Key Takeaways
Coherent Inc.’s stock fell 6.7% after reporting record third-quarter earnings, as a minor miss on profit and a significant drain on operating cash flow overshadowed a landmark $2 billion investment from Nvidia Corp. and accelerating growth. The results highlight the intense pressure on AI supply-chain companies to deliver flawless execution amid soaring investor expectations.
"The successful ramp of our 6-inch Indium Phosphide wafer production is the single most important driver for our next phase of growth," Coherent CEO Jim Anderson said on the earnings call. "This technology allows us to produce more than four times the number of devices per wafer at less than half the cost of our previous 3-inch lines, a structural advantage that will drive margin expansion for years to come."
For its third quarter ending March 31, Coherent reported revenue of $18.06 billion, a 21 percent increase from the prior year, and slightly ahead of analyst estimates. However, non-GAAP earnings per share of $1.41 came in two cents below the consensus of $1.43. The real concern for investors was the company’s cash flow statement: for the first nine months of the fiscal year, Coherent generated just $10 million in operating cash flow, down from $503 million in the same period last year, primarily due to a nearly $700 million increase in inventory.
The selloff demonstrates that in the current AI-driven market, even record growth and a strategic partnership with the world’s most valuable chipmaker aren’t enough to satisfy investors if operational metrics falter. Coherent must now prove it can convert its massive inventory build-up—a strategic investment in its next-generation technology—into the profitable revenue and cash flow that its partnership with Nvidia promises.
The centerpiece of Coherent's long-term strategy is its deep partnership with Nvidia, which includes a $2 billion equity investment and a multi-year supply agreement for components used in Co-Packaged Optics (CPO). CPO technology, which integrates optics and silicon in a single package, is critical for the next generation of AI data centers and represents a more than $15 billion addressable market for Coherent.
The company is supplying a full suite of CPO components, including high-power continuous-wave lasers and external laser source modules. Management noted that scale-out CPO revenue would begin in the second half of 2026, with more advanced scale-up CPO systems contributing in 2027. This positions Coherent as a foundational technology provider for Nvidia's future platforms.
The primary reason for the massive inventory build is Coherent's aggressive transition to 6-inch Indium Phosphide (InP) wafers. The company announced it will achieve its goal of doubling InP capacity a quarter ahead of schedule, with plans to double it again by the end of 2027, resulting in a four-fold increase in two years.
This transition is the core of the company's plan to expand its non-GAAP gross margin from the current 39.6% to its target of over 42%. While the upfront investment in raw materials and work-in-progress inventory has consumed significant cash, it is a necessary step to meet committed demand and realize the substantial cost benefits. The market's negative reaction suggests investors are weighing the near-term cash drain more heavily than the long-term margin potential.
Despite a balance sheet transformation that saw net leverage drop from 2.1x to just 0.5x, the operating cash flow figure became a sticking point for analysts and investors. A nine-month operating cash flow of just $10 million for a company with over $18 billion in revenue is a significant red flag in any other context.
Management attributed the cash consumption to the strategic build-up of its 6-inch InP wafer production. While this is a plausible explanation for a company in a hyper-growth phase, it introduces a new risk for investors: execution. The company must now efficiently convert this inventory into shipments and, more importantly, cash. The next two to three quarters will be critical in demonstrating that this was a well-managed strategic investment rather than a sign of operational inefficiency.
The stock's performance, particularly when compared to competitor Lumentum, which also saw its stock fall after a strong report, indicates the market has priced AI-related stocks for perfection. For Coherent, which trades at a lower margin profile than its rival, the path to a higher valuation depends entirely on converting its technological advantage in 6-inch wafers into tangible financial results. While Stifel raised its price target to $412 from $275 after the report, the market appears to be in "show-me" mode, waiting for the cash flow to follow the compelling growth story.
This article is for informational purposes only and does not constitute investment advice.
