Description

Perceptron is a consistent and profitable business in a niche they essentially created. The company generates cash at the rate of a 10% free cash flow yield (post all capex); trades at 5.7x forward EBITDA, and trades at a reasonable premium to tangible book value (1.4x tangible book value). The company has an enterprise value of $45 million, and has generated $16 million in FCF in the last two years.

Since 1981, Perceptron has been developing laser scanning systems that are designed to augment manufacturing processes. The company primarily markets its products to the automobile industry, where its scanning systems detect defects and also aid automakers in the development of new parts. Now, before readers write this story off as another auto parts provider selling cheaply, let me be clear that Perceptron's systems reduce costs for auto manufacturers at an attractive value proposition with usually short paybacks for their manufacturing processes. There is ALSO a strong likelihood that the company's expertise in scanning systems will be increasingly exploited in other fields, which represents a potential growth opportunity (this portion of the business has shown strength, recently, but is still some time away from being at a revenue base that will shepherd significant overall revenue growth...see below for more on this).

The company first made its name with a unique laser scanning machine that could almost instantaneously inspect cars for defects at the end of an assembly line. The $200,000 machine, then dubbed the P1000, quickly found a market among all automakers, which drove sales up from $17 million in 1992 to $65 million in 1997. Sales peaked at this level as the company fully penetrated the market with its one-trick product.

Whereas Perceptron once was a one-product company - end-of-the-line gauging - the company now offers an entire family of laser-based measurement systems that encompass various points along the manufacturing line. This came due as the company aggressively ramped up R&D and began selling various equipment enabling automakers to scan for anything with mass, and even the gaps between the masses, throughout the production line. As an example, the company's AutoSpect system allows auto manufacturers to detect defects in paint, door and panel fit -- all in a drive to improve "perceived quality," or small visual defects that detract from a car's reputation among buyers. Toyota's only means of collecting paint appearance data had been through manual sampling at the end of the production line. With the introduction of Perceptron's AutoSpect system – the laser-based inspection solution for in-process measurement of paint quality – Toyota's paint data collection process is now completely automated and key points are inspected on every vehicle that leaves the production line. Over time manufacturers are able to realize significant cost savings by eliminating labor costs or flawed manufacturing processes with Perceptron's products.

Today, the company markets most of its lines of products with the "Auto" moniker. For example, its AutoGauge system measures 75 critical build points, mostly dimensional characteristics, of automotive vehicles and parts in high-speed production lines using lasers. This information is then uploaded to a plant database and is available for company wide distribution and analysis. The AutoFit system, currently rolling out to Asian customers, measures the gap and flushness between fitted parts, such as front and rear doors, hoods and fenders, and deck lids and rear quarter panels. In addition to the AutoSpect mentioned above, the company also offers AutoScan and AutoGuide products that all use laser based systems to collect data at various points in the manufacturing process.

For several years investors have waited for the company to devise a complimentary windfall technology for use in other industries. This foray into non-auto industries is led by its ScanWorks system. Developed four years ago, it acts like a sophisticated hand-held grocery store scanner. The scanner collects more than 23,000 points of data per second to create a three-dimensional image that can be stored on a laptop computer. Now, for the first time, the company is currently actively marketing this technology outside of the automobile industry. For example, online cataloguers can use the scanning technology to produce a 3D image of an article of clothing that is placed on a website whereby visitors are able to rotate the image via their browser. There are numerous applications for this technology. Early progress is encouraging: sales of the ScanWork's system was up 50% to $1mm in the most recent quarter relative to the year-ago quarter. Though the core business remains closely aligned to the automotive industry, the presence in the portable 3D scanning market has increased more than 10 fold during the past few years, due to partnerships with value-added resellers. Although the plan to focus on these smaller scanning systems that are designed for non-automotive use is another future growth opportunity, I believe it will be quite some time that the company will ship these out the door to move the needle towards meaningful overall revenue growth. These are $30k gizmos, and you will need to sell a lot of these in lieu of a state-of-the-art $250k AutoGauge system that the company is installing in order to move the needle. On its latest conference call, the company hinted that some sort of "announcement" will be made at the beginning of the calendar year that provides more insight into ScanWorks potential in non-auto markets. Regardless, I believe investors' expectations regarding the technology are minimal given that the company is trading less than 6x EBITDA; in other words, this is simply icing on the cake. More momentum and any new "news" regarding a windfall technology that moves the company away from the auto industry will most likely help expand the valuation multiple.

The true near-term opportunity lies in what the company does best: outfitting the world's automakers with the company's core suite of products. Two core themes occurring in the auto industry makes the company's products ever more crucial in today's environment. First, auto makers are increasingly under pressure to bring new models to market faster; and second, auto makers are increasingly searching for more flexible production lines. The company's scanning solutions allow manufacturers to generate digital representation of components used in computer simulation. Prototype components produced by multiple suppliers at different locations can then be analyzed quickly in a virtual setting to determine fit and compatibility. This can dramatically diminish the product development cycle. As it relates to more line flexibility, Perceptron is the only company in the world capable of adapting most of their solutions to any standard industrial robot. This is important since manufacturers are increasingly using the same robot for various functions, or for various car models. Its AutoGauge offering can be mounted on a robotic arm that performs more functions than stationary models and can be programmed to inspect multiple vehicle models. Flexible manufacturing is critical to allow automakers to respond quickly to changes in customer demand and adjust products according to market trends. Perceptron's solutions are easily adaptable to robotic adjustments along the manufacturing line.

Recent contract wins are evidence of this. The company just announced that it started shipping 15 of an order of 30 AutoGauge systems to a North American auto manufacturer. This order is probably worth $6 million in total (total company revs are projected to be $54 million in FY05). The company also announced that DaimlerChrysler completed a three year transition from replacing the company's P1000 machines to AutoGauge systems.

Recent financials present a company in a stable financial situation and a generous source of cash. Recent results and my projections for next year:

FYE 6/30 (in millions) 2002A 2003A 2004A
Revs 44.0 54.7 53.4
Op Income 1.4 8.5 5.6
Net Income .9 3.6 4.0
EPS $.11 $.42 $.43
EBITDA 2.6 9.8 7.1
EBIDA 2.8 7.3 4.5
FCF 0 8.8 7.3
Tangible Book Value 33.4 38.2 45.1

Using a fully diluted share count of 9,394 shares, the company's market cap is $67.2 million. The company has no debt, and $22 million in cash (or $2.32 per share). Enterprise value is therefore $45 million. Excluding any foreign currency gains and losses, I'm expecting the company to report $.43 in 2005. Revenues, Operating Income, and EBITDA should come in around $56.2, $6.5, and $8.0 million, respectively, for the year. The company’s closest competitor, Cognex, trades at a p/e of over 30x, so there exists a big valuation differential on a relative basis. But ignoring relative valuation, investors should be content to know that the company will grow its tangible book value to a level commiserate to it's market cap over the next few years if the company can continue to pump out $8 million in FCF/year. This, coupled with the fact that the company trades attractively on almost any valuation metric, makes me believe that downside is limited at these levels.

I expect the company to announce a use for their cash in the next six months. I'm not a big fan of acquisitions, so I prefer the company to return the company's current treasure chest of cash with stock buybacks, and/or dividends. On its most recent conference call, the company announced that they were evaluating all options (including implementing a dividend), and delineated the criteria management was using to evaluate acquisitions. A poor or mismanaged acquisition is probably the largest risk to the story. However, management has emphasized that any acquisition will be accretive in the first twelve months.

The other risk to the story that should be noted is the company's reliance on the automobile industry. The company's four largest customers are GM, DaimerChrysler, Volkswagon, and Ford, and sales to these customers were 52% of total revenues in their most recent fiscal year. However, this concentration is slowly abating:

% of Total Revs to Top Four Customers:
'04 - 52%
'03 - 55%
'02 - 63%
'01 - 55%
'00 - 62%

As a compelling counterpoint, Perceptron will bode well given the automobile manufacturers' focus on (1) driving down costs (Perceptron's products are designed to ultimately lower costs for customers), (2) accelerating their time-to-market for new vehicles, and (3) implementing more flexible production lines.

At these levels, Perceptron represents a favorable risk/reward profile to investors. Investors get a minimum 10% FCF yield company (at a minimum), and an opportunity to participate in a true growth story if the company can replicate its technology in other fields.

Catalyst

Further announcement for uses of Scanworks technology
Possible announcement of dividend
Continued execution