Vicon Industries, Inc. (VII) sells private network video surveillance systems – think of the video cameras in shopping malls or retail stores to catch shoplifters and detect intruders.

With a market capitalization of only $17m, the business is in a heavily competitive, cyclical industry, leading to large variability in Vicon’s revenue and income.

Revenue Fluctuations

Since video network installations generally occur in newly constructed buildings (it’s probably pretty rare that a shopping mall rips out and replaces their entire network), the company is heavily dependent on new construction and the overall economy.

Here is a chart of the company’s sales over the past 15 years:

It is very clear from the chart that the company’s business is variable, with a ‘boom-and-bust’ cycle lasting approx 6-7 years. The latest upturn occurred from 2004-2007, followed by a sharp decrease in 2008-2009.

Fiscal 2010 sales will show a significant drop as well, as the most recent filing revealed that revenues are off 21%. The drop in revenue over the past three years looks very similar to the 2001-2003 time period.

Sales should level off as the economy rebounds.

Historic Financials

Vicon operates in a tough business with lots of competition from large multinational companies such as Panasonic, Sony, Bosch & GE Security.

In a tough environment, the company has done a great job improving its gross margin over the past 5 years, raising it from 38.8% in 2004 to 46.4% last year. Operating and net margins average 3% and 1.6% respectively.

Both ROE and CROIC are not the greatest, although the averages have improved to 9.8% and 8.2% respectively during the latest 3-yr upswing.

Balance Sheet Strength

It is difficult assigning a price tag on such a cyclical business, especially from an earnings & cash flow basis, so the best way to evaluate the company is through its balance sheet & assets.

The stock trades at almost half of its book value of $7.40.

VII trades at a significant discount to Net Current Asset Value (NCAV), and right around Net Net Working Capital (NNWC), a very conservative estimate of value if the company is liquidated:

These are very conservative valuations for a business that historically has traded right around book value.  However, these assume a ‘normal’ operating environment, but outside catalysts could severely affect the business as well..

Patent Litigation

One drag on the stock price is recent news regarding a piece of patent legislation originating from over 6 years ago. Back in May 2003, a company called Lectrolarm Custom Systems, Inc. filed suit against Vicon Industries regarding ‘camera dome’ pieces.

While VII does not break out sales by product category, the company reports that this product represents a significant amount of sales.

The original suit claimed damages of $11.7m, a substantial number for a company like Vicon with a market cap of only $17m.

As the suit made its (long & drawn-out) way through the USPTO system, most of the news went Vicon’s way. In a series of rulings in 2006 and 2007, the USPTO examiner declared all 5 claims invalid.

Lectrolarm re-filed the suit to the USPTO Board of Patent Appeals & Interferences (BPAI). Last week, the BPAI

“ affirmed the USPTO Examiner’s finding of invalidity of two of the claims and reversed the USPTO Examiner’s finding of invalidity of the other three asserted claims.”

This ruling reopens the patent infringement suit.

Based on the initial rulings back in 2006, Vicon seems to have a strong case to dismiss the claims, but obviously has to go through the proper channels to come to a final resolution.

It is very hard to determine a timeline for such a transaction. A negative ruling would seriously affect the stock price, while a positive verdict would remove a big weight off of the company.

In the mean time, this potential negative catalyst will put downward pressure on the stock price.

Conclusion

Based on the company’s history, business should start picking up with the global economy. As an investor, timing the very bottom of such a business cycle is extremely difficult .

However, several notable institutional investors continue to hold shares including Dimensional Fund Advisors (8.4%) and Renaissance Technologies (6.4%). According to a recent 13-G filing, another institutional investor picked up a 5% stake recently as well.

From an asset perspective, the company’s financial position remains very strong, providing the sort of downside protection that many value investors seek.

However, a prolonged recession could put the company in jeopardy and erode the margin of safety, not to mention the dark cloud of a possible patent verdict.

After experiencing three down years in a row, will VII manage to level out and start another upswing?

If so, the stock should appreciate considerably from its current lows.

Disclosure

No positions.