Database software master and online-banking software dabbler Sybase (NYSE:SY) releases Q3 2006 earnings tomorrow, when it's expected to report its first year-over-year flat earnings quarter since Q2 2004. Will Sybase pliantly follow Wall Street's lead? Simon says ...

What analysts say:

  • Buy, sell, or waffle? Sybase has picked up an additional analyst since last quarter. Of the five who now track it, three rate it a buy, and two give it a hold.
  • Revenues. On average, the analysts expect to see 7.5% sales growth to $214.3 million .
  • Earnings. . and profits that are flat against last year at $0.33 per share.

What management says:
Sybase's big news of the quarter has to be its $425 million purchase of mobile-messaging software maker 365 Mobile. As fellow Fool Tom Taulli points out, the move gives Sybase "a bump up in its top line from the acquisition. The deal is also expected to add to earnings within six months."

Looking further back, we see why Sybase is so interested in getting hold of this revenue bump. In the Q2 2005 earnings release, CEO John Chen characterized growth as "strong" in a report headlined with numbers like "core database license revenue grows 31%" and "mobile & wireless license revenue increases 21%." Don't be fooled -- headlines like these are used for highlighting the good, and it was only later in the release that we saw that overall revenue growth was a meager 5%. That said, the fact that mobile revenue helped to turn analysts' expected 4% sales growth into the 5% Sybase actually produced explains why the company believed this was a business ripe for further investment.

What management does:
Moreover, you don't need a lot of sales growth to grow profits when your profitability is improving as fast as Sybase's. Over the past 18 months, we've watched the firm's rolling gross margins grow and grow. Operating profitability has been a bit wobblier, but on the net line, the trend is again onward and upward.

Margins %

3/05

6/05

9/05

12/05

3/06

6/06

Gross

72.1

73.4

74.2

74.6

75.2

75.8

Op.

13.9

15.4

15.7

15.0

15.3

16.1

Net

8.5

8.7

10.0

10.5

10.9

12.0

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:
Sybase has been able to grow its margins in two ways. First, it's benefiting from a lower cost of providing its services. Second, it's working to improve efficiency of operations. Year to date, its anemic sales growth of 4% has been mitigated by a 7% reduction in cost of services and a muted rise in selling, general, and administrative costs of just 3%.

Unfortunately, I don't see either of those trends as sustainable long-term. Cost of services will inevitably rise -- additional sales always bring at least some additional costs with them. And there's only so much fat that can be cut out of a firm's operating costs. Combine those two "facts of business life" with the R&D write-offs and restructuring costs that are bound to come from the 365 Mobile acquisition, and I expect that Sybase's operating and net margins will weaken in the quarters to come. For the company's assessment of the likely damage, tune in tomorrow.

Competitors:

  • BEA Systems (NASDAQ:BEAS)
  • Borland Software (NASDAQ:BORL)
  • CA (NYSE:CA)
  • IBM (NYSE:IBM)
  • Microsoft (NASDAQ:MSFT)
  • Oracle (NASDAQ:ORCL)

What did we expect out of Sybase last quarter, and what did it produce? Find out in:

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Fool contributorRich Smithdoes not own shares of any company named above.