Hot Growth Companies

Designed to keep the feet of Colorado river guides comfortable both in the water and out, Teva sports sandals weren't originally intended for the mass market. But at a time when high-tech sneakers are losing their cachet, the sturdy shoes with rubber soles, bright nylon straps, and nifty velcro fasteners are as likely to be spotted in New York's concrete canyons as the Grand Canyon.

Deckers Outdoor Corp., which manufactures and distributes Tevas, sold 2 million pairs in 1993, accounting for 90% of its $57 million in sales--a 64% increase over 1992 revenues. Earnings rose 55%, to $6.3 million, last year. And so far this year, Deckers has exceeded analysts' expectations by posting an earnings increase of 68% in the first quarter--all at a time when most athletic-shoe makers have offered only disappointments.

NEW LAUNCHES. The combination of strong sales, earnings growth, and high return on invested capital over the past three years has earned Deckers the No.2 spot on BUSINESS WEEK's annual Hot Growth list. But it will take more good ideas for the Carpinteria (Calif.) company to stay there. Nike Inc. and Reebok International Ltd. have moved in on Tevas' territory, introducing their own lines of sports sandals. To stay ahead, Deckers will step up its marketing of Tevas, while launching new outdoorsy footwear and apparel lines. "The challenge is to keep the steam up on Teva and at the same time diversify," says Peter Link, Deckers' vice-president for marketing. "We've made the right moves so far. If we continue, the sky's the limit."

The 99 other companies on the 1994 Hot Growth list have equally high hopes and healthy starts. They form a roster of the nimble and the innovative: Some thrive by being first, others by being better, and still others by being leaner. The rewards can be sweet. For the past three years, sales of companies on the list grew an average of 62.6%, compared with 2.8% for the companies that make up the Standard & Poor's industrial index. Earnings climbed 116%, compared with a 1% drop for the S&p Industrials, and return on invested capital averaged 33%, against 8.8%.

Timely ideas have propelled many of these companies onto the list. Some entrepreneurs, for example, spotted opportunity in the reengineering, or downsizing, that has left so many large corporations short on staff or equipment. Barrett Business Services Inc. in Portland, Ore., which leases people, and Leasing Solutions Inc. in San Jose, Calif., which rents out equipment, are No.4 and No.10 this year. In this era of health-care reform, companies that offer ways to cut medical costs are also prominent on the list. IntegraCare Inc. (No.5) provides rehabilitation services that can help get people out of hospitals faster, and Express Scripts Inc. (No.23) supplies prescription drugs via direct mail.

MANY MENUS. Still other companies prosper by filling specialized niches. That's the case for many of the 12 software companies that make up the biggest industry group on the list. Interlinq Software Corp. (No.18) develops residential mortgage-lending software, and PeopleSoft Inc. (No.57) offers human-resource-management systems.

But the No.1 spot goes to a low-tech company in an industry that's hardly ignored by the giants: Papa John's International Inc., a Louisville-based chain of take-out and delivery pizza stores. With its tightly focused menu and rapid franchise expansion, the company has garnered annual average sales and earnings increases of 108% and 117%, respectively, over the past three years. There are six other restaurants on the list, including Lone Star Steakhouse & Saloon Inc. (No.14) and Pollo Tropical Inc. (No.35).

But watch out. The highfliers on BUSINESS WEEK's list are always vulnerable to crashing and burning. Larger competitors can swoop down and imitate their designs or ideas. Or a once promising trend that fueled sales could prove to be a fleeting fad. And like their bigger brethren, Hot Growth companies must also keep a wary eye on the economy. As interest rates rise under the Federal Reserve Board's inflation-fighting campaign, companies large and small face higher borrowing costs and the threat that a cooling economy could slow sales. But managers of small-capitalization-stock funds still expect their favorites to excel. "Most of the true emerging growth companies will do well regardless of what the economy and interest rates do," says John Ballen, portfolio manager of MFS Emerging Growth Fund.

That's because these companies typically offer a product or service that's truly different. In contrast, many big companies are continuing to focus on downsizing and cost containment instead of product development. "Young, emerging growth companies have the flexibility and energy to respond to market needs much quicker than the big uglies," says Robert C. Czepiel, manager of the Robertson Stephens Emerging Growth Fund. Companies without innovative offerings face a profit squeeze if their unit volume is flat and they are unable to raise prices. But even if emerging companies can't hike prices, they achieve rapid growth by selling more of what they make, says Ballen.

ROUTINE CORRECTION? Still, there's no denying that small-cap stocks have joined the rest of the market under the hammer so far this year. Shares of stocks on this year's list are currently trading at an average of 26% below their 52-week highs while the S&p Industrials are trading 15% below their highs. And the T. Rowe Price New Horizons Fund, which is used as a proxy for small-cap growth stocks, was down 3.96% through April.

But money managers are confident that we're not in a full-fledged bear market for small-cap stocks and say such corrections are routine. Jack H. Laporte, manager of New Horizons, says small-cap stocks typically outperform the rest of the market for five- to seven-year-long cycles, during which they'll experience several 15% to 20% declines. As more than 30 years of data show, small-cap cycles last until the relative price-earnings ratio of New Horizons is double that of the rest of the market, Laporte says. Right now, the fund's p-e is 30% higher than the market, and Laporte judges the cycle to be a little more than half over. His one-year total return through the end of April is still looking pretty glamorous at 26%.

New companies are finding no shortage of investment capital to fuel their growth. The recent boom in initial public offerings brought a record 626 companies public in 1993, including 49 of the names on BUSINESS WEEK's 1994 Hot Growth list.

According to Securities Data Co., IPO volume is strong again in 1994. Venture capital funds, now with slightly less than $35 billion under management, are back up near the 1990 high, after a two-year decline, according to Venture Capital Journal. The biggest problem facing venture capitalists and underwriters is the shortage of good deals, says W. Keith Shilit, an author and consultant who evaluates emerging growth companies. He expects the IPO market to cool down, especially if the overall stock market continues to decline.

But that's of little concern to the agile companies on BUSINESS WEEK's Hot Growth list, which have already demonstrated rapid sales growth, mounting earnings, and a healthy return on investment. For sandalmaker Deckers Outdoor and for all the other companies on the list, the challenge is to continue to put their best foot forward.

                     Millions of dollars*
      ROPER INDUSTRIES      $146.4
      GBC TECHNOLOGIES       143.0
      CYRIX                  142.3
      GYMBOREE               129.6
      *Latest four quarters
                       Average annual rate*
      NETMANAGE               597.9%
      SALOON                  190.8
      USA WASTE SERVICES      176.8
      WALL DATA               141.9
      *Latest three years
                           Millions of dollars*
      ROPER INDUSTRIES         $21.7
      ZEBRA TECHNOLOGIES        18.8
      CYRIX                     18.4
      FTP SOFTWARE              18.2
      *Latest four quarters
                         Average annual rate*
      NETMANAGE                750.6%
      K-TEL INTERNATIONAL      532.1
      NATIONAL TECHTEAM        352.2
      CORNERSTONE IMAGING      329.2
      *Latest three years
                          Millions of dollars*
      & SALOON                  $704
      GYMBOREE                   540
      CATALINA MARKETING         466
      CYRIX                      459
      FTP SOFTWARE               438
      *As of Apr. 29
                          Average annual rate*
      K-TEL INTERNATIONAL       87.5%
      FOSSIL                    69.5
      MONACO COACH              65.2
      INTEGRACARE               63.0
      *Latest three years' return on invested capital
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