One had to get through a lot of excluded items in order to decipher Encore Medical's( ENMC) first-quarter results. But once investors waded through it, there was a lot to like.

It appeared the company missed the First Call consensus of a penny per share in earnings when it reported a loss of 4 cents. But after eliminating items related to the Compex acquisition, it looks like Encore earned 4 cents per share. More importantly, the outlook for next year is very strong.

Encore reported first-quarter revenue of $88.1 million, a 23% jump over the year-ago period. The orthopedic rehab group, the bulk of Encore's business, grew 22.7% to $72.7 million while surgical implants spiked 25.5%. The growth in implants was especially noteworthy as it grew at more than double the industry rate.

Gross margin edged higher by10 basis points but would have been up about 30 basis points if not for an inventory write-up to fair market value -- one of the extraordinary items associated with the closing of the Compex acquisition on Feb. 24.

But what has bulls excited is the integration of Compex and Empi, which was acquired in late 2004.

The company has begun filling some holes in its sales network, most notably in Chicago. Management expects to bring on more sales teams to cover territories that are not currently serviced by Encore. Additionally, the company is planning a massive integration of its IT systems.

While it was known that the process would take all of this year and partly into 2007, what was unclear was the timing. On Monday's conference call, management indicated that the integration costs would be front-end loaded, which means more of the cost will be sustained in 2006, leaving 2007's results cleaner and absent much of the overhang of the added expense.

Another positive on the call was the company's hint that it would divest its consumer products division. The Slendertone unit, which makes toning products for abs, thighs and bottoms, isn't a natural fit with Encore's other product lines, which include prosthetic shoulders, hips and knees. Slendertone is a cash drain, and there has been speculation since it was acquired in the Compex deal that the company would sell it or close it down.

Encore's management indicated Monday that it is finished evaluating the business and expects to have an announcement regarding the division by the end of the current quarter.

Wall Street appeared to like what it heard, as the stock rallied almost from the moment the conference call ended and finished the day down 8 cents to $5.40, but off its intraday low of $5.09.

The stock is a very attractive value according to Jon Loth, health care analyst with

(FRMPX) - Get Report

First American Small Cap Growth Opportunities Fund, which owned over 1 million shares as of Dec. 31. Loth expects the company to earn 40 cents a share in 2007, 3 cents higher than the consensus estimate.

Even at the consensus, the stock is trading at less than 15 times earnings with a long-term growth rate of over 23%. Encore shares are trading at less than one times expected 2006 sales. As Loth says, "Over time, people will increasingly focus on 2007 earnings."

One reason the stock trades at a discount is its leveraged balance sheet. Encore has over $341 million in long-term debt on its books and $23 million in cash. A balance sheet was not released for the first quarter, but will be included in the 10-Q filed with the

Securities and Exchange Commission

. (The company has 45 days from the end of the quarter to file, meaning a deadline of May 15.)

Last quarter there was $315 million in long-term debt compared with $167 million in shareholders' equity and $552 million in assets (although $372 million of the assets are labeled "intangibles"), and 37% of the debt is of the floating-rate variety. So if interest rates continue to rise, Encore's interest expense will climb as well.

Loth set his price target at $7 to $8, which includes a discount due to the high level of debt.

The analyst believes that the company's offerings are very high quality and says Encore's 3DKnee is a product that would likely sell significantly heavier volume if it were part of a larger company's portfolio.

While there hasn't been much takeover talk regarding Encore, it wouldn't surprise me if larger competitors such as

Stryker

(SYK) - Get Report

or

Zimmer Holdings

(ZMH)

became interested, especially as some of Encore's newer products gain traction.

There's no doubt that the company has some integration issues to get through, but assuming it does, Encore should become a well-run growth story whose discount is not likely to last a lot longer.

In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86,87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback;

click here

to send him an email.