Insight Infinera

Infinera President Dave Welch takes the stage at the company's recent Insight Infinera conference. Source: Infinera. 

Shares of Infinera (NASDAQ:INFN) entered the week up roughly 25% year to date. Will the rally continue after the company reports third-quarter earnings tomorrow, or are worse days ahead? A lot depends on how well the business performs. Here's a closer look at what Infinera has achieved over the trailing 12 months:

INFNQ2 2015Q1 2015Q4 2014Q3 2014
Revenue $207.3 million $186.9 million $186.3 million $173.6 million
Earnings From Continuing Operations $17.9 million $12.4 million $8.4 million $4.8 million
Adjusted EPS $0.07 $0.06 $0.06 $0.02
Cash From Operations $55 million $19.8 million $18.7 million $22.4 million

Source: S&P Capital IQ

As you can see, Infinera has reported respectable sequential gains in every category over the past year. Here's a closer look at how those results measure up year over year:

INFN Growth RatesQ2 2015Q1 2015Q4 2014Q3 2014
Revenue 25.4% 30.8% 33.9% 22.2%
Earnings From Continuing Operations 274.6% Not material Not material 44.7%
Adjusted EPS 234.9% Not material Not material 38.1%
Cash From Operations 436.8% Not material (27.4%) 75.6%

Source: S&P Capital IQ

Revenue growth hasn't been accelerating as much as I'd like, but earnings and cash flow are blossoming. That's a good sign. Looking at the rest of the business, I'm watching for momentum in each of these three areas:

1. Diverse deals. Infinera sells big-ticket gear for powering networks that routinely transmit data at 10 to 100 gigabits per second. A limited number of companies can afford the type of investment that Infinera demands. Yet in Q2, Infinera was still able to sell a (relatively) diverse field with its top five customers all hailing from different verticals. Three of them accounted for at least 10% of revenue: a cable operator, a "Tier 1" carrier that supplies the fastest type of Internet service, and an "enterprise carrier" with big communications needs. Look for similar diversity in the Q3 results. 

2. Positive inventory divergence. Like other hardware makers, Infinera stockpiles inventory. What we want to see is called "positive inventory divergence," in which raw materials and works in process grow faster than finished goods and perhaps even revenue. In Q2, raw materials inventory more than doubled year over year, while works in process improved 8% and finished-goods inventory grew just 5%.  Revenue jumped 25.4% over the same period. Look for this trend to continue or accelerate in the third quarter, leading to bigger deals.

3. Sustained investment in R&D. Infinera's technology has the potential to change the way we interact with communications networks. New ultra-fast backbones to the Internet could make it so that any user on any device is able to stream video instantly. No wait times or buffering. Providers would love this sort of functionality today, of course, but there are limits to what they'll spend on gear. Investors need Infinera working on enterprising ways to break this barrier, which is why R&D spending is so crucial. Infinera generally commits between 19% and 21% of revenue toward new breakthroughs. Watch for a similar cut in the Q3 income statement.

Infinera reports Q3 results on Tuesday, Oct. 27, after the market closes.

Tim Beyers is optically challenged. He's also a member of the Motley Fool Rule Breakers stock-picking team and the Motley Fool Supernova Odyssey I mission but didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's web home and portfolio holdings or connect with him on Google+Tumblr, or Twitter, where he goes by @milehighfool.

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