For six straight quarters, "virtually there" communications equipment provider Polycom (NASDAQ:PLCM) has consistently thumped the earnings expectations of Wall Street's Wisest. On Thursday, the company reports its Q2 2007 numbers, going for lucky No. 7.

What analysts say:

  • Buy, sell, or waffle? Eleven analysts follow Polycom, with seven rating it a buy and four a hold.
  • Revenue. On average, analysts expect to see 40% sales growth, to $230.1 million.
  • Earnings. Profits are predicted to rise 21% to $0.29 per share.

What management says:
No sooner had Motley Fool Rule Breakers recommended that our members invest in Polycom than the company reported Q1 earnings that left investors yawning. The stock fell 2% in response, but has since regained its pre-Q1 earnings level. Part of the problem, I suspect, was its 31% decline in GAAP earnings, thanks to a $0.10-per-share charge taken in connection with the purchase of voice-over-Wi-Fi pioneer SpectraLink. Back out the charge, though, and profits would have grown 31% on 22% revenue growth -- not bad. However, it's also worth pointing out that free cash flow for the quarter declined by more than half, to $10.9 million.

Management did not give much in the way of guidance, but the facts contained in the earnings release do tell us that the growth driver here lies more in Polycom's video offerings than in voice. Video revenue grew 30% organically in the quarter, increasing this segment's relative importance. At 56% of total revenue, video was twice as big a business as was voice last quarter.

What management does:
Charges to earnings for the SpectraLink purchase depressed Polycom's net margin last quarter, but it's good to see that gross margins remain pretty steady in the 62%-ish range, and that operating margins continue to grow. Incidentally, they also put to shame the single-digit (or negative) operating margins posted by many rivals in this space, including 3Com (NASDAQ:COMS), Avaya (NYSE:AV), Nortel (NYSE:NT), and Sony (NYSE:SNE). Only Cisco's (NASDAQ:CSCO) 25% operating margin looks better than Polycom's.





























All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Let's go back to cash flow for a moment, which as I noted above fell even more sharply in Q1 than did earnings. Pulling up the firm's data from last quarter, I see that sales rose 22% year over year. Meanwhile, accounts receivable were up 38%, and inventories, 57%. But is this a bad thing?

Not necessarily. Remember the principle of positive inventory divergence, which tells us that rising inventories -- while they suck up working capital and lower free cash flow in consequence -- may also signal strong sales growth in the near future (or at least that management expects this). The key is to dig into the firm's 10-Q filings to see what kind of inventories are piling up. Hint: raw materials needed to build products to fill anticipated orders -- good. Unsold finished goods sitting on shelves unwanted -- bad.

In Polycom's case, the news here is good, sort of. Finished goods are indeed growing faster than sales, up 28% last quarter in comparison to Q1 2006. But raw materials ... are going gangbusters, up nearly seven-fold year over year! That suggests that management, at least, expects sales to continue coming in strong in future quarters. Let's just hope they're right.

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Fool contributor Rich Smith does not own shares of any company named above.