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100 sizzling small companies to watch

The 100 companies on BusinessWeek's list may not be big, but they're agile and fiercely competitive. Many have sniffed out niches no one else thought of. Some have only a little marketing experience. Quite a few are catering to aging baby boomers. And each year, they're creating 60 percent of the net new jobs.
/ Source: BusinessWeek Online

In the tough, ultracompetitive world of football, Vernon Davis stands out for his strength, agility, and fighting spirit. When he played for the University of Maryland, the 6-ft.-3-in. powerhouse drew raves as one of the best tight ends in college football. During the National Football League's draft in late April, Davis was snapped up by the San Francisco 49ers. It's no surprise, then, that scrappy sportswear maker Under Armour, which got the jump on giants like Nike in the market for skintight athletic wear, chose Davis to be a celebrity endorser of its products.

As Davis ascends to the elite realm of professional football, Under Armour is scoring some touchdowns of its own. Its sales have grown an average of 78.4% annually for the past three years, and profits have doubled, causing the Baltimore company to bolt into the No.6 spot on BusinessWeek's Hot Growth list of America's 100 fastest-growing small companies. Under Armour's signature tight-fitting shirts, along with its shorts, jackets, and other products, have become athlete favorites, because they're made of lightweight material that wicks away sweat. "Plus, it makes you look stronger than you are," says Davis.

The 100 companies in BusinessWeek's 2006 ranking may not be big, but like the best in the NFL, they're strong, agile, and fiercely competitive. Many have carved out niches that no one else was smart enough to spot or quick enough to pounce on. Some have only a few years of marketing experience. Others have been around for decades but recently pulled off revivals that returned them to the front of the pack. Together, they're a powerful economic force. Small businesses produce 14 times as many patents per employee as large companies do, and they are twice as likely to turn those inventions into successes, according to a Congressional report. They account for half of the private gross domestic product, create more than 60% of net new jobs each year, and pay 44.3% of the private payroll.

Wrinkle boom
During the vetting of our Hot Growth contenders, an economic quirk emerged. The rising thirst for petroleum has driven prices up, translating to gold for the 14 oil and energy-services companies on the list, and a No.1 spot for VAALCO Energy Inc. Yet despite high prices for gasoline, consumers have yet to slash discretionary spending. The average household spends $44 a week on gas — 15.8% more than it did a year ago, according to the International Council of Shopping Centers. Yet same-store sales in the second week of May jumped 4.2% over the same period a year ago. Shoppers aren't hesitating to shell out $40 for an Under Armour shirt. And they still flock to malls to shop at Guess? (No.78) and to watch their kids make stuffed animals at Build-a-Bear Workshop (No.40).

Spending is especially strong among the nation's 77 million baby boomers, who are snapping up the latest kitchen gadgets, having their wrinkles erased, and doing whatever else makes them feel better as they age. "We continue to see an ongoing skewing of the distribution of wealth" to people over 60, says Mark Zandi, chief economist at Moody's "If you cater to aging boomers, you've got a powerful tailwind."

The costly war that boomers are waging against the aging process makes them a lucrative target. No.20 NutriSystem sells its weight-loss products mostly to younger boomers—women in their mid-40s — but older dieters have started to catch on to the Horsham (Pa.) company's program. So CEO Michael J. Hagan has launched an over-60 program and will introduce a seniors program this year, with a menu featuring more protein and fiber and an exercise program tailored to a crowd with creaky joints. "We see this as a big, attractive segment," he says. "They buy as much for life extension as for vanity." That could fuel NutriSystem's hot run: Annual sales have jumped 94.4% on average over the past three years, and profits 101%.

As the population ages, it's no surprise that 11 Hot Growth companies are clustered in the health-care and pharmaceutical industries. Palomar Medical Technologies, which at No.3 is making its second consecutive appearance in the Hot Growth top 10, sells machines that use light-based technology to erase wrinkles, varicose veins, unwanted hair, and other unpleasant consequences of growing older. No.35 Endo Pharmaceuticals Holdings has been chasing the gray set by developing pain relievers, one of which has attracted a cult-like following. This drug, Lidoderm, is a prescription patch that delivers a powerful analgesic through the skin to sore muscles and joints. It was approved by the Food & Drug Administration in 1999 to treat just 200,000 patients with pain related to shingles. But doctors started doling it out off-label for everything from sore back muscles to arthritis. Endo expects Lidoderm sales to grow 26%, to at least $530 million, this year. The Chadds Ford (Pa.) company is conducting clinical trials that may allow it to expand the label for Lidoderm, and it is working on several other pain drugs. "The data show that two-thirds of adults over 65 have some type of pain that really interferes with their daily life," says Endo CEO Peter A. Lankau.

The healthier boomers stay, the more they can savor the little joys in life, such as entertaining. That's evident in the sparkling performance of No.96 Lifetime Brands. The Westbury (N.Y.) company owns or licenses some of the most famous names in housewares, including KitchenAid and Farberware. CEO Jeffrey Siegel believes pain at the gas pump hasn't kept consumers away because many of his goods are essential. "If your can opener isn't working, you have to buy a new one," says Siegel. And items like crystal glasses appeal to wealthy consumers who are less sensitive to high gas prices, he says. "People who shop at Tiffany will still go there. It will just cost them a little more."

To determine who's hot and who's not, BusinessWeek combs a database of 5,275 public companies with revenues of $50 million to $1.5 billion a year. We rank them by sales and earnings growth, as well as return on capital over three years. To be considered for the final ranking, companies must have a market cap of $25 million or more and a stock that trades for at least $5 a share. Only finalists whose shares rose at least 5% over the past 12 months were included. Recent profit shortfalls can also cause companies to get the ax. Of those still standing, the top 100 make our list.

The raw numbers show just how hot the class of 2006 is. Sales for the 100 top finishers grew at an average annual rate of 37.5% over a three-year period. Earnings increased 110.6% a year. The group blew past the S&P Industrials, which posted average revenue growth of just 11.1% a year and earnings growth of 41.2%. And the average return on capital among the Hot Growth winners was 17.4% — double that of the S&P Industrials.

Shop at the top
Retailers have traditionally made a strong showing on the Hot Growth list. What's notable this year is that stores catering to upscale, mature women are enjoying the most foot traffic. Winners include No.39 Chico's FAS and No.62 Coldwater Creek. Chico's, which targets boomer women earning $75,000 or more, is making a record eighth consecutive appearance on our ranking. With sales during the last three years up an average of 38.3% a year, to $1.4 billion in the most recent 12-month period, Chico's is on the verge of outgrowing the Hot Growth list. If it does, it will join a distinguished list of graduates that include Whole Foods Market, Cisco Systems, and Abercrombie & Fitch.

Despite its continuing success, Chico's has taken investors on a nauseating ride of late. On May 4, the Fort Myers (Fla.) company announced that because of a lower-than-expected increase in April same-store sales, earnings would come in a penny or two per share below expectations. The stock fell 19% in one day, to $30. "To me, it's irrational," says CEO Scott A. Edmunds, who adds that its April same-store sales growth of 5.4% isn't bad for a retailer. Chico's experience shows how shares of Hot Growth companies can get bid up to ridiculous highs by investors enamored of hot niches—and then suffer spectacular free-falls.

In a drastic change from last year, the 2006 winners include two dot-com retailers and five Internet software providers. In 2005, there was just one Web company in the Hot 100. Much of today's boom is driven by a rise in online advertising. Among the beneficiaries: No.75 aQuantive and No.55 ValueClick, which create or manage online ad campaigns. "There's more content on the Web now, so people spend more time there," says aQuantive CEO Brian P. McAndrews.

The diversity of businesses in the Hot Growth 100 shows that no one industry has the lock on ingenuity. But whether they're tracking eyeballs on the Web, looking for liquid gold, or reaching the pocketbooks of aging boomers, the members of the elite Hot Growth 100 have all clearly mastered the art of winning.