Hot Growth Companies

Steven Nichols has seen good times and bad in his business career. But the 49-year-old chairman of K-Swiss had never before been forced to watch as first a recession, then a war drove American consumers out of stores and behind their doors to wait it out. That would be enough to bust a small company struggling to make it. But to stay hot when the economy's not, a company has to have its feet planted squarely on the ground.

Fortunately, K-Swiss makes footwear. And despite tales of economic woe, K-Swiss had a boffo 1990--good enough to bring it in at No. 22 on BUSINESS WEEK's seventh annual list of Hot Growth Companies. This year looks good for K-Swiss, too: First-quarter earnings were up 63%, to $2.2 million, on a 45% increase in sales. The 25-year-old Pacoima (Calif.) company even managed to gain a smidgen of market share in the $5.5 billion athletic footwear business against front-runners Nike Inc. and Reebok International Ltd. K-Swiss' focus on durable, unfaddish sport and casual shoes is helping it ride out the recession. Concludes Nichols: "Bad times are a great time for a company like us." FLEET FEET. Nichols has been in the shoe business long enough to have seen previous recessions. He began selling footwear in college and owned several stores in and around New York City before joining Stride Rite Corp. in 1979. But Nichols longed to run his own operation. So 4 1/2 years ago, he bought out two brothers from Switzerland and assumed command of K-Swiss. The company is known for its "Classic," a leather tennis shoe that was first introduced back in 1966. But K-Swiss isn't just a one-shoe shop. It makes 30 different styles for men, women, and children, including hiking boots, boating shoes, and basketball sneakers. With that kind of variety, Nichols has managed to increase company revenues fivefold, to $98 million, since 1986.

Indeed, there's nothing pedestrian about K-Swiss or any of the 99 other companies mentioned on these pages. Although these firms are small--the combined sales of all 100 companies are equal to the revenues of $5.4 billion James River Corp.--the chutzpah and entrepreneurship necessary to take risks and shine during tough times make these a fleet-footed crew.

BW's Hot Growth list was compiled from a universe of 3,579 publicly traded companies with sales of less than $150 million, tracked by Standard & Poor's Compustat Services Inc. BUSINESS WEEK chose the top 100 based on average growth in sales, earnings, and return on invested capital over the past three years. Average sales growth for the period hit 62.7%, while earnings growth averaged 115.7%. The top 100 companies also enjoyed an average return on capital of 28.2%.

Although those numbers are hot by most standards, war and recession have left the averages mixed, compared with the vapor trails of previous years. For last year's list, average sales growth was slower, at 56.1%, but earnings grew at a blistering 124%. Still, these companies fared better than many of their larger brethren. In 1990, the average company on Standard & Poor's 400-stock index saw earnings drop 7% on sales growth of 11%. In a recession, Hot Growth companies can thrive by providing a product or service that helps other businesses cut costs or improve efficiency. Or they might ride a big trend, such as the boom in outpatient health care. Or they might offer the latest, must-have fashion.

So what's really hot? Consider Cisco Systems Inc., a seven-year-old manufacturer of routers--devices that connect computer networks. Over the past three years, earnings at the Menlo Park (Calif.) company have soared an annual average of 489.4%. Cisco has recently been bolstered by a joint-distribution agreement with Digital Equipment Corp., whose sales force could boost Cisco's sales even higher. With revenues expected to reach $183 million for the fiscal year ending in July, George J. Kelly, a computer analyst with Morgan Stanley & Co., predicts Cisco's biggest problem will be controlling its growth.

Cisco has plenty of colleagues on the list. With 34 entries, outfits that serve the computer industry are this year's Hot Growth heavyweights. Second, with 17 entries, are health-related companies, including instrument makers and health care facilities, such as Surgical Care Affiliates Inc. in Nashville, which is riding a U. S. trend toward outpatient services.

Neither silicon chips nor scalpels reign supreme, however. Risk-takers are an eclectic lot, and some of the other companies that made the list include a sports-memorabilia marketer (Score Board, No. 3), a prepared meats maker (Bridgford Foods, No. 98), and a consulting business (Right Management Consultants Inc, No. 86).

There are also a few throwbacks to another era. Check out No. 27, DeVlieg-Bullard Inc. A year ago, Chief Executive Laurence DeFrance took public this group of machine-tool companies, some of which date back to the 1800s. Nashville-based DeVlieg-Bullard makes tool-and-die machines and replacement parts. Not glamorous, perhaps, but good enough to hike earnings by an average of 81.1% since 1988.

SHRINKING UNIVERSE. BW's annual survey does reflect some cooler trends. Many once-hot companies have suffered flameouts. New accounting rules are expected to put a slight chill on revenue for software companies. And this year's data suggest that the number of small public companies is shrinking. Aside from a 7% drop in earnings growth from last year, the universe of more than 3,500 companies from which BW culled its list has shrunk for three straight years. Back in 1988, it was 4,500. Some companies have outgrown the $150 million sales cap. But the group of businesses that might normally step up and take their place has been shrinking, too. Data from Dun & Bradstreet show that the number of new business incorporations has declined 6% since its peak in 1986, to 659,571 last year.

One reason: Entrepreneurs just might be waiting for better times. "Some people rationally see that we're at the end of a long upturn," says Thomas A.

Gray, chief economist for the Small Business Administration, "and they will hold on until the next up cycle."

Money has been scarce, too, for those trying to get a new business off the ground. Besides the tightening of bank credit, other sources of financing are holding back. Back in 1987, venture capitalists raised about $4 billion to invest in new projects, mostly the $ 1million to $20 million capital infusions that sustain small businesses. But two years later, the total figure raised was just some $1.8 billion.

Venture capitalists say there are a number of factors involved in that drop. The 1986 hike in capital-gains tax rates made venture-capital pools less attractive to investors. And the rising rate of business failures--421,239 since 1985, up 31% over the first half of the decade--has made venture capitalists skittish. But the bottom line for a new business is the same. "You have to assume right now that the market is very selective, and unless you have an outstanding project, you won't get financed," says Robert D. Pavey, past president of the National Venture Capital Assn. "If you are a startup today, you will have to bootstrap it, try to get rolling, and wait for the environment to improve."

Bootstrap? Now, there's a word shoemaker Nichols and any of the other 99 company managers here would appreciate. The economy may pinch, but these entrepreneurs will keep marching along with new ideas.

               Millions of dollars *
      ALDUS             $149.8
      SUPERIOR TELETEC   148.3
      CISCO SYSTEMS      148.2
      CIRRUS LOGIC       141.8
      BMC SOFTWARE       139.5
      *Latest four quarters
                       Average annual rate *
      GB FOODS                  275.6%
      CISCO SYSTEMS             273.4
      SCORE BOARD               246.3
      NOVELLUS SYSTEMS          168.0
      T superscript 2  MEDICAL  151.5
      *Latest three years
         Millions of dollars *
      CISCO SYSTEMS         $34.6
      BMC SOFTWARE           31.4
      ALDUS                  26.2
      T superscript MEDICAL  21.1
      *Latest four quarters
         Millions of dollars *
      BMC SOFTWARE             $941
      CISCO SYSTEMS             848
      SCIMED LIFE SYSTEMS       708
      ALDUS                     694
      *As of May 10
         Average annual rate *
      LASERSCOPE                    710.6%
      CISCO SYSTEMS                 489.4
      GB FOODS                      330.5
      SCORE BOARD                   294.7
      *Latest three years
         Average annual rate *
      CAMBEX                      77.1%
      KNOWLEDGEWARE                58.6
      SOUTHERN ELECTRONICS         50.2
      GRAND VALLEY GAS             49.8
      *Latest three years' return on invested capital