"Pop, pop, pop those bubbles." So go the lyrics to one popular ditty at a Gymboree (NASDAQ:GYMB) class here in suburban Virginia. And speaking of bubbles, after nearly doubling over the past year, Gymboree's stock price is stretched to breaking, looking about a molecule thin right now. Will tomorrow's Q4 and full-year 2005 earnings news pop it? Let's look for some clues.

Wall Street Wisdom:

  • General consensus. Ten analysts watch Gymboree, and their views split right down the middle: Five say buy, five say hold.
  • Revenues. Quarterly sales are expected to climb 17% to $205.4 million.
  • Earnings. Stock price bubble or not, earnings are certainly expected to inflate. Analysts predict they will nearly triple year over year, to $0.54 per share.

Margin watch:
Gymboree's recent income statements have been well-stocked with one-time charges and one-time benefits, making fair comparisons between quarters difficult. A better way to make sense of where the company is heading is to look at the big picture, through the lens of trailing-12-month, or as I call them, "rolling" margins. From that vantage, we see that on average, gross margins have held steady over the past 18 months. Operating profitability is about where it was a year ago, and net profitability has fallen by nearly half.

Margins %

7/04

10/04

1/05

4/05

7/05

10/05

Gross

40.6

40

39

38.4

38.4

40.1

Op.

6.3

5.1

3.5

2.9

2.8

5

Net

4.3

3.5

1.5

0.8

0.9

1.9

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

Foolish lookout:
Last month, Gymboree reported lower sales than the analysts predicted for this quarter: $202.9 million. In that same sales announcement, Gymboree projected earnings between $0.52 and $0.54 per share. Meanwhile, the analysts say that despite Gymboree selling less than it had expected, and despite its current margins being about half what they were a year ago, the company will still report earnings at the top of its projected range tomorrow. Sorry, but I don't buy it.

Don't assume that I'm totally down on the company. For example, Gymboree appears to be managing its inventories and bill collection much better now than it did a year ago. Year over year, inventories grew only 10% last quarter, versus a 14% rise in sales. And accounts receivable actually declined against the rising sales. This helped Gymboree generate $29.4 million in year-to-date free cash flow, versus negative free cash flow through the first three quarters of 2004.

Competitors:
Gymboree's on the upswing, with operations improving and free cash flowing once more. But its resurgence won't go unchallenged. Be sure to keep an eye on its rivals: Children's Place (NASDAQ:PLCE), Gap (NYSE:GPS), and Target (NYSE:TGT).

Gap has been recommended by our Stock Advisor and Inside Value newsletters.

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