. headquarter and manufacturing outside of China, I think there's a compelling reason for customers to come our way. So we expect to not only grow our datacom module business and EML chip business, but gain significant share through the next coming years.”

Conclusion:

It’s important to emphasize that it’s not clear who will win the networking wars, yet we think given our detailed process of tracking earnings reports for material inflections, combined with technicals that allow us to reduce risk while tracking breakouts, that we will be able to carefully add the correct winners to our portfolio for 2025.

To hear more on how we plan to position this year, plan to join me for a one-hour special webinar for Q1 2025 on January 14th at 4:30 pm EST.

That’s a wrap for 2024! Thank you for an amazing year, we look forward to continued outperformance in 2025.

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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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.

Transceiver speed has been growing with the highest data rates ranging from 100G to 200G to 400G. AI servers are driving a market for 800G data rates, which are shipping in production now, and 1.6T rates, which are shipping in 2025. We’ve been covering these AI-driven upgrades around optical networking in our Marvell write-up and Semtech write-upwrite-up and Semtech write-up.

Coherent’s transceivers work with both Ethernet or InfiniBand, as well as proprietary protocols such as Nvidia’s NVLink and Nvidia’s interconnect chips NVSwitch. The company has stated that their 100ZR pluggable transceivers can upgrade old 10GBps Ethernet links with 100 GBps at the optical network edge, representing a 10X upgrade.

Coherent designs and manufactures the components, such as lasers, detectors and passive optics. Manufacturing the components (as opposed to buying them) is a strength as the company has supply chain resiliency by controlling the end-to-end process, and the manufacturing takes place primarily in the United States with some in Europe. Notably, the discussion as to where AI chips and their components are manufactured is setting up to become a hot topic come 2025.

Overview of Coherent’s Products:

Last quarter, Coherent’s networking revenue increased 12% sequentially and 61% year-over-year to $763 million. The strong growth was led by the AI-related datacom segment, which grew 16% sequentially and 89% year-over-year. The company has seen strong rebounds in this segment since September of last year, partly due to being a supplier for Nvidia’s NVLink and InfiniBand. Coherent also supplies components for Ethernet networking.

Coherent provides laser technologies for 100-gig to 400-gig, plus the AI-centric 800-gig optics and the AI-centric 1.6T optics. Of these, the 800-gig is the primary interconnect for AI deployments with 1.6T shipping in 2025. Artificial intelligence and machine learning drive demand for the 800-gig PAM to increase the speed of input-output and to process the data flows. This doubles the throughput (bandwidth) due to an 8x100Gpbs optical transceiver for inside and between AI clusters.

Marvell was first to launch the 1.6T solution 5nm and 3nm with 200-gig per lane for both. The highly newly launched 1.6T 3nm optical DSPs will reduce power consumption, something that Blackwell is breaking the upper limits of with an estimated 140kW per rack. Right now, any component that lowers power consumption will be in high demand come Q1-Q2. Coherent is expected to launch their solution next year, per the earnings call: “Having delivered initial samples in the preceding quarter, we continue to expect to begin ramping sales of 1.6T datacom transceivers in calendar 2025.”

Although Marvell and Broadcom are the two that first come to mind when discussing PAM4-based networking and DSPs, it’s important to remember that Nvidia is a leader in AI networking in their own right. Last quarter, Nvidia reported networking revenue of $3.13 billion while Broadcom most recently reported AI revenue of $3.7 billion for the quarter. If we remove the $300 million for custom silicon, Broadcom reported $3.4 billion in AI networking. Nvidia is a newcomer to the field following the acquisition of Mellanox in 2019.

Coherent supplied content is likely to increase with Nvidia as Blackwell is a catalyst for this partnership. With the upcoming release of Blackwell, NVLink speeds will double from the fourth-generation to the fifth-generation. We pointed out a few months back the significance of NVLink’s fifth-generation as it’s the most important generational leap to-date for Nvidia’s networking products:

“NVLink Switch is a major component to the Blackwell upgrade. Fifth-generation NVLink enables multi-GPU communication at high speed, reaching 1.8 TB/s bidirectional throughput or 14X the bandwidth of PCIe for a single GPU.

For the NVL72 systems, NVLink Switch can reach 130 TB/second, which is “more than the aggregate bandwidth of the internet.” Therefore, it’s the compute and the communication capabilities of the upcoming GB200 release that are important to consider. The 72 GPUs in the NVL72 can be used as a single accelerator for 1.4 exaflops of AI compute power.”130 TB/second, which is “more than the aggregate bandwidth of the internet.” Therefore, it’s the compute and the communication capabilities of the upcoming GB200 release that are important to consider. The 72 GPUs in the NVL72 can be used as a single accelerator for 1.4 exaflops of AI compute power.”

The result is that the GB200 will deliver a 30X speedup for 1 trillion­­+ parameter models by leveraging FP4 precision and fifth-generation NVLink. The NVL72 rack-scale systems are exascale computers that will contain up to 5,000 NVLink cables for up to 2 miles of networking.

To put it simply, Nvidia is set to report roughly $200 billion in AI systems revenue next year (we think it’ll be higher than this), with the GB200 systems driving a surge in demand for Nvidia’s in-house networking solutions. There is no other player in the ballpark or zip code of this AI accelerator revenue, and thus, this year will offer a unique opportunity for Nvidia to greatly increase its networking segment driven the scale-out and scale-up of GPUs. That is to say, the 4.5X to 9X increase in systems from 8 GPUs to 36 GPUs or 72 GPUs, plus the scale-out toward clusters with 100,000-GPUs and eventually million-plus GPUs.

Below are a few products that Coherent offers that are set to benefit.

Coherent’s AI-Related Products:

Coherent has a highly technical suite of hardware products. To streamline the discussion, I’ll focus on the three product lines that management calls out as major contributors to the rebound in its AI-related datacom segment (part of the larger networking segment).

• Next-generation transceiver technologies, such as VCSELs, EMLs and CW lasers for silicon photonics – reported in the networking segment
• Datacom optical switch platform – reported in the datacom segment
• Data center interconnects (DCIs) – not part of the AI segment, rather this is reported in the telecom segment.

Next-Generation Transceivers:

Last quarter, Coherent’s networking revenue increased 12% sequentially and 61% year-over-year to $763 million.

VCSELs: >100 meters Distance:

Vertical Cavity Surfacing Emitting Lasers (VCSELs) are for link distances of less than 100 meters. As Coherent explains, these are the lowest-cost, lowest power consumption solution. In March, the company announced its 200G VCSELs that replace the oxide-aperture with a lithographic-aperture. When combined with a DSP, the 200G VCSELs allow for a 1.6T multimode optical transceiver for AI, high-performance computing (HPC) and networking applications.

Silicon Photonics >100m: Nvidia to Launch SiPho Product H2 2025

For distances greater than 100m, silicon photonics-based transceivers are used. We wrote about silicon photonics previously before Nvidia Hopper had shipped in volume. Back in early 2023, an article from Next Platform discussed the previous generation of GPUs, where the NVSwitch fabric on the DGX-A100 systems has “a range of about 300 centimeters and moves data at 8 picojoules per bit. The goal is silicon photonics to do it at half the energy and boost the range to as far as 100 meters between devices.”

Coherent recently announced a continuous wave (CW) InP laser for silicon photonics that “are on the forward edge of data transmission technology, crucially addressing the explosive bandwidth demands brought on by the rapid adoption of machine learning networks within AI-driven data centers.” According to the press release, Coherent’s CW lasers will result in 15% better power efficiency and are more reliable due to eliminating aluminum.

The first CW laser to launch was in September of 2024 with a higher-power laser for cooled operations launching in 2025. The press release cited that production capacity is expanding 500% over the next two years: “And with our upcoming expansion to a state-of-the-art 6-inch InP fab in Sherman, Texas, by 2026, we expect production capacity to be 5x our current production rate, a significant ramp given the complexity of this material.”

At the end of September, Coherent demonstrated a new 1.6T-DR8 transceiver module running a 5nm Nvidia chip. The SiPho product, or silicon photonics product, will read and write data at the speed of 1.6Tbps. The initial reaction from analysts is that this product will become more impactful at the end of 2025, taking up to 10% to 20% of the market in 2026, pointing toward Nvidia customers Microsoft, Coreweave and Lambda as being names that would drive the sales come 2026.

EML Lasers:

Electro-absorption modulated lasers (EMLs) help to enable the 200G per lane transmission, which is enabling the 1.6TBps data rate. In the future, it is likely AI networking will expand to a 3.2TBps data rate. The EML device that Coherent supplies offers signal integrity for 200G optical transmission due to the wide bandwidth of the modulator and on-chip integrated radio frequency (RF) termination.

EMLs were traditionally used by telecom customers, yet became attractive for AI servers due to meeting the 200G per second speeds necessary to support AI models and capabilities for 1.6T optical modules. EMLs are more expensive than CW lasers for silicon photonics, with 1.6T SiPho being the more popular choice. Where four EML lasers are required to run 1.6T, two less-expensive CW lasers are needed to run four channels with a silicon photonics module.

Coherent’s press releases point toward EML lasers becoming more impactful with the push toward reading and writing data at 3.2TB per second speeds.

When asked on the call which product will be most influential at 1.6TB ramps, Coherent’s management was declined to state it would be primarily SiPho, rather stating it would be a mix of all three:

Q: “[…] And then if you think that the world is kind of ramping on 1.6T, do you guys see kind of more of a silicon photonics world or an EML world as that 1.6T ramp?”

A: “[…] We look at it as we'll deploy whatever the best technology is for the benefit of the customer and the application that we're trying to drive. So, whether that's an EML, a VCSEl, or silicon photonics, we're developing all of those different options and we'll deploy whatever technology is strongest to create the biggest differentiation for our products and the biggest benefit for our customers. So, that's kind of the approach that we take to the technology. And I think we've got the broadest set of technology options of certainly any of our peers and competitors. So, I think that's a real competitive strength for us.”

Datacom Optical Switch Platform (OCS Switch):

Optical current switches are a new kind of switch for AI clusters that handles the switching optically instead of using transceivers to convert photons to electrons, and back again. According to the earnings call, “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.”

According to a Dell’Oro analyst, optical switches are a new kind of switch that offers high bandwidth, low latency and are less expensive to operate. Per Coherent: “this kind of optical switching tends to be more reliable – something that will pay dividends in very larger clusters in which mean time to failure tends to be quite low.”

At Hot Chips 2023, Google’s TPU group technical lead, Andy Swing, explained that Google has been able to “switch together very large quantities of AI accelerators” in pods with 64 TPUs. According to Google, the optical circuit switch results in a sizable boost in network bandwidth and can be reconfigured if a node fails. It doesn’t take much imagination to consider other hyperscalers are likely to follow in Google’s footsteps by using an OCS switch as cluster sizes for AI accelerators are set to increase. 

Datacom Interconnects (DCIs):

For long distance transmission, Coherent offers data center interconnects (DCIs). This can range up to hundreds of kilometers. There was a recent press announcement that Marvell, Lumentum and Coherent worked on optical modules with transmission links of up to 500km.

DCIs are recognized under the telecom segment, which saw growth of 9% sequentially and 17% year-over-year. Within this, management stated: “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.”

Financials:

Coherent’s Q1 FY2025 revenue grew by 28% YoY to $1.35 billion, beating estimates by 2.4%. Revenue accelerated by 18.9 percentage points from the 9.1% growth reported in the June quarter. The strong growth was primarily led by AI-related datacom revenue, which grew 16% sequentially and 89% YoY.

Management has guided FQ2 revenue of $1.37 billion, representing 21.1% YoY growth at the midpoint. Analysts expect growth to sustain 15.6% YoY growth to $1.40 billion in FQ3.

Looking further out, analysts expect FY2025 ending in June revenue to grow 17.9% YoY to $5.55 billion and 11.2% YoY to $6.17 billion in FY2026.

Revenue by End Market:

Communications

Communications end market FQ1 revenue grew by 68% YoY and 14% sequential growth to $774 million. It is the largest end market and constitutes 57.4% of total revenue. Revenue accelerated by 49 percentage points from 19% growth in FQ4. The strong growth was led by datacom and telecom revenue.

FQ1 datacom revenue grew by 89% YoY and 16% sequentially due to strong AI data center demand. The company witnessed a continued ramp for 800-G transceivers, benefitting from the increased number of customers ramping 800-G transceivers. Management expects strong growth in 800-G transceivers to continue in the coming quarter with revenue from 1.6T transceivers starting to ramp in CY2025. The company delivered initial samples of 1.6T transceivers in FQ4.

Telecom revenue grew by 17% YoY and 9% sequentially, primarily due to end market improvement and the ramp of the company’s new products, namely 100G ZR and 400G ZR+ Coherent transceivers. Although management expects the telecom end market to remain weak in the near term, they expect a ramp in revenue from these new products over FY2025. Overall, they expect the communications market to be a long-term growth driver for the company.

Industrial

The industrial end market is the second largest end market and constitutes 30.2% of revenue. The industrial end market grew by 1% YoY and down (-6%) QoQ to $407 million. Revenue decelerated from 5% growth in FQ4 as the strength in display capital equipment was offset by the weakness in the precision manufacturing. The company faced demand headwinds in the precision manufacturing, mirroring broader industry trends. However, despite the near-term weakness, management “expects 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.”

Instrumentation

The Instrumentation end market constitutes only a small 6.8% of total revenue. FQ1 revenue was down (-8%) YoY and (-10%) sequentially to $91 million.

Electronics

The Electronics end market also constitutes only a small 5.6% of total revenue. FQ1 revenue was down (-16%) YoY and (-27%) QoQ to $76 million.

Segments

• Networking FQ1 revenue reported strong growth of 61% YoY and 12% sequentially to $763 million due to the AI data center demand. Revenue accelerated from 16% growth in FQ4.
• Lasers segment revenue increased 4% YoY and down (-2%) QoQ to $348 million. Revenue decelerated from 7% growth in FQ4.
• Materials segment FQ1 revenue was down (-3%) YoY and (-15%) QoQ to $237 million.

Margins

Margins are expanding yet they remain low compared to other semiconductor companies, and this will remain a predominant concern with Coherent. Management has set a goal of achieving a consistent adjusted gross margin level of above 40% and has two important initiatives: pricing optimization in the industrial business (includes industrial end market, instrumentation, and electronics) and product cost reductions for the datacom transceiver business.

Per the earnings call:

“[…] And I do see opportunity to do a much better job of optimizing the pricing of the [industrial] products and capturing what I would say — what I would call is the fair value for the technology and the innovation that we're bringing to those industrial markets.

Now, in pricing in the datacom transceiver space, there I think there's, I would say, there's not as much opportunity on the pricing side. But what I would say is, but there's definitely opportunity on the product cost side. And that's one of the examples I gave earlier on the call is on product costs within transceivers. And I highlighted, I believe this on the last earnings call, yields as definitely an opportunity. And Sherri and I, as I said earlier, we're in an operational review this morning, spending time talking to the team about yields, the improvements that they've driven over the past few months, and what we need to see in terms of yield improvements moving forward as well. And that is definitely an area of focus for us. So, I would — back to your datacom transceiver question in particular, I would say maybe not so much on pricing, but definitely there's opportunity for us in cost and we're certainly very focused on that.”

• FQ1 gross margin improved five percentage points YoY to 34.1%. Adjusted gross margin improved 2.9 percentage points YoY to 37.7%, primarily helped by higher revenue, favorable product mix, and yield improvements.
• Management has guided for an adjusted gross margin of 37% at the midpoint for FQ2 compared to 36% in the same period last year. The CFO provided more clarity during the earnings call Q&A on the gross margins and assured to provide more details before the Investor Day in May 2025 on its plan to achieve the long-term goal of above 40% gross margins.

“When we look at Q2, the guide for Q2, that is a range, right, 36% to 38%, it is a range, and there can certainly be fluctuation on a quarterly basis with respect to gross margin. But we did talk about, last quarter; Jim mentioned that we launched our gross margin expansion strategy which includes product pricing optimization, as well as product cost reduction. And so that's an area where we're going to focus on because we want to achieve a long-term gross margin of greater than 40%, and so that's really how to think about what our goal is for our long-term gross margin.”

• FQ1 operating margin improved significantly to 5.6% from (-2%) in the same period last year. Adjusted operating margin improved 4.7 percentage points YoY to 17.3%. Management guide for the next quarter is 16.2%. Even though the guide is down sequentially, it is up from 15.2% in the same period last year.
• The operating margin is expected to improve along with the gross margins in the long term. The company is prioritizing its R&D investments in the growth areas and divesting non-profitable businesses. Another key takeaway from the earnings call is the CEO’s comment, “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.”
• Net income was $25.9 million or 1.9% of revenue compared to a net loss of (-$67.5) million or (-6.4%) of revenue in the same period last year. Adjusted net income was $149.7 million or 11.1% of revenue compared to $55 million or 5.2% of revenue in the same period last year.

EPS

Coherent has strong EPS growth. Analysts expect EPS growth to continue going forward, and there is potential for further upgrades to the EPS estimates due to the new CEO’s streamlining/restructuring plan.

• FQ1 adjusted EPS grew by 357% YoY to $0.74, primarily helped by operating leverage, favorable product mix, improvement in yield, product price optimization, and product cost reductions.
• Analysts expect adjusted EPS to grow 86.3% YoY to $0.67 and 43.2% YoY to $0.76 in the subsequent two quarters.
• Looking further out, analysts expect the adjusted EPS for FY2025 ending June to grow 80.5% YoY to $3.01 and 45.1% YoY to $4.37 for FY2026.
• Jefferies analyst believes that the new CEO’s streamlining and cost reduction initiatives could potentially double the adjusted EPS from the current about $3.0 to as much as $6.40 annual EPS in 2026.

Cash Flow and Balance Sheet: 2.4X Debt Leverage

Operating cash flow margins have been hovering around 10% of revenue and are expected to improve with higher revenue and profits in the coming quarters.

• FQ1 operating cash flow was $152.98 million or 11.4% of revenue compared to 18.9% in the same period last year. The operating cash flow margin was in line with the full year operating cash flow margin of 11.6% for FY2024 and 12.3% for FY2023.
• FQ1 free cash flow was $61 million or 4.5% of revenue compared to 13% in the same period last year. The free cash flow margin was in line with the full year free cash flow margin of 4.2% for FY2024 and 3.8% for FY2023.
• Cash was $1.02 billion; debt was $3.99 billion compared to $926 million and $4.1 billion at the end of FQ4.
• During FQ1, the company repaid $118 million in debt from the cash from operations and proceeds from the sale of the Newton Aycliffe fabrication facility. The sale is part of the company’s ongoing efforts to streamline operations.
• With the $118 million debt repayment, the company has reduced the debt leverage ratio to 2.4x, and debt reduction will continue to be the priority for the management.

Divestment

The company is looking to divest or shut down non-strategic product lines and assets. The company recently sold the Newton Aycliffe fabrication facility in the UK. The proceeds from the sale of the facility were used to repay debt and will also help to reduce the overhead expenses and interest expenses.

Similarly, it is looking for strategic alternatives for the battery technology business. Although the business accounts for a small percentage of revenue, it is dilutive to the company’s margins. It will allow the company to focus on investments that have better returns on investments, such as the AI data center transceiver business. The management is expected to provide more updates in the coming months and during the Investor Day in May 2025. The company might also divest the silicon carbide business, in which Denso and Mitsubishi Electric have a 25% non-controlling stake.

New Management from Lattice Semiconductor:

Jim Anderson was appointed CEO of Coherent Corp. and a member of the Board of Directors on June 3, 2024. He previously served as CEO of Lattice Semiconductor Corporation since September 2018. Prior to joining Lattice, Mr. Anderson served as the Senior Vice President and General Manager of the Computing and Graphics Business Group at AMD.

Jim, who is credited for bringing about a turnaround in Lattice Semiconductor, is also expected to repeat his success at Coherent along with the new CFO Sherri Luther. The company appointed Sherri Luther as CFO on Oct 11, 2024. Prior to that, she was the CFO of Lattice Semiconductor since 2019. Prior to joining Lattice in 2019, she worked at Coherent for 16 years, including as Corporate Vice President of Finance.

Commentary from FQ1 2025 Earnings Call:

800-Gig drove the Revenue Beat, 1.6T Shipping in 2025:

There were questions as to where the upside from the quarter came from, given the top line and sizable 20%+ bottom-line beat. As noted, there was sizable growth in the datacom transceiver business of 16% QoQ growth and 89% YoY growth. The CEO points out customer breadth is expanding on the 800G product.

Q: Simon Leopold, Raymond James: “[…] And I guess what I'm trying to understand is where was the, really, upside surprise this quarter, was it really 800 gig and above or was there more strength from the more traditional products below — 400-gig and below, did that provide any upside or was it all coming from the higher performance? Thank you.”

A: Jim Anderson, CEO: “We did see sequential growth there [400-gig and under speeds]. 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.”

Although the customer breadth has grown with 800-gig, it was stated on the call the 1.6T will launch with a customer breadth that is smaller and matches the start of the 800-gig.

Supply Constraints Could be a Catalyst for Coherent:

There were three questions on the call from three separate analysts about potential supply constraint in lasers, with two analysts calling out the supply constraint being specifically with EMLs: “certainly on the EML side as we're hearing about constraints, et cetera, as you think about '25 and '26?”

The CEO pointed out this is an area incremental strength for Coherent as they make most of their parts internally (which is quite rare) yet will source when the demand requires it. The CEO also pointed out their breadth of technologies helps to meet demand if there were to be a shortage in a specific laser, such as EML.

Here are a few statements from the CEO that addressed Coherent having an advantage by building their own products in a fairly crowded market of networking components:

“On that first area of technology roadmap, I think our customers really recognize the breadth and the depth of the technology portfolio that we can bring to bear, specially in the optical networking space, where we don't just assemble the modules, but we build a lot of the ingredient components that go into the module; the lasers, whether they're VCSELs, EMLs for silicon photonics that we design, or a lot of the other ingredients that go into those modules […] and then, our verticalized structure could be a real advantage, especially in a very fast ramp situation, which we're in right now with our datacenter customers. When demand is increasing very quickly, it's really important to have that verticalized strategy and structure that we have, because I think that's really allowed us to supply them in a really reliable.”

This statement was reiterated a few times, which is that Coherent’s advantage lies within the breadth of the technologies they offer alongside the capability to build internally.

United States Domiciled:

The discussions around supply constraints potentially helping Coherent as the company builds its own products are further supported by the fact Coherent components are primarily manufactured in the United States, with some in Europe. The company has plans to expand its presence in the United States with a 6-inch InP wafer fab in Sherman Texas. According to an announcement last week, Coherent was awarded $33 million from the United States CHIPS act to support the expansion of the Texas facility.

Competitors:

According to the 10-K, the company “had one customer who contributed more than 10% of revenue during fiscal 2024.” This is understood to be Nvidia. Yet, B.Riley downgraded the stock due to Nvidia seeking more suppliers for the 1.6T products, with the analyst note naming Eoptolink, Innolight and Fabrinet as notable competitors.

Conclusion:

If you had “reading about AI networking components” on your Christmas list, then consider yourself in luck. The I/O Fund is leaving no stone unturned in delivering a full hardware stack analysis on what’s to come in 2025 as AI systems increase in complexity. Although we saw some outliers in AI software this year, we continue to foresee 2025 to be the year for AI hardware – far more so previous years. This goes back to how the Blackwell systems are being built, by scaling out 4-9X, and also requiring new components to handle the surge in AI server power consumption.

Of course, with every great opportunity, there comes some element of risk. The clear risk to semiconductors are tariffs with rumors that Chinese tariffs could be as high as 60% on imports from this region.  This would technically be a tailwind for Coherent — a key Nvidia supplier as we go into 2025 that would not only circumvent the majority of tariffs but potentially come out on top.

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.

Additional Readings:

• Semtech: Fiber Optics and Copper (ACC) AI Networking Components
• Vertiv: AI Data Center and Direct Liquid Cooling Stock; Nvidia Supplier
• Marvell Q3 Earnings: Strong Sequential Growth; Expanded AWS Partnership
• Optical Interconnects Overview: Strong Growth Expected Ahead

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.

Transceiver speed has been growing with the highest data rates ranging from 100G to 200G to 400G. AI servers are driving a market for 800G data rates, which are shipping in production now, and 1.6T rates, which are shipping in 2025. We’ve been covering these AI-driven upgrades around optical networking in our Marvell write-up and Semtech write-upwrite-up and Semtech write-up.

Coherent’s transceivers work with both Ethernet or InfiniBand, as well as proprietary protocols such as Nvidia’s NVLink and Nvidia’s interconnect chips NVSwitch. The company has stated that their 100ZR pluggable transceivers can upgrade old 10GBps Ethernet links with 100 GBps at the optical network edge, representing a 10X upgrade.

Coherent designs and manufactures the components, such as lasers, detectors and passive optics. Manufacturing the components (as opposed to buying them) is a strength as the company has supply chain resiliency by controlling the end-to-end process, and the manufacturing takes place primarily in the United States with some in Europe. Notably, the discussion as to where AI chips and their components are manufactured is setting up to become a hot topic come 2025.

Overview of Coherent’s Products:

Last quarter, Coherent’s networking revenue increased 12% sequentially and 61% year-over-year to $763 million. The strong growth was led by the AI-related datacom segment, which grew 16% sequentially and 89% year-over-year. The company has seen strong rebounds in this segment since September of last year, partly due to being a supplier for Nvidia’s NVLink and InfiniBand. Coherent also supplies components for Ethernet networking.

Coherent provides laser technologies for 100-gig to 400-gig, plus the AI-centric 800-gig optics and the AI-centric 1.6T optics. Of these, the 800-gig is the primary interconnect for AI deployments with 1.6T shipping in 2025. Artificial intelligence and machine learning drive demand for the 800-gig PAM to increase the speed of input-output and to process the data flows. This doubles the throughput (bandwidth) due to an 8x100Gpbs optical transceiver for inside and between AI clusters.

Marvell was first to launch the 1.6T solution 5nm and 3nm with 200-gig per lane for both. The highly newly launched 1.6T 3nm optical DSPs will reduce power consumption, something that Blackwell is breaking the upper limits of with an estimated 140kW per rack. Right now, any component that lowers power consumption will be in high demand come Q1-Q2. Coherent is expected to launch their solution next year, per the earnings call: “Having delivered initial samples in the preceding quarter, we continue to expect to begin ramping sales of 1.6T datacom transceivers in calendar 2025.”

Although Marvell and Broadcom are the two that first come to mind when discussing PAM4-based networking and DSPs, it’s important to remember that Nvidia is a leader in AI networking in their own right. Last quarter, Nvidia reported networking revenue of $3.13 billion while Broadcom most recently reported AI revenue of $3.7 billion for the quarter. If we remove the $300 million for custom silicon, Broadcom reported $3.4 billion in AI networking. Nvidia is a newcomer to the field following the acquisition of Mellanox in 2019.

Coherent supplied content is likely to increase with Nvidia as Blackwell is a catalyst for this partnership. With the upcoming release of Blackwell, NVLink speeds will double from the fourth-generation to the fifth-generation. We pointed out a few months back the significance of NVLink’s fifth-generation as it’s the most important generational leap to-date for Nvidia’s networking products:

“NVLink Switch is a major component to the Blackwell upgrade. Fifth-generation NVLink enables multi-GPU communication at high speed, reaching 1.8 TB/s bidirectional throughput or 14X the bandwidth of PCIe for a single GPU.

For the NVL72 systems, NVLink Switch can reach 130 TB/second, which is “more than the aggregate bandwidth of the internet.” Therefore, it’s the compute and the communication capabilities of the upcoming GB200 release that are important to consider. The 72 GPUs in the NVL72 can be used as a single accelerator for 1.4 exaflops of AI compute power.”130 TB/second, which is “more than the aggregate bandwidth of the internet.” Therefore, it’s the compute and the communication capabilities of the upcoming GB200 release that are important to consider. The 72 GPUs in the NVL72 can be used as a single accelerator for 1.4 exaflops of AI compute power.”

The result is that the GB200 will deliver a 30X speedup for 1 trillion­­+ parameter models by leveraging FP4 precision and fifth-generation NVLink. The NVL72 rack-scale systems are exascale computers that will contain up to 5,000 NVLink cables for up to 2 miles of networking.

To put it simply, Nvidia is set to report roughly $200 billion in AI systems revenue next year (we think it’ll be higher than this), with the GB200 systems driving a surge in demand for Nvidia’s in-house networking solutions. There is no other player in the ballpark or zip code of this AI accelerator revenue, and thus, this year will offer a unique opportunity for Nvidia to greatly increase its networking segment driven the scale-out and scale-up of GPUs. That is to say, the 4.5X to 9X increase in systems from 8 GPUs to 36 GPUs or 72 GPUs, plus the scale-out toward clusters with 100,000-GPUs and eventually million-plus GPUs.

Below are a few products that Coherent offers that are set to benefit.

Coherent’s AI-Related Products:

Coherent has a highly technical suite of hardware products. To streamline the discussion, I’ll focus on the three product lines that management calls out as major contributors to the rebound in its AI-related datacom segment (part of the larger networking segment).

• Next-generation transceiver technologies, such as VCSELs, EMLs and CW lasers for silicon photonics – reported in the networking segment
• Datacom optical switch platform – reported in the datacom segment
• Data center interconnects (DCIs) – not part of the AI segment, rather this is reported in the telecom segment.

Next-Generation Transceivers:

Last quarter, Coherent’s networking revenue increased 12% sequentially and 61% year-over-year to $763 million.

VCSELs: >100 meters Distance:

Vertical Cavity Surfacing Emitting Lasers (VCSELs) are for link distances of less than 100 meters. As Coherent explains, these are the lowest-cost, lowest power consumption solution. In March, the company announced its 200G VCSELs that replace the oxide-aperture with a lithographic-aperture. When combined with a DSP, the 200G VCSELs allow for a 1.6T multimode optical transceiver for AI, high-performance computing (HPC) and networking applications.

Silicon Photonics >100m: Nvidia to Launch SiPho Product H2 2025

For distances greater than 100m, silicon photonics-based transceivers are used. We wrote about silicon photonics previously before Nvidia Hopper had shipped in volume. Back in early 2023, an article from Next Platform discussed the previous generation of GPUs, where the NVSwitch fabric on the DGX-A100 systems has “a range of about 300 centimeters and moves data at 8 picojoules per bit. The goal is silicon photonics to do it at half the energy and boost the range to as far as 100 meters between devices.”

Coherent recently announced a continuous wave (CW) InP laser for silicon photonics that “are on the forward edge of data transmission technology, crucially addressing the explosive bandwidth demands brought on by the rapid adoption of machine learning networks within AI-driven data centers.” According to the press release, Coherent’s CW lasers will result in 15% better power efficiency and are more reliable due to eliminating aluminum.

The first CW laser to launch was in September of 2024 with a higher-power laser for cooled operations launching in 2025. The press release cited that production capacity is expanding 500% over the next two years: “And with our upcoming expansion to a state-of-the-art 6-inch InP fab in Sherman, Texas, by 2026, we expect production capacity to be 5x our current production rate, a significant ramp given the complexity of this material.”

At the end of September, Coherent demonstrated a new 1.6T-DR8 transceiver module running a 5nm Nvidia chip. The SiPho product, or silicon photonics product, will read and write data at the speed of 1.6Tbps. The initial reaction from analysts is that this product will become more impactful at the end of 2025, taking up to 10% to 20% of the market in 2026, pointing toward Nvidia customers Microsoft, Coreweave and Lambda as being names that would drive the sales come 2026.

EML Lasers:

Electro-absorption modulated lasers (EMLs) help to enable the 200G per lane transmission, which is enabling the 1.6TBps data rate. In the future, it is likely AI networking will expand to a 3.2TBps data rate. The EML device that Coherent supplies offers signal integrity for 200G optical transmission due to the wide bandwidth of the modulator and on-chip integrated radio frequency (RF) termination.

EMLs were traditionally used by telecom customers, yet became attractive for AI servers due to meeting the 200G per second speeds necessary to support AI models and capabilities for 1.6T optical modules. EMLs are more expensive than CW lasers for silicon photonics, with 1.6T SiPho being the more popular choice. Where four EML lasers are required to run 1.6T, two less-expensive CW lasers are needed to run four channels with a silicon photonics module.

Coherent’s press releases point toward EML lasers becoming more impactful with the push toward reading and writing data at 3.2TB per second speeds.

When asked on the call which product will be most influential at 1.6TB ramps, Coherent’s management was declined to state it would be primarily SiPho, rather stating it would be a mix of all three:

Q: “[…] And then if you think that the world is kind of ramping on 1.6T, do you guys see kind of more of a silicon photonics world or an EML world as that 1.6T ramp?”

A: “[…] We look at it as we'll deploy whatever the best technology is for the benefit of the customer and the application that we're trying to drive. So, whether that's an EML, a VCSEl, or silicon photonics, we're developing all of those different options and we'll deploy whatever technology is strongest to create the biggest differentiation for our products and the biggest benefit for our customers. So, that's kind of the approach that we take to the technology. And I think we've got the broadest set of technology options of certainly any of our peers and competitors. So, I think that's a real competitive strength for us.”

Datacom Optical Switch Platform (OCS Switch):

Optical current switches are a new kind of switch for AI clusters that handles the switching optically instead of using transceivers to convert photons to electrons, and back again. According to the earnings call, “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.”

According to a Dell’Oro analyst, optical switches are a new kind of switch that offers high bandwidth, low latency and are less expensive to operate. Per Coherent: “this kind of optical switching tends to be more reliable – something that will pay dividends in very larger clusters in which mean time to failure tends to be quite low.”

At Hot Chips 2023, Google’s TPU group technical lead, Andy Swing, explained that Google has been able to “switch together very large quantities of AI accelerators” in pods with 64 TPUs. According to Google, the optical circuit switch results in a sizable boost in network bandwidth and can be reconfigured if a node fails. It doesn’t take much imagination to consider other hyperscalers are likely to follow in Google’s footsteps by using an OCS switch as cluster sizes for AI accelerators are set to increase. 

Datacom Interconnects (DCIs):

For long distance transmission, Coherent offers data center interconnects (DCIs). This can range up to hundreds of kilometers. There was a recent press announcement that Marvell, Lumentum and Coherent worked on optical modules with transmission links of up to 500km.

DCIs are recognized under the telecom segment, which saw growth of 9% sequentially and 17% year-over-year. Within this, management stated: “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.”

Financials:

Coherent’s Q1 FY2025 revenue grew by 28% YoY to $1.35 billion, beating estimates by 2.4%. Revenue accelerated by 18.9 percentage points from the 9.1% growth reported in the June quarter. The strong growth was primarily led by AI-related datacom revenue, which grew 16% sequentially and 89% YoY.

Management has guided FQ2 revenue of $1.37 billion, representing 21.1% YoY growth at the midpoint. Analysts expect growth to sustain 15.6% YoY growth to $1.40 billion in FQ3.

Looking further out, analysts expect FY2025 ending in June revenue to grow 17.9% YoY to $5.55 billion and 11.2% YoY to $6.17 billion in FY2026.

Revenue by End Market:

Communications

Communications end market FQ1 revenue grew by 68% YoY and 14% sequential growth to $774 million. It is the largest end market and constitutes 57.4% of total revenue. Revenue accelerated by 49 percentage points from 19% growth in FQ4. The strong growth was led by datacom and telecom revenue.

FQ1 datacom revenue grew by 89% YoY and 16% sequentially due to strong AI data center demand. The company witnessed a continued ramp for 800-G transceivers, benefitting from the increased number of customers ramping 800-G transceivers. Management expects strong growth in 800-G transceivers to continue in the coming quarter with revenue from 1.6T transceivers starting to ramp in CY2025. The company delivered initial samples of 1.6T transceivers in FQ4.

Telecom revenue grew by 17% YoY and 9% sequentially, primarily due to end market improvement and the ramp of the company’s new products, namely 100G ZR and 400G ZR+ Coherent transceivers. Although management expects the telecom end market to remain weak in the near term, they expect a ramp in revenue from these new products over FY2025. Overall, they expect the communications market to be a long-term growth driver for the company.

Industrial

The industrial end market is the second largest end market and constitutes 30.2% of revenue. The industrial end market grew by 1% YoY and down (-6%) QoQ to $407 million. Revenue decelerated from 5% growth in FQ4 as the strength in display capital equipment was offset by the weakness in the precision manufacturing. The company faced demand headwinds in the precision manufacturing, mirroring broader industry trends. However, despite the near-term weakness, management “expects 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.”

Instrumentation

The Instrumentation end market constitutes only a small 6.8% of total revenue. FQ1 revenue was down (-8%) YoY and (-10%) sequentially to $91 million.

Electronics

The Electronics end market also constitutes only a small 5.6% of total revenue. FQ1 revenue was down (-16%) YoY and (-27%) QoQ to $76 million.

Segments

• Networking FQ1 revenue reported strong growth of 61% YoY and 12% sequentially to $763 million due to the AI data center demand. Revenue accelerated from 16% growth in FQ4.
• Lasers segment revenue increased 4% YoY and down (-2%) QoQ to $348 million. Revenue decelerated from 7% growth in FQ4.
• Materials segment FQ1 revenue was down (-3%) YoY and (-15%) QoQ to $237 million.

Margins

Margins are expanding yet they remain low compared to other semiconductor companies, and this will remain a predominant concern with Coherent. Management has set a goal of achieving a consistent adjusted gross margin level of above 40% and has two important initiatives: pricing optimization in the industrial business (includes industrial end market, instrumentation, and electronics) and product cost reductions for the datacom transceiver business.

Per the earnings call:

“[…] And I do see opportunity to do a much better job of optimizing the pricing of the [industrial] products and capturing what I would say — what I would call is the fair value for the technology and the innovation that we're bringing to those industrial markets.

Now, in pricing in the datacom transceiver space, there I think there's, I would say, there's not as much opportunity on the pricing side. But what I would say is, but there's definitely opportunity on the product cost side. And that's one of the examples I gave earlier on the call is on product costs within transceivers. And I highlighted, I believe this on the last earnings call, yields as definitely an opportunity. And Sherri and I, as I said earlier, we're in an operational review this morning, spending time talking to the team about yields, the improvements that they've driven over the past few months, and what we need to see in terms of yield improvements moving forward as well. And that is definitely an area of focus for us. So, I would — back to your datacom transceiver question in particular, I would say maybe not so much on pricing, but definitely there's opportunity for us in cost and we're certainly very focused on that.”

• FQ1 gross margin improved five percentage points YoY to 34.1%. Adjusted gross margin improved 2.9 percentage points YoY to 37.7%, primarily helped by higher revenue, favorable product mix, and yield improvements.
• Management has guided for an adjusted gross margin of 37% at the midpoint for FQ2 compared to 36% in the same period last year. The CFO provided more clarity during the earnings call Q&A on the gross margins and assured to provide more details before the Investor Day in May 2025 on its plan to achieve the long-term goal of above 40% gross margins.

“When we look at Q2, the guide for Q2, that is a range, right, 36% to 38%, it is a range, and there can certainly be fluctuation on a quarterly basis with respect to gross margin. But we did talk about, last quarter; Jim mentioned that we launched our gross margin expansion strategy which includes product pricing optimization, as well as product cost reduction. And so that's an area where we're going to focus on because we want to achieve a long-term gross margin of greater than 40%, and so that's really how to think about what our goal is for our long-term gross margin.”

• FQ1 operating margin improved significantly to 5.6% from (-2%) in the same period last year. Adjusted operating margin improved 4.7 percentage points YoY to 17.3%. Management guide for the next quarter is 16.2%. Even though the guide is down sequentially, it is up from 15.2% in the same period last year.
• The operating margin is expected to improve along with the gross margins in the long term. The company is prioritizing its R&D investments in the growth areas and divesting non-profitable businesses. Another key takeaway from the earnings call is the CEO’s comment, “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.”
• Net income was $25.9 million or 1.9% of revenue compared to a net loss of (-$67.5) million or (-6.4%) of revenue in the same period last year. Adjusted net income was $149.7 million or 11.1% of revenue compared to $55 million or 5.2% of revenue in the same period last year.

EPS

Coherent has strong EPS growth. Analysts expect EPS growth to continue going forward, and there is potential for further upgrades to the EPS estimates due to the new CEO’s streamlining/restructuring plan.

• FQ1 adjusted EPS grew by 357% YoY to $0.74, primarily helped by operating leverage, favorable product mix, improvement in yield, product price optimization, and product cost reductions.
• Analysts expect adjusted EPS to grow 86.3% YoY to $0.67 and 43.2% YoY to $0.76 in the subsequent two quarters.
• Looking further out, analysts expect the adjusted EPS for FY2025 ending June to grow 80.5% YoY to $3.01 and 45.1% YoY to $4.37 for FY2026.
• Jefferies analyst believes that the new CEO’s streamlining and cost reduction initiatives could potentially double the adjusted EPS from the current about $3.0 to as much as $6.40 annual EPS in 2026.

Cash Flow and Balance Sheet: 2.4X Debt Leverage

Operating cash flow margins have been hovering around 10% of revenue and are expected to improve with higher revenue and profits in the coming quarters.

• FQ1 operating cash flow was $152.98 million or 11.4% of revenue compared to 18.9% in the same period last year. The operating cash flow margin was in line with the full year operating cash flow margin of 11.6% for FY2024 and 12.3% for FY2023.
• FQ1 free cash flow was $61 million or 4.5% of revenue compared to 13% in the same period last year. The free cash flow margin was in line with the full year free cash flow margin of 4.2% for FY2024 and 3.8% for FY2023.
• Cash was $1.02 billion; debt was $3.99 billion compared to $926 million and $4.1 billion at the end of FQ4.
• During FQ1, the company repaid $118 million in debt from the cash from operations and proceeds from the sale of the Newton Aycliffe fabrication facility. The sale is part of the company’s ongoing efforts to streamline operations.
• With the $118 million debt repayment, the company has reduced the debt leverage ratio to 2.4x, and debt reduction will continue to be the priority for the management.

Divestment

The company is looking to divest or shut down non-strategic product lines and assets. The company recently sold the Newton Aycliffe fabrication facility in the UK. The proceeds from the sale of the facility were used to repay debt and will also help to reduce the overhead expenses and interest expenses.

Similarly, it is looking for strategic alternatives for the battery technology business. Although the business accounts for a small percentage of revenue, it is dilutive to the company’s margins. It will allow the company to focus on investments that have better returns on investments, such as the AI data center transceiver business. The management is expected to provide more updates in the coming months and during the Investor Day in May 2025. The company might also divest the silicon carbide business, in which Denso and Mitsubishi Electric have a 25% non-controlling stake.

New Management from Lattice Semiconductor:

Jim Anderson was appointed CEO of Coherent Corp. and a member of the Board of Directors on June 3, 2024. He previously served as CEO of Lattice Semiconductor Corporation since September 2018. Prior to joining Lattice, Mr. Anderson served as the Senior Vice President and General Manager of the Computing and Graphics Business Group at AMD.

Jim, who is credited for bringing about a turnaround in Lattice Semiconductor, is also expected to repeat his success at Coherent along with the new CFO Sherri Luther. The company appointed Sherri Luther as CFO on Oct 11, 2024. Prior to that, she was the CFO of Lattice Semiconductor since 2019. Prior to joining Lattice in 2019, she worked at Coherent for 16 years, including as Corporate Vice President of Finance.

Commentary from FQ1 2025 Earnings Call:

800-Gig drove the Revenue Beat, 1.6T Shipping in 2025:

There were questions as to where the upside from the quarter came from, given the top line and sizable 20%+ bottom-line beat. As noted, there was sizable growth in the datacom transceiver business of 16% QoQ growth and 89% YoY growth. The CEO points out customer breadth is expanding on the 800G product.

Q: Simon Leopold, Raymond James: “[…] And I guess what I'm trying to understand is where was the, really, upside surprise this quarter, was it really 800 gig and above or was there more strength from the more traditional products below — 400-gig and below, did that provide any upside or was it all coming from the higher performance? Thank you.”

A: Jim Anderson, CEO: “We did see sequential growth there [400-gig and under speeds]. 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.”

Although the customer breadth has grown with 800-gig, it was stated on the call the 1.6T will launch with a customer breadth that is smaller and matches the start of the 800-gig.

Supply Constraints Could be a Catalyst for Coherent:

There were three questions on the call from three separate analysts about potential supply constraint in lasers, with two analysts calling out the supply constraint being specifically with EMLs: “certainly on the EML side as we're hearing about constraints, et cetera, as you think about '25 and '26?”

The CEO pointed out this is an area incremental strength for Coherent as they make most of their parts internally (which is quite rare) yet will source when the demand requires it. The CEO also pointed out their breadth of technologies helps to meet demand if there were to be a shortage in a specific laser, such as EML.

Here are a few statements from the CEO that addressed Coherent having an advantage by building their own products in a fairly crowded market of networking components:

“On that first area of technology roadmap, I think our customers really recognize the breadth and the depth of the technology portfolio that we can bring to bear, specially in the optical networking space, where we don't just assemble the modules, but we build a lot of the ingredient components that go into the module; the lasers, whether they're VCSELs, EMLs for silicon photonics that we design, or a lot of the other ingredients that go into those modules […] and then, our verticalized structure could be a real advantage, especially in a very fast ramp situation, which we're in right now with our datacenter customers. When demand is increasing very quickly, it's really important to have that verticalized strategy and structure that we have, because I think that's really allowed us to supply them in a really reliable.”

This statement was reiterated a few times, which is that Coherent’s advantage lies within the breadth of the technologies they offer alongside the capability to build internally.

United States Domiciled:

The discussions around supply constraints potentially helping Coherent as the company builds its own products are further supported by the fact Coherent components are primarily manufactured in the United States, with some in Europe. The company has plans to expand its presence in the United States with a 6-inch InP wafer fab in Sherman Texas. According to an announcement last week, Coherent was awarded $33 million from the United States CHIPS act to support the expansion of the Texas facility.

Competitors:

According to the 10-K, the company “had one customer who contributed more than 10% of revenue during fiscal 2024.” This is understood to be Nvidia. Yet, B.Riley downgraded the stock due to Nvidia seeking more suppliers for the 1.6T products, with the analyst note naming Eoptolink, Innolight and Fabrinet as notable competitors.

Conclusion:

If you had “reading about AI networking components” on your Christmas list, then consider yourself in luck. The I/O Fund is leaving no stone unturned in delivering a full hardware stack analysis on what’s to come in 2025 as AI systems increase in complexity. Although we saw some outliers in AI software this year, we continue to foresee 2025 to be the year for AI hardware – far more so previous years. This goes back to how the Blackwell systems are being built, by scaling out 4-9X, and also requiring new components to handle the surge in AI server power consumption.

Of course, with every great opportunity, there comes some element of risk. The clear risk to semiconductors are tariffs with rumors that Chinese tariffs could be as high as 60% on imports from this region.  This would technically be a tailwind for Coherent — a key Nvidia supplier as we go into 2025 that would not only circumvent the majority of tariffs but potentially come out on top.

Additional Readings:

Semtech: Fiber Optics and Copper (ACC) AI Networking ComponentsSemtech: Fiber Optics and Copper (ACC) AI Networking Components

Vertiv: AI Data Center and Direct Liquid Cooling Stock; Nvidia SupplierVertiv: AI Data Center and Direct Liquid Cooling Stock; Nvidia Supplier

Marvell Q3 Earnings: Strong Sequential Growth; Expanded AWS PartnershipMarvell Q3 Earnings: Strong Sequential Growth; Expanded AWS Partnership

Optical Interconnects Overview: Strong Growth Expected AheadOptical Interconnects Overview: Strong Growth Expected Ahead

Micron reported surging data center growth up 400% YoY and 40% QoQ, with data center revenue mix surpassing 50% of Micron’s revenue for the first time. The Compute and Networking Business Unit reported revenue growth of 46% QoQ and was up 153% YoY for revenue of $4.4 billion.

An analyst did some digging around on the call and came up with the number of $800 million to $900 million coming from HBM: “You guys don't report HBM revenue [..] But based on everything you've said over the past couple of quarters, we're sort of estimating you did, I don't know, $800 million, $900 million in revenue in the quarter.”

Despite Micron’s data center revenue surging this quarter, the comments about the consumer recovery taking longer tanked the stock. Management is expecting these segments to resume around May of next year, which clearly wasn’t strong enough commentary to sustain the stock after hours.

We closed the bulk of the position because semis are breaking support across the board right now, and the broad market also broke critical support today following the FED meeting. An earnings call that focused on consumer weakness throws fuel on the fire.

The headline numbers are that Micron reported fiscal Q1 revenue nearly in line with consensus at $8.70 billion, yet it forecast Q2 revenue to decline nearly 10% sequentially to $7.9 billion, well below the $8.97 billion consensus estimate. The CEO acknowledged that consumer-facing markets and NAND were weaker in the near term and weighing on growth.

Micron also shared some positive details on the DRAM/HBM side, sharing that its HBM3E is shipping with Nvidia’s B200 and GB200s, with high volume shipments to its second large customer commencing this quarter and shipments to a third customer beginning in calendar Q1 2025. Management also elaborated on the long-term growth runway for HBM4 and HBM4e.

Revenue

Revenue of $8.71 billion increased 84.3% YoY and met consensus estimates. Management said that they “achieved new records in both total data center revenue and the revenue mix for data center in fiscal Q1,” with data center revenue rising 40% QoQ and 400% YoY.

For Q2, Micron guided far below consensus, seeing revenue of $7.9 billion, +/- $200 million, versus estimates for $8.97 billion. This corresponds to a sequential decline of (9.3%), whereas analysts had expected to see 3.1% sequential growth. The YoY growth is thus expected to decelerate to 35.7% in Q2, a much sharper deceleration than the expected 55.4% YoY growth next quarter.

Micron offered some commentary as to the unexpectedly weak guide:

“We had previously shared our expectation that customer inventory reductions in the consumer-oriented segments and seasonality would impact fiscal Q2 bit shipments. We are now seeing a more pronounced impact of customer inventory reductions; fiscal Q2 bit shipment outlook is weaker than we previously expected.”

Micron expects this transition period to be “relatively brief” with inventories getting healthier by the early part of 2025, setting up for stronger bit shipments in the second half of the fiscal year. Management also reiterated that they remain on track to hit HBM targets and deliver a “substantial” revenue record with “significantly improved profitability” this fiscal year, though the degree of that comes into question with the large guide lower.

Key Segments

DRAM is the AI-related high bandwidth memory (HBM) segment. DRAM revenue increased 20% QoQ and 88% YoY to $6.4 billion, decelerating slightly from 93% YoY growth last quarter. DRAM ASPs rose in the high single-digit % QoQ while bit shipments rose in the low double-digit % QoQ.

NAND revenue declined (5%) QoQ but increased 83% YoY to $2.2 billion. Both ASPs and bit shipments declined in the low single-digit % QoQ. NAND is where a majority of Micron’s issues are arising at the moment, with management saying they expect a “meaningful decline” in bit shipments in Q2 and growth resuming in the back half of the year. NAND conditions are impacting Q2’s gross margins to a degree, while management also expects underloading in NAND to continue to impact gross margins in Q3.

Here is what was stated regarding a mismatch between inventory and demand: “It’s more that they have built inventory and therefore, their purchases are less than their sell-through. And we saw that the inventories improved in CQ4 and we expect them to improve further in CQ1 time frame.”

Industry-wide NAND bit demand growth in 2024 and 2025 is now seen in the low double-digit percentage range, lower than management’s prior expectations, with Micron cutting back on NAND technology upgrades and cutting some supply to align with demand signals.

Regarding what is driving the higher NAND inventories, the following was shared on a more granular level in terms of devices versus data center, plus the comment below provided clarity that high NAND inventories will cause margin compression as far out as Q3.

“First, as Sanjay mentioned, the NAND industry market conditions were weaker than we had expected and that consumer market, PC, smartphones demand is weaker and inventory adjustments are occurring. Secondly, NAND data center SSD volumes moderated. And so there’s this period of digestion. And that was, as we know, higher-margin NAND business. So those two things are the principal driver. Of course, with revenue down in the guide $800 million we see some negative leverage effects on ongoing period costs, but those costs do not include underload charges in the second quarter. So those charges will begin to affect us in the third quarter.”

Margins

Gross margins were reported in line with management’s guidance and are slowly expanding as AI-related HBM3 results in higher margins – which is rare as AI chips and some hardware weighs on other companies (outside of NVDA). Per the opening remarks: “In fiscal Q1, our HBM gross margins were significantly accretive to both DRAM and overall company gross margins.”

The operating margins were ahead of guidance due to tight cost control.

• GAAP gross margin was 38.4%, up 3.1 percentage points QoQ and more than 39 points YoY. Adjusted gross margin was 39.5%, up 3 percentage points QoQ and nearly 31 points YoY.
• For Q2, due to the aforementioned NAND weakness, gross margins are projected to decline ~1 percentage point QoQ, with GAAP gross margin seen at 37.5% and adjusted gross margin at 38.5%. Per the commentary on the call: “We expect fiscal Q2 gross margins to be impacted by NAND industry conditions, partly offset by continued growth in HBM and data center DRAM. In addition to these factors, we expect NAND under loading to affect fiscal Q3 gross margins.”
• GAAP operating margin was 25.0% (ahead of guidance for 24.6%), up 5.4 percentage points QoQ and nearly 49 points YoY. Adjusted operating margin was 27.5%, up 5 percentage points QoQ and nearly 48 points YoY.
• Due to the impacts from NAND, operating margins are forecast to contract in Q2, with GAAP operating margin declining 3.2 percentage points to 21.8% and adjusted operating margin declining 2.9 percentage points to 24.6%.
• GAAP net margin was 21.5%, up more than 47 percentage points YoY and 11.1 percentage points QoQ as net income more than doubled sequentially to $1.87 billion. Adjusted net margin was 23.4%, up more than 45 percentage points YoY and 6.1 points QoQ.

EPS

Profitability significantly improved in Q1, with GAAP net income rising 111% QoQ to $1.87 billion. GAAP EPS was $1.67, more than double the $0.79 from last quarter and a major improvement from the loss of ($1.10) in the year ago quarter.

Adjusted EPS of $1.79 was up more than 51% QoQ from $1.18, and also marked a major turnaround from a ($0.95) loss a year ago.

For Q2, given the margin contractions, both GAAP EPS and adjusted EPS are forecast to decline quite substantially. GAAP EPS was guided at $1.26, +/- $0.10, and adjusted EPS was guided at $1.43, +/- $0.10, well below the $1.96 expected by analysts.

Cash and Balance Sheet

Operating cash flow generation remained strong for a third quarter with OCF margin above 35%. Free cash flow generation was limited in the quarter due to $3.1 billion in capex. Micron noted that it expects FY25 capex to be $14 billion, +/- $500 million, primarily to support HBM.

• Operating cash flow of $3.24 billion rose more than 130% YoY. OCF margin was 37.3%, down slightly from 43.6% in Q4 but up from 29.6% in the year ago quarter.
• Adjusted FCF was $112 million, due to Micron’s capex spend in the quarter. Adjusted FCF margin was 1.3%, down from 4.2% in Q4 but improving from (7%) in the year ago quarter.
• Inventory totaled $8.71 billion.
• Cash and equivalents totaled $8.74 billion, while debt totaled $13.79 billion.

Earlier this month, Micron finalized an agreement with the U.S. Department of Commerce for an award of up to $6.1 billion under the CHIPS and Science Act to support advanced DRAM manufacturing fabs in Idaho and New York. The company also plans to expand its fab in Virginia and Singapore.

Business Segments

Compute and Networking (CNBU)Compute and Networking (CNBU)

Compute and Networking revenue rose more than 153% YoY and 46% QoQ to a record $4.4 billion, comprising more than 50% of Micron’s sales for the first time. Management said the unit’s strength was “driven by cloud server DRAM demand, as well as HBM revenues, which more than doubled sequentially in the quarter.”

Micron was quite optimistic of the opportunity in HBM, both in the near future and the longer-term. Management said that its HBM revenue more than doubled QoQ on solid execution on yield and capacity ramps, with multiple billions in HBM revenue still expected in fiscal 2025. HBM remained “significantly accretive to both DRAM and overall company gross margins” in the quarter.

Additionally, management also increased their HBM TAM forecast for calendar 2025, now seeing the opportunity at $30 billion, a 20% increase from their previous view from $25 billion. In the longer-term, management expects HBM’s TAM to reach $64 billion by 2028 and $100 billion by 2030, or larger than the entire DRAM industry (incl. HBM) in 2023.

Mobile (MBU)Mobile (MBU)

Mobile revenue declined (19%) QoQ but rose approximately 16% YoY to $1.5 billion, with inventory optimization in Micron’s mobile customers a key theme of the quarter. Micron said that due to the inventory management from customers, it pivoted supply to meet data center demand. Smartphone customer shipments are expected to be weighted to the second half of the fiscal year.

Embedded (EBU)Embedded (EBU)

Embedded revenue declined (10%) QoQ and up in the single digits YoY, as automotive, industrial and consumer customers continued with inventory management.

Storage (SBU)Storage (SBU)

Storage revenue rose 3% QoQ but accelerated to 160% YoY to $1.7 billion, a new quarterly record, driven by data center SSDs. Micron said its 9550 PCIe Gen5 data center SSDs were qualified for the recommended vendor list for Nvidia’s GB200 NVL72 system, offering 34% higher throughput and over 80% lower energy per terabyte of data transfer versus competing products.

Management added that they expect “to generate multiple billions of dollars in data center SSD revenue in fiscal 2025 and to grow our market share once again in calendar 2025.” However, they did provide a hint of caution to not expect triple-digit growth to continue the entire year, saying they see “temporary moderation in near-term data center SSD purchases by customers after several quarters of very rapid growth.”

Earnings Call Q&A Notes:

The AI-related segments had bullish commentary while the consumer commentary was bearish. As stated in the introduction, the combination of catching the market off guard following a negative surprise from the FED was not ideal. The tone around the two customer end markets of data center versus consumer were sharply bifurcated.

Bullish HBM3e Commentary and HBM4:

Management pointed out they are raising their view of server unit percentage growth for the current year and they “anticipate server unit growth to continue in 2025.” The CEO also stated that HBM has exceeded their plans due to “solid execution on yield and capacity ramps.”

The company also stated “We are proud to share that Micron’s HBM3E 8H is designed into NVIDIA’s Blackwell B200 and GB200 platforms. Micron’s HBM3E operates at full speed while maintaining leadership in power efficiency”

They also stated there are more customers on the way: “This month, we commenced high-volume shipments to our second large HBM customer and will start high-volume shipments to our third large customer in CQ1, expanding our HBM customer base. We continue to receive positive feedback from our leading customers for Micron’s HBM3E 12H best-in-class power consumption, which is 20% lower than the competition’s HBM3E 8H, even as the Micron product delivers 50% higher memory capacity and industry-leading performance.”

Regarding the next catalyst, which is HBM4, Micron stated this should be available in calendar year 2026:

“Leveraging the strong foundation and continued investments in proven 1-beta process technology, we expect Micron’s HBM4 will maintain time to market and power efficiency leadership while boosting performance by over 50% over HBM3E. We expect HBM4 to ramp in high volume for the industry in calendar 2026.”

Bearish Consumer Commentary:

Regarding the more bearish consumer commentary, one question in the Q&A really drove at the heart of what is on the Street’s mind right now, which is why the sudden negative surprise in guidance? The exchange was long, and normally I would abbreviate it, but the stock is down considerably right now and this Q&A excerpt summarizes what is driving the negative price reaction:

Chris Caso

Yes. Hi. I guess the first question is, maybe just some clarity on what may have precipitated some of the cautious — some of the incremental caution here and what might have changed over the last couple of months? I know that is kind of back and forth a little bit, there were some cautious signs kind of back in August and they kind of received in the last earnings call. Was it — I guess the question is, is it a function of the customer inventories turned out to be a bit more than we had expected or do you think it was a function of demand?

Sumit Sadana

Yeah. Let me try to maybe address what changed. So, if you think about over the course of CQ4, we have seen a pushout of the PC refresh cycle that our customers had been anticipating, we had been anticipating. And it's not like the refresh cycle won't happen. It will happen in 2025. It just been a little bit delayed. There are numerous drivers which we mentioned in our prepared remarks as to why we believe and our customers believe that the refresh cycle will happen […]

But the delay in that upgrade cycle means that our calendar '24 PC shipment forecast at the unit level for PCs at our end customers has been reduced and is now very flattish year-over-year in calendar '24, so that has been one driver. The other is that definitely the inventories that we had highlighted in the last earnings call, that we expected by spring would become healthier at our customers, that inventory and inventory reduction as well as the seasonality of CQ1, those are continuing impacts. Some impact coming from the moderation.

You mentioned — previous discussion we just had a short while ago about lumpiness of demand on the data center SSD side. So some moderation in data center SSD into CQ1 after significant bout of buying over several quarters in calendar '24. So those are the things that have impacted the near-term outlook. But I just wanted to mention that most of the impact is limited to consumer-oriented segments, and the trajectory of demand in the data center continues to be very robust. Our own data center segment view of the overall revenue trajectory through fiscal '25, calendar '25 remains in a very solid trajectory.

You have seen our F Q1 results as well that we highlighted. So it's mainly the consumer-oriented segments and some very temporary moderation of the data center SSD, which we expect will pick up again in a couple of months. And so if you think about just these consumer-oriented segments, we do expect that by spring time, the inventories will be much healthier. And then we are back to shipment growth because right now, we are shipping to these customers at a rate that is lower than their ship out because they are consuming DRAM and NAND at a faster rate than they're purchasing from us and from the industry.

So that's the effect of the inventory that we expect will be in a much healthier place by spring and then a resumption of shipments and growth in shipments for the second half of the fiscal year and then things will be much better. And overall, DRAM will be continuing to be in a much healthier place. The supply is tight. HBM continues to pressure non-HBM availability of supply. So a large part of the issue is NAND related, and we have outlined the actions we are taking on the supply there to decisively bring our supply and balance with the demand.”

Conclusion:

It’s quite clear something important is going on with this stock given the surging data center revenue (the highest AI/DC-related growth percentage we saw from any company this quarter – if you strip out MU’s data center’s 400% YoY growth and 40% QoQ growth, it even beat high-flier ALAB on growth percentages), yet the market will not be forgiving to a company that is guiding for nearly 6-months of a soft consumer in its NAND segment on the very day the FED disappointed by announcing fewer rate cuts next year. Had Micron warned the market appropriately, the stock might be doing better right now. The market greatly dislikes surprises, and Micron provided a negative surprise about the consumer in a fairly pronounced manner this evening.

We saw critical support break in the S&P 500, of which are Members have been aptly warned about for months with non-stop coverage in Knox’s weekly webinars with the exact level that needs to hold. We have a plan for when the market goes up, and we have a plan for when the market goes down. For now, it’s the latter that is in play until the broad market says otherwise. There are other consumer-facing semis we may need to trim should the selloff sustain, please keep an eye out on your trade alerts.

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.

Recommended Reading:

• Micron FQ1 Earnings Preview: Look for a Focus on Profitability and Pricing Power
• Marvell Q3 Earnings: Strong Sequential Growth; Expanded AWS Partnership
• Vertiv: AI Data Center and Direct Liquid Cooling Stock; Nvidia Supplier
• Dell Q3 Earnings Preview: Riding the AI wave

Nvidia is breaking support, while also strongly diverging from the broad market. If this level fails, the next level will be our first buy spot around $126.

Bitcoin is extending the 3rd wave of 5. We're not chasing this. Our game plan remains the same – buy the 4th wave drop and ride the 5th wave to new highs. Then sell most of it. The only thing that has changed is the 4th wave target – now, $90K – $80K.

Advanced Signals Members receive in-depth technical analysis from our Portfolio Manager, Knox Ridley.  Learn more here.here.

Recommended Reading:

• Nvidia Q3: Lackluster Quarter until Blackwell Arrives
• Real Vision Video Interview: Will Nvidia Continue to Dominate AI?
• Q4 2024 Webinar Highlights
• TSMC Q3 2024 Earnings: Strong results led by AI demand

Micron will release its Q1 FY2025 results on Dec 18. Analysts expect revenue to grow 84.3% YoY to $8.71 billion. The adjusted EPS is expected to come in at $1.77, compared to (-$0.95) in the same period last year and a solid 50% sequential growth from $1.18 in FQ4.

The AI-related portion of its revenue will not only ramp in FY2025, but it’s also accretive to margins. Meanwhile, peer-related semiconductor stocks that provide custom silicon or AI servers will see the opposite effect, which is that a higher mix of AI products actually weighs on margins.

Management had guided margins to improve sequentially due to better pricing and portfolio mix. During the FQ4 earnings call, the CFO said, “Fiscal Q1 gross margin is projected to improve sequentially primarily due to better pricing and portfolio mix. Recall that, in fiscal Q4, HBM remained accretive to both DRAM and overall company gross margins. We project changes in our portfolio mix to continue to be an important and favorable contributor to gross margins over time.”

Last week, there was an important announcement that stated Samsung is unable to supply HBM3e to Nvidia in 2024. Per the report: “Daily Korea indicates that Samsung’s hopes of supplying HBM3E to NVIDIA in 2024 now appear almost impossible, though prospects for beginning supply in 2025 seem more promising.” This is a major positive for Micron, who along with SK Hynix, is a key supplier for HBM3e. With Samsung unable to supply HBM3e, this could help to increase Micron’s pricing power on what limited supply there is available. We expect the earnings call to focus on this news as analysts will want to figure out how to update their estimates based on the recent announcement that memory-behemoth Samsung is out of the picture for now.

Per our free newsletter last week, Micron has low exposure to China in the mid-teens compared to many AI semiconductor companies and equipment providers having 30% or higher exposure. Plus, with Micron being a United States memory fab, the company will continue to see a boost from the CHIPS Act as well as incremental strength compared to peers once tariffs are implemented.

Revenue

FQ1 revenue is expected to grow 84.3% YoY to a record $8.71 billion, led by strong AI data center demand. Strong growth is expected to continue, and analysts expect revenue to grow by 55.4% and 43% YoY in the subsequent two quarters.

• Last quarter revenue grew by 93.3% YoY to $7.75 billion and was the peak revenue growth quarter for the company.
• DRAM revenue increased 93% YoY and 14% QoQ to $5.3 billion in FQ4, representing 69% of total revenue. Bit shipments were flat sequentially and prices increased in the mid-teens percentage.
• NAND revenue increased 96% YoY and 15% QoQ to $2.4 billion, representing 31% of total revenue. Bit shipments and prices increased by a high single-digit percentage sequentially.

• Looking further out, analysts expect FY2025 revenue ending Aug to grow 52.2% YoY to $38.22 billion and 21.6% YoY growth to $46.46 billion in FY2026.

Margins

Margins have improved, helped by better pricing due to the favourable supply-demand environment, cost controls, and ramp of higher-value products.

• FQ4 gross margin was 35.3% compared to (-10.8%) in the same period last year. Management expects it to further improve to 38.5% in the next quarter. Adjusted gross margin also improved significantly to 36.5% from (-9.1%) in the same period last year, which was helped by higher pricing and a higher-margin product mix. The same positive attributes will help the adjusted gross margin to improve to 39.5% in FQ1.
• FQ4 operating margin improved to 19.6% compared to (-36.7%) in the same period last year. Management expects it to further improve to 24.6% in the next quarter. Adjusted operating margin improved 52.6 percentage points YoY to 22.5%, which was helped by higher gross margins and operating leverage. Management guide for FQ1 is 27%.
• FQ4 net income was $887 million or 11.4% of revenue compared to a net loss of (-$1.43 billion) or (-35.7%) of revenue in the same period last year. Adjusted net income was $1.34 billion or 17.3% of revenue compared to (-$1.18 billion) or (-29.4%) of revenue in the same period last year.

EPS

Micron has officially bottomed on EPS and is firmly returning to positive growth. Adjusted EPS was $1.18, up 90% QoQ from $0.62 in Q3 and significantly improved from (-$1.07) in the year-ago quarter, helped by better pricing, cost controls, and higher-value products.

• FQ1 EPS guide is $1.54 and adjusted EPS guide is $1.74. Analysts expect adjusted EPS to come at $1.77, compared to (-$0.95) in the same period last year and a solid 50% sequential growth.
• Analysts expect strong EPS growth to continue in the coming quarters as they expect FQ2 adjusted EPS to grow 366.3% YoY to $1.96 and 272.7% YoY to $2.31 in FQ3.

• Looking further out, analysts expect FY2025 ending Aug adjusted EPS to grow 579% YoY to $8.83 and 47% YoY to $12.98 in FY2026.

Cash Flow and Balance Sheet

The operating cash flows have improved with higher revenue and profitability.

• FQ4 operating cash flow was $3.41 billion or 43.9% of revenue compared to $249 million or 6.2% of revenue in the same period last year.
• Adjusted free cash flow was lower at $323 million or 4.2% of revenue compared to (-$758 million) or (-18.9%) of revenue in the same period last year, as Micron spent $3.1 billion in capex. Management expects capex to increase sequentially to $3.5 billion in FQ1.
• Management stated that capex would be meaningfully higher in fiscal 2025 in the mid-30s percentage range to support “growth in both greenfield fab construction and HBM” investments as Micron works to build out its fabs in New York and Idaho. Capex totaled $8.1 billion in FY24; management expects capex to rise around 35% of FY2025 revenue, i.e., it comes to about $13 billion, and the company is able to support it due to higher profitability.
• The company stated wafer capacity is below peak levels, partly due to an increasing mix of HBM that is reducing DRAM supply for traditional products. The capex spending is needed to continue to supply HBM. There is also a low-capex environment for NAND at the moment, and it was stated this would ultimately lead to healthy NAND supply-demand dynamics.
• The U.S. Department of Commerce also recently finalized the $6.1 billion funding to Micron under the Chips Act. The Department will disburse the funds based on Micron’s completion of project milestones.
• Inventory was $8.9 billion, or 158 days, and Micron expects to draw down this inventory to support revenue growth in FY25.
• The company had cash and investments of $9.16 billion and debt of $13.4 billion compared to $9.22 billion and $13.3 billion at the end of FQ3.
• The company repurchased shares worth $300 million and paid $129 million in dividends in FQ4.

Business Units

Compute and Networking (CNBU) revenue was $3.02 billion, up 17% QoQ and 152% YoY. This was a significant growth acceleration, up from 85% YoY in Q3 and 59% YoY in Q2.

Management said that “data center server DRAM achieved a quarterly revenue record in fiscal Q4, driven by strong demand for high-capacity solutions as well as our continued ramp of HBM.” ‘

The company expects HBM TAM to grow from $4 billion in CY23 to over $25 billion in CY25. Micron reiterated it will be able to capture a similar market share of HBM as it has in DRAM sometime in CY2025, which was 21.5% of market share in early 2024.

Mobile (MBU) revenue increased 18% QoQ to $1.88 billion, though YoY growth of 55% decelerated from 94% YoY in FQ3. Management said seasonal product launches drove the sequential growth.

Micron hinted when investors can expect AI PC growth, which looks to be H2 2025: “PC unit volumes remain on track to grow in the low single-digit range for calendar 2024. We expect unit growth to continue in 2025 and accelerate into the second half of calendar 2025 as the PC replacement cycle gathers momentum with the rollout of next-gen AI PCs, end of support for Windows 10 and the launch of Windows 12.”

The demand for DRAM is increasing due to the rise of AI-powered devices. On average, PCs required 12GB of DRAM last year, while AI PCs will need a minimum of 16GB and up to 32 to 64GB of DRAM for the mid and premium segments. Similarly, mobile devices required 8GB of DRAM, whereas AI-powered mobile devices will come with 12GB to 16GB of DRAM.

Storage (SBU) revenue rose 24% QoQ and 127% YoY to $1.68 billion, with the YoY growth rate accelerating from 116% in Q3. Management said the growth was “led by data center SSD, which reached a quarterly revenue record,” while NAND storage reached a record for the full year.

Embedded (EBU) was the only segment to record a sequential decline in Q4, with growth down (-9%) QoQ but rising 36% YoY to $1.17 billion. Management added that the “automotive segment achieved a new fiscal year revenue record for the fourth consecutive year.”

Management expects automotive growth in the second half of the FY2025. “The automotive industry continues to adjust the mix of EV, hybrid and traditional vehicles to meet evolving customer demand. As auto customer inventories adjust to this new mix, we expect a resumption in our automotive growth in the second half of fiscal 2025.”

Other noteworthy points to watch

HBM Revenue

Micron started shipments of HBM3e 12 high 36-gigabyte units in FQ4. These units provide up to 20% lower power consumption and 50% higher DRAM capacity than its competitors’ 8 high, 24-gigabyte solutions. They expect the ramp of HBM3E 12-high in early CY2025 and an increase in the 12-high mix in the shipments throughout 2025.

Management also said that in CY2025 and 2026, they have a diversified HBM revenue base since they have won business with a broader range of customers for the HBM3E. They expect robust demand for the D5 and LP5 solutions.

Management mentioned that they expect multiple billions of HBM revenues in FY2025. “We delivered several hundred million dollars of revenue in fiscal year '24 and we look forward to delivering multiple billions of dollars of revenue of HBM in fiscal year '25.” The other key point is that the HBM business will continue to be accretive to margins in FY2025.

DRAM/NAND Commentary

The management stated during the FQ4 earnings call that they are upgrading their expectation for calendar 2024 industry DRAM bit demand growth to be in the high-teens percentage range. It was further stated: “In calendar 2025, we expect both DRAM and NAND industry bit demand growth to be around the mid-teens percentage range.”

The management also stated: “We see increasing DRAM and NAND content both in traditional as well as AI servers” and that “our mix of data center revenue reached a record level in fiscal 2024 and we expect will grow significantly from here in fiscal 2025.”

There is a slight slowdown in management’s guide for DRAM for next year, as it’s being stated that growth in the high teens is expected for 2024, while growth in the mid-teens is expected for 2025. As we noted in our previous analysis, the slowdown is coming from AI PCs and smartphones.

“At 2024, we have increased the outlook to high teens based on the strength in the data center. And 2025, as we look at it, just keep, in fact — mind two factors: one is we are now comparing it to the higher base of 2024, which has gone to high teens. So that, of course, impacts the percentage of the '25. And second piece is that, as we have noted, that smartphone and PC, which at the end market level are continuing to do fine.

But given for the 3 factors that we have mentioned in our earnings call script that the customers built some inventory. The sell-in is somewhat less than their sellout in terms of memory, and we have said that by spring of 2025, we expect in PCs customer inventory levels to get to healthier levels versus now, and these will continue to improve.”

Another factor is that HBM3E is leading to wafer capacity constraints. It has a 3:1 trade ratio, which means it takes 3X more wafers to produce HBM3e.

Valuation

The company is trading at a P/S ratio of 4.9 and a forward P/S ratio of 3.2. It is trading at a P/E ratio of 160.4 and an attractive forward P/E ratio of 12.5, helped by the strong top-line and bottom-line growth.

Conclusion

Wall Street has doubted the company for most of the year yet the last earnings report for FQ4 was quite strong. Some of the weakness may be coming from Samsung’s entry into the space, which now looks decidedly delayed. The company has strong top-line and bottom-line growth. Along with this, the HBM revenue will ramp up in FY2025 and continue to be accretive to margins, which will be a key catalyst.

Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.

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