|Shares Out. (in M):||2||P/E||12.3x||10.6x|
|Market Cap (in $M):||8||P/FCF||12.3x||10.6x|
|Net Debt (in $M):||-7||EBIT||1||1|
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Solitron Devices, Inc., (SODI) is at an extremely interesting point in its history, which we believe makes the shares attractive for purchase. SODI is an electronics component manufacturer predominately for the US government. The Company has been consistently profitable and well managed. Its shares currently trade below net current assets and unencumbered cash represents 70% of the Company’s market value.
The Company filed for bankruptcy twenty years ago and it has taken a long time to completely resolve and fully pay for all its post-bankruptcy liabilities, which included some environmental liabilities. By this summer, with a final payment to the EPA, all of the bankruptcy contractual obligations should be resolved and the Company will be free to use its cash for the benefit of shareholders.
Over the years the Company has been lax in conducting annual meetings, but shareholders protested vehemently last year and the Company agreed to hold an annual meeting this summer. Shevach Saraf, the Chairman and CEO who has been with the Company for over twenty years, has reached out to shareholders recently and has been willing to listen to their concerns.
The above developments made us very interested in the shares, but over the past few weeks the situation has become much more enticing. A small group of young investors, Furlong Financial, recently filed a lawsuit demanding an annual meeting in April and initiated a proxy contest in an attempt to gain control of the SODI Board. The group could be considered inexperienced, but the Company will be forced to defend itself against the litigation and proxy fight. It’s open to speculation whether the activist will be successful, but we believe that SODI management is not in a position to take the risk. We believe this activism should pressure Mr. Saraf to take material action for the benefit of shareholders. Given his insensitivity to outside shareholders over the past decade, he must be concerned that the group may receive significant support from disgruntled external shareholders in a proxy contest. It will be in his best interest to offer some enticement to shareholders to support management.
Solitron designs, develops, manufactures and markets solid-state semiconductor components and related devices primarily for the military and aerospace markets. They manufacture a large variety of bipolar and metal oxide semiconductor power transistors, power and control hybrids, junction and power field effect transistors, field effect transistors and other related products. The Company’s semiconductor products can be classified as active electronic components. Active electronic components are those that control and direct the flow of electrical current by means of a control signal such as a voltage or current. Most of the Company's products are custom made pursuant to contracts with customers whose end products are sold to the United States government.
It is customary to subdivide active electronic components into discrete and non-discrete. Discrete devices contain only one single semiconductor element and non-discrete devices consist of integrated circuits or hybrid circuits, which contain two or more elements. In the case of an integrated circuit, a number of active and passive elements are incorporated onto a single silicon chip. A hybrid circuit, in contrast, is made up of a number of individual components that are mounted onto a suitable surface material, interconnected by various means, and suitably encapsulated. Hybrid and integrated circuits can either be analog or digital; presently, the Company manufactures only analog components.
The Company’s products are either standard devices, such as catalog type items (e.g., transistors and voltage regulators), or application-specific devices, also referred to as custom or semi-custom products. The latter are designed and manufactured to meet a customer’s particular requirements. For the fiscal year ended in February 2012, approximately 90% of the Company’s sales were of custom products.
The Company’s semiconductor products are used as components of military, commercial, and aerospace electronic equipment, such as ground and airborne radar systems, power distribution systems, missiles, missile control systems, and spacecraft. The Company’s products have been used on the space shuttle and on the spacecraft sent to the moon, to Jupiter (on Galileo) and, most recently, to Mars (on Global Surveyor and Mars Sojourner). Custom products are typically sold to the United States Government and defense or aerospace companies such as Raytheon Company, Lockheed Martin, Smith Industries, Harris Corporation, General Electric Aviation, and Northrop Grumman Systems Corporation, while standard products are sold to the same customer base and to the general electronic industry and incorporate such items as power supplies and other electronic control products. The Company has standard and custom products available in all of its major product lines.
The electronic component industry is clearly highly competitive and has been characterized by price erosion, rapid technological changes and foreign competition. However, in the market segments in which the Company operates, while highly competitive and subject to the same price erosion, technological change is slow and minimal. The Company believes that it is well regarded by its customers and competition is dependent less on price and more on product reliability, performance and service. The Company believes, however, that to the extent the Company’s business is targeted at the military and aerospace markets, where there has been virtually no foreign competition, it is subjected to less competition than manufacturers of commercial electronic components. Additionally, the decline in military orders in programs the Company participates in and the shift in the requirement of the Defense Department has prompted the number of competitors to decline which has given the Company the opportunity to increase its market share. On the other hand, the sequestration and possible other future military cuts may impact the Company.
The Company has numerous competitors across all of its product lines. The Company is not in direct competition with any other semiconductor manufacturer for an identical mixture of products; however, one or more of the major manufacturers of semiconductors manufactures some of the Company’s products. A few such major competitors (e.g., IXYS Corporation, Motorola Inc. (now On Semiconductors), Fairchild Semiconductor, among others) have elected to withdraw from the military market altogether, which can only be a positive for the Company.
Environmental and Bankruptcy Liabilities
With the $475,000 payment in October 2012 to settle its remaining bankruptcy debt and a final payment due to the EPA this summer, it appears to us that the Company’s cash will be unencumbered by environmental and bankruptcy liabilities by the end of the summer. We are not attorneys or accountants and would recommend that you read the Company discussions contained in its SEC filings of its bankruptcy and environmental liabilities and form your own opinion.
Recent operating results have been good, without much impact being observed from defense cuts.
Net sales for the nine months ended November 30, 2012 decreased 6% to $6.0 million as compared to $6.4 for the nine months ended November 30, 2011. This decrease was primarily attributable to a lower level of orders that were shipped and unanticipated delays in receipt of key raw material components. Gross profit for the nine months ended November 30, 2012 decreased to $1.31 million from $1.57 million for the nine months ended November 30,2011, primarily due to a lower level of shipments, a higher cost of materials and lower yields on devices produced. Gross margins on the Company’s sales decreased to 22% as compared to 25% for the same period in 2011.
For the nine months ended November 30, 2012, the Company’s backlog of open orders increased 27% to $7.63 million as compared to the same period of the prior year. The Company has experienced an increase of 64% to $7.64 million in the level of bookings during the nine months ended November 30, 2012 when compared with the nine months ended November 30, 2011.
Operating income for the nine months ended November 30, 2012 decreased to $483,000 from $776,000 for the nine months ended November 30, 2011. This decrease is due primarily to lower net sales and higher cost of materials as outlined above. Net income for the nine months ended November 30, 2012 decreased slightly to $745,000 from $783,000 for the same period in 2011. This decrease is due primarily to lower net sales and higher cost of materials as outlined above, offset by an increase in other income.
Fourth quarter results are expected to be good.
Shevach Saraf, the Chairman and CEO, has done a commendable job over the past twenty years leading the Company out of bankruptcy, returning the Company to solid profitability, and building a significant cash position. Unfortunately, during this period he has completely ignored outside shareholders. During this period he has not held one annual meeting, completely ignoring Delaware Law.
At the end of last year a group of shareholders contacted the Company and demanded an annual meeting and after much pressure, Mr. Saraf agreed to hold such a meeting. Recently, to his credit, he has reached out to outside shareholders and has listened to their concerns.
In February of this year, the pressure on the Company was elevated to a much higher level as a complaint was filed in Delaware by Furlong Fund demanding an immediate annual meeting. In addition, Furlong Fund filed a preliminary proxy statement which would attempt to gain control of Solitron’s Board. Furlong holds a small position in Solitron and we are not familiar with them, but we believe they have gotten management’s attention. Given management’s historical treatment of outside shareholders, they are concerned about the proxy fight.
Solitron shares have reacted favorably to the recent shareholder activism and accumulation by various new shareholders, but we believe they remain materially undervalued. The Company has no debt and has fully accrued for all environmental and bankruptcy liabilities. At $3.70 per share the shares trade for 94% of fully diluted net current assets and marginally above ten times operating earnings. The P/E ratio is materially overstated as it fails to consider the Company’s cash balance. If we subtract the fully diluted cash balance of $2.60 per share from the share price, we get an adjusted P/E of 3!
What would be a reasonable value for the Company’s shares? Let’s assume the expected $.35 in earnings is overstated and turns out to be a more conservative $.25, essentially what the Company earned during the first nine months of the current fiscal year. If we only give the earnings a very low P/E of 10, the company would be worth about $5.10 per share ($2.60 in cash plus 10 times $.25 in earnings), a 38% premium to the current share price.
1) Environmental liabilities may turn out to be greater than anticipated.
2) Management may spend significant cash defending itself from the imminent proxy fight.
3) Management may elect not to use the cash in a shareholder friendly manner.
4) The shares are illiquid.
5) Management has been historically unconcerned about outside shareholders.
6) Management holds 30% of the Company’s fully diluted shares and may not respond to activist pressure.
7) The sequester and potential defense cuts may significantly impact sales.
We strongly believe SODI shares provide an attractive investment opportunity with active catalysts that will allow value to be realized in the short term:
1) The shares trade for less than liquidation value.
2) Cash represents 70% of the market value.
3) The Company is solidly profitable and is well managed.
4) Activist shareholders have begun to put pressure on the Company to pay a dividend and to be more responsive to shareholder concerns.
5) An activist fund has initiated litigation and a proxy contest.
1) Imminent Proxy Contest and litigation.
2) Final settlement of environmental liabilities with the EPA will end restriction on use of cash.
3) Activist pressure to pay a dividend with excess cash.
4) Management’s need to appease outside shareholders to avoid loss of control of Board.
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