China Medical Technologies  (Nasdaq: CMED) is doing its best to mine opportunity out of misfortune. But if the company's latest quarterly report is any guide, the company's efforts aren't really working.

With distributors already carefully managing inventories in response to lower hospital spending, medical-device makers like China Medical have had some headwinds to contend with lately. That's put a big hit on operating margins in the industry, with companies like Luminex  (Nasdaq: LMNX), DexCom (Nasdaq: DXCM), and Thoratec  (Nasdaq: THOR) feeling pressure to earn any profits at all.

In that regard at least, China Medical hasn't fallen that far. Revenue was up 29% in its fiscal first quarter. That's not as strong as the 37% growth it posted during the fourth quarter of 2008, due largely to falling demand for its Enhanced Chemiluminescence technology in advance of anticipated price reductions. Still, tight margins compressed GAAP net income by 93% to $0.02 per American depositary share (ADS), including non-cash charges for stock-based compensation and amortization.

Taking its eyes off the prize
China Medical has issues. Small-cap stocksoften bring big opportunities for investors. But there's a big difference between a speculative start-up play like Orthovita (Nasdaq: VITA), which is fighting for its place in the synthetic-bone market and just needs to get its overhead down, and China Medical, which always seems to have some sort of distraction weighing it down.

For instance, lately, the company has been bogged down defending itself against allegations of financial misconduct raised by an anonymous letter. Furthermore, China Medical's CEO and board chairman is attempting to get $15.5 million from the company after learning that the HIFU program, which his separate, wholly owned company bought from China Medical, was due for licensing renewal. Since the program won't be able to generate revenue for the CEO's other company until its license gets renewed, the $15.5 million is intended to cover those revenue losses.

Down, but definitely not out
Shares took a nasty haircut after the earnings announcement, and investors should expect to see both sales and gross margins adversely affected by the dramatic price reductions now in place. But while a risky bet, the industry clearly has a lot of potential, and China Medical's place in the most-populous country in the world can only help its growth prospects going forward.

What investors should take away from this quarter is that while China Medical's problems have been largely self-inflicted, many of them have nothing to do with the company's core business. If the company could just stop getting distracted from its primary focus, China Medical might finally get itself taken off the injury list.

Further Foolish reading:

This article was originally published as China Medical, Heal Thyselfon Fool.com

Copyright © 2009 The Motley Fool, LLC. All rights reserved.