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Omniture (OMTR) , a small-cap company that makes software for gathering data about traffic to Web sites, will make its market debut this morning after pricing its initial public offering Tuesday night at $6.50 per share, raising net proceeds of $50.1 million. The underwriters -- Morgan Stanley, Deutsche Bank, J.P. Morgan and CS First Boston -- expected the 10.7 million-share offering to price between $7.50 and $9 a share.

Although the stock warranted speculation in that range, this discount makes for a somewhat attractive entry point for risk-takers.

Omniture is a pure play on the growing need and demand for Web traffic intelligence and analysis. As a result of increased affordable Web access, companies are more dependent on the Web for retail sales and marketing campaigns, and knowing where and how to stimulate consumer interest will be as a key competitive differentiator.

Omniture's main revenue-generating service is SiteCatalyst, which helps businesses manage and enhance online, offline and multichannel marketing and sales initiatives. Much like better known services Coremetrics and



, Omniture customers use SiteCatalyst to gather and analyze Web traffic patterns and form sales and marketing initiatives to optimize their sites and match consumer trends.

The key growth driver for Omniture and its competitors, including Coremetrics, aQuantive and



, is the overall growth in Internet usage and increased corporate spending. Omniture, for one, captured data on more than 280 billion pageviews in the first quarter of 2006 from its 1,000-plus customers. Cheaper access to high-speed Internet services should continue to drive growth, leading to meaningful jumps in the amount of time consumers spend online. In turn, this increases the importance of data-gathering and analysis for companies that generate revenue from Web-based operations.

Omniture's customer base is a who's who of the Internet world. The company has generated more than 10% of its total revenue from


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in each of the past three years. and revenue from America Online, a division of

Time Warner

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, accounted for more than 10% of total revenue in both 2005 and the first quarter of 2006. The company is also doing business with


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, which needs all the help it can get in figuring out the Web,


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, which is growing increasingly dependent on growth in its iTunes portal following the introduction of the video iPod in 2005 and subsequent surge in demand for high-bandwidth downloads.

Founded in 1996, the company's operating results have been impressive. Its annual revenue, according to its S-1 filing, increased from just $3.7 million in 2002 to $42.8 million in 2005 . This 11-fold increase was accompanied by an eight-fold jump in gross profits to $22.3 million in 2005 vs. 2002 levels. The company is working toward achieving breakeven on a cash flow basis.

Omniture revenue increased 110% in 2005 over 2004, after posting nearly 150% top-line growth in 2004. Gross margins have remained in the 50% range, bogged down slightly by a $10 million patent infringement settlement that is being expensed through 2012 (although there was a slight jump in first-quarter margins to 58%).

The company is still not making money, which can be largely attributed to the company's aggressive expansion, particularly in headcount. In order to deliver stellar top line growth, Omniture's headcount grew to 312 at the end of March from 33 employees at the end of 2002.

But ultimately, Omniture's profitability is somewhat less important than cash flow due to the company's revenue recognition policy and the large upfront capital expenditures that come with adding new customers.

Omniture defers a majority of its revenue upon adding a customer and only puts it on the income statement as it's earned over the duration of an agreement. While not visible on the income statement, this revenue does immediately flow through the cash flow statement to the balance sheet, making deferred revenue a key metric to monitor. The company ended 2005 with $12.8 million in deferred revenue vs. just $7.12 million at the end of 2004. Deferred revenue reached a record $14.3 million at the end of the first quarter this year, indicating strong sales results in the next three quarters.

Omniture also spends a lot on new equipment when it adds a large customer, which causes a jump in depreciation and amortization (D&A) expense. While a near-term negative to profitability, higher D&A should be viewed as a positive as it is indicative of strong new-customer additions.

D&A typically represents about 15% to 20% of the company's sales, and adding this back to operating income and backing out the legal settlement charges yields earnings before interest, taxes, depreciation and amortization (EBITDA) of approximately negative $6 million. This is meaningfully better than the $17.4 million net loss the company reported for 2005.

Based on the indicated valuation ranges for the stock, offered by the underwriters, and the implied sales and EBITDA results these ranges yield, the company should turn a cash profit in 2007 on the heels of a 62% revenue growth to $130 million, which is based on expectations of 75% revenue growth in 2006. Although the company's estimated 2007 EBITDA would be just $24 million, for a multiple to EBITDA of 18 based on the high-end of the indicated IPO pricing range, the company's top-line growth rate far exceeds this multiple. Also, publicly traded peers such as Websidestory and aQuantive trade at similar multiples despite the prospects for slower revenue growth in the coming 24 months.

However, there are reasons to be concerned about Omniture.

For one, sales and marketing expenses have been growing at a much quicker clip than revenue, which is not sustainable in the long run because it makes reaching profitability impossible. The company also needs to show that its 1,000% increase in headcount will lead to meaningful revenue growth with little incremental hiring in the coming nine months in order for the business model to work.

This is one of the gripes I have had with


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-- spending to grow without regard for profitability -- and it is a key risk to a bullish thesis on Omniture.

Even so, the company's top line growth rate and growing deferred revenue balance bode well for revenue in the coming quarters. As such, this speculative, small-cap name may deserve investor attention once we get an idea of how the market reacts to the public offering in trading Wednesday morning.

William Gabrielski is a research analyst at In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gabrielski welcomes your feedback;

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