With economic weakness continuing to hit both large-caps and small-caps, today's Small-Cap Spotlight looks at Omnicell ( OMCL), another stock that could provide investors with nice returns even in a tough market.

The company offers an under-the-radar play on the health care industry, targeting improved efficiency and patient safety in prescribing medications. The company's products range from software for ordering prescriptions to mobile organizers and storage systems used in hospitals.

Prognosis Mixed for Omnicell

Kusick: Omnicell Offers Growth and Safety

In last week's Spotlight , we offered Dawson Geophysical ( DWSN) as a name that small-cap investors could rely on even in a weak market. In the days since our last feature, it seems the economic outlook has only gotten worse, with a U.S. recession in 2008 looking more likely with each new set of economic data.

In the current market, investors should do their best to control the urge to move entirely to cash. While it's important to have some funds ready to put to use gradually as some best-in-breed names decline alongside the indices, investors looking for long-term returns need to "pick the right tool for the job," so to speak.

In this case, our job is to find small-cap picks that are less susceptible to the economic pressures that continue to weigh on the broader markets. Health care has always been a sector with many subdivisions worth considering, from pharmaceutical makers to health care plans to hospitals.

With the stock market heading into bear market territory, virtually all of health care looks a lot more appealing thanks to the sector's limited leverage to broad economic weakness. Coach ( COH) stores may be empty and Google ( GOOG) may see a slowdown in ad revenue, but you won't see a reduction in hospital traffic.

The key driver for Omnicell is the constant search for additional efficiency and patient safety in all health care settings. The company has delivered in this respect, and as a result of the steady demand for its products, Omnicell has posted nine consecutive quarters of revenue growth.

During that time (from June 2005 to the present), sales have grown 93%, from $28.6 million to $55.2 million. Operating margins -- a key indicator of whether the business is taking off -- rose steadily over the same period, going from slightly negative in mid-2005 to above 14% for the most recent quarter. Gross margins have held steady in the low- to mid-50% area.

Current analyst estimates have Omnicell's 2008 earnings per share declining to 88 cents from $1.01 in 2007, but a closer look shows that the decline is a result of the company finally hitting a normal tax rate of around 38% from recent years when it benefitted from a lower effective tax rate (in the single digits) relating to operating losses in earlier years.

For a better idea of Omnicell's growth rate, we should use EBITDA (earnings before interest, taxes, depreciation and amortization). Consensus estimates currently have the company's EBITDA increasing to $40.31 million this year from $31.85 million in 2007, for a growth rate of about 27%. Because a potential U.S. recession is unlikely to significantly affect Omnicell's growth potential, I think investors are getting a bargain here. The stock has a P/E ratio of 26 times 2007 earnings (or just under 30 times 2008 consensus estimates).

Ideally, I'd like to see management show increased commitment to controlling expenses. Not that expenses have been extremely high in recent quarters, but as sales continue to grow at a steady pace, a good growth company that's properly scaling its business should show declines in SG&A expenses (that's sales, general and administrative) as a percentage of revenue.

Omnicell's SG&A expense ate up 42% of revenue last year, but has come in under 40% in the first three quarters of 2007. If management is able to keep this number trending lower over time, it will be a great sign for investors that the company can continue to benefit from traditional economies of scale.

As I said earlier, I like Omnicell as a small-cap play in an industry that is fairly insulated from consumer-related economic weakness. In the broad market, pure growth plays have been unreliable, as economic uncertainties have left institutional investors unwilling to pay a high multiple for companies whose growth rates might turn out to be much lower than anticipated just a few months ago.

That helps Omnicell stand out, as it's trading at less than 30 times next year's earnings, with projected 26% growth in EBITDA, a rate that could prove conservative, based on management's history of providing modest guidance.

Curzio: Not Jumping on this Bandwagon

Larsen makes a great point about the importance of finding companies that are less susceptible to economic pressures -- such as health care offers. After all, people will continue to go to the doctor no matter how many billions Merrill ( MER) and Citigroup ( C) continue to write down.

However, that's not an excuse to buy just any health care company, and although Omnicell's balance sheet is strong and its industry is seen as a safe haven in an otherwise weak economy, several negatives suggest that the good times may be nearing an end.

Shares of Omnicell are up more than 125% over the past two years, and with good reason, as the company managed to outpace estimates over the past nine quarters -- as Larsen mentions. In the process, management was able to build up the company's balance sheet to more than $5 a share in cash, a hoard that was recently used to fund the acquisition of mobile cart technology company Rioxx Vision.

The company held a conference call on Dec. 3 outlining the positives of Rioxx and how it would complement its existing business. Also on the call, management announced a new product called SinglePointe, which is expected to reduce the risk of medication errors and boost staff efficiency.

President and CEO Randall Lipps seemed quite enthused about the potential for Rioxx and SinglePointe and the good they would do for Omnicell in the future. However, it is difficult for me to get excited about these catalysts while Lipps is heavily selling his stock.

Over the past six months, there were 44 separate insider sells, including numerous 10,000-lot sales from Lipps since October, when the stock was trading at its all-time high. In fact, in a search through Yahoo! Finance back to February 2006, I could not find one insider buy vs. more than 100 insider sales. While I consider this a clear negative, insider sells (or buys) should not be the sole reason for selling (or buying) a stock.

Which brings us to growth. Revenue in the last quarter grew 34% year over year -- higher than analyst estimates, and on the conference call, management said it expects revenue in 2007 to grow 36% to 37%. That is impressive, but growth is expected to slow sharply to 21% to 23% in 2008.

Trading at roughly 30 times 2008 earnings estimates, Omnicell appears fully valued if not expensive here. Also, we cannot discount that growth stocks are being punished in this market, and based on Omnicell's current valuation, the downside risk could be extreme if earnings next quarter are just in line.

Finally, during that conference call, management said that it would no longer include quarterly guidance for its backlog, mentioning that the quarter-to-quarter change is not a meaningful measure of its long-term success. While this was not considered a negative for most analysts, I believe this is a red flag.

In my experience covering equities, whenever management decides to do something out of character, it makes me nervous. For example, the company beat earnings estimates nine quarters in a row and now suddenly decides to give analysts less information on future orders.

Looking into the backlog number provided, product orders increased 23% year over year, which is positive given that the third quarter is normally Omnicell's weakest. However, this is down sharply from 40% year over year growth from the four prior quarters. Maybe it's coincidence, but the slower growth in backlog coupled with the drop in guidance doesn't add up to a positive.

So Omnicell is a company with a very strong balance sheet that bulls can lean on, but reduced clarity on its backlog, high valuation and insider selling are just too difficult to ignore, so I can't recommend buying this stock here.
Have a small-cap you'd like to see covered? Email Curzio and Kusick.

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