Business
Solitron Devices is the a company that designs, develops, manufactures and markets solid-state semiconductor components and related devices, primarily for the military and aerospace markets. It manufactures a large variety of bipolar and metal oxide semiconductor, power transistors, power and control hybrids, junction and power MOS field effect transistors, field effect transistors and other related products. Most of the products are custom made pursuant to contracts with customers whose end products are sold to the United States government. Other products, such as Joint Army/Navy transistors, diodes and Standard Military Drawings voltage regulators, are sold as standard or catalogue items.
Customers
Based on the annual report of the company fiscal year 2011, for the last two years, the main products which account the large percentage of the revenue are Hybrids (>50%) and Power MOSFETS (20%). The customized products take around 90% of the total sales, being attributable to contracts with customers whose products are sold to the United States government. The rest of 10% of sales are for non-military, scientific and industrial applications. Custom products are typically sold to the United States government and defense or aerospace companies such as Raytheon Company (RTN, Financial), Lockheed Martin (LMT, Financial), Smith Industries, Harris Corporation (HRS, Financial), General Electric Aviation (GE), and Northrop Grumman Systems Corporation (NOC, Financial), 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.
In the most recent fiscal year, the company got total 106 customers, including 36 new customers. Raytheon accounted for 27% of total sales, BAE Systems Australia accounted for 12%, and Harris Corporation, 11%. Fifteen of the company’s customers accounted for 86% of sales. What we can see from here is that the customers are quite concentrated. Relatively small number of customers is what the company has been experiencing for years, and it expects to continue.
Suppliers
The company sources its raw material from multiple suppliers. It has a minimum of two suppliers for most of its material requirements. It purchases raw materials and finished packages from Egide USA, Platronic Sales, Coining Inc. etc. The company itself has reported that it has been obliged to pay higher prices due to declining a number of sources for components and packages, and the sharp rise in raw silicon wafers, precious metals and gold which were used in the finish of the packages).
Operating performance
We will have a look at the operating performance of Solitron Devices for the past 10 years.
As it can be seen, the gross margin, the operating margin and the net margin are at the rising trend. Even though the company reported the rising price in raw silicon wafers, precious metals and gold, the gross margin has been increasing for the past 10 years, standing at around 28.7%, more than double 10 years ago. The operating margin and the net margin stay around 14-15%.
The spike of net margin in the year 2006 is due to the forgiveness of debt settlement to be recorded as other income, including settling debt obligations to unsecured creditors and entering the Ability to Pay Agreement with the United States Environmental Protection Agency (USEPA).
Profitability
Figures are in %
The positive thing is that the net margin keeps increasing over time as we can see both from the graph above and this table, and the level of financial leverage is reducing overtime, standing at Asset/Equity of 1.24. However, it is offset by the asset turnover which will be lower over time, fluctuating at 0.7-1 for the last five years.
Financial Health
Solitron Devices are currently in very good shape when it comes to financial strength. The main item in its assets is cash and cash equivalents, taking 58.7% of the total assets, whereas the total liabilities in its balance sheet are around 19%. It has the operating lease, but the amount is not very significant; if we put the operating lease back to its balance sheet, the ratio of debt/asset would be around 22%. Half of the total liabilities is the obligation that the company has to make under the reorganization plan after the company filed voluntary petitions under the Federal Bankruptcy Code.
At the fiscal year of 2011, the company is scheduled to pay approximately $1 millions to holders of allowed unsecured claims in quarterly installments of approximately $7,000.
Free Cash Flow
For the last 10 years, the firm has been experiencing a fluctuating but increasing trend in both operating cash flow and free cash flows. The highest amount of net income in 2006 has been explained above, due to the other income recorded from the forgiveness of debt paid to unsecure debt holders and entrance into the agreement with USEPA.
Enterprise Value
The current market value at the time of writing is at $8.14 million, and the market price per share is $3.59. As of the fiscal year of 2011 (February), the amount of cash in the company is around $6.8 million, whereas the total liabilities (including operating lease) are at $2.7 million. Adjusting for that, the effective price paid for the company currently stands at $4 million.
Management
In the key executive team, there are several important roles incorporated in only one guy, who is Shevach Saraf, chairman of the board, chief executive officer, president, chief financial officer and treasurer. Mr. Shevach Saraf has been president of the company since November 1992, CEO of the company since December 1992, chairman since September 1993 and CFO since 2000. He has 46 years experience in operations and engineering management with electronics and electromechanical manufacturing companies.
According to their annual report filing on fiscal year of 2011, Mr. Shevach effectively owns nearly 27% of the total outstanding shares. There are two other individuals who hold 20.4% of the company, not the key executives or directors. GRT Capital Partners holds nearly 5.2%.
The concentration in the management of one guy, who takes the role of chairman, CEO, CFO and treasurer altogether raises questions. And there might be some potential risks if Mr. Shevach doesn’t have any contingency plan for his successor yet.
Competitors
Solitron Devices has numerous competitors across all of its product lines. Some of the major manufacturers of semiconductors manufactures some of the company’s products. A few major competitors have elected to withdraw from the military market altogether (e.g, On Semiconductors and Fairchild Semiconductor). Other competitors in the military market include International Rectifier (the Omnirel Division), Microsemi Corporation (the NES and APT Divisions), M.S. Kennedy Corporation (a wholly owned subsidiary of Anaren Inc.), Natel Engineering Company and Sensitron Semiconductor.
Below is some listed competitor comparison by Yahoo! Finance
Source: Yahoo! Finance
To compare with its competitors and its industry in general, the table has shown that the gross margin of SODI to be the lowest in the industry and when comparing it to other competitors, however, it’s in the rising trend. The operating margin and the net margin seems to be on the upper side, higher than the industry. For the relative valuation, SODI seems to be the cheapest, even excluding the high cash balances and the low debt for now.
Valuation
For seven years from 2004 to 2011, the growth in free cash flows is around 10.5% compounded annually. We have two scenarios; one is the best case and the other is the worst case.
Worst case
For the worst case, the growth rate for the next five years is only at 5%, and 1% for infinity. At that time the enterprise value of SODI would stand around $9.1 million; the market value should be $13.2 million.
Best case
We adjust the growth rate for the next five years in free cash flow to 8% as representing our best case. For that, the enterprise value of SODI should be $21.7 million, meaning that the market value should be $25.8 million.
With both worst case and best case, I think SODI is a good business to own for the patient investor, when it increases its value to my calculated range. However, there are some potential downsides relating to the structure of management and the concentration of customers that might drag the company down. Any investors should take great care when taking any positions in this stock.
Disclosure: long SODI
It is not the recommendation for buying, holding and selling the stock. Any investor who wishes to do so should conduct his/her own research for his/her own actions, bearing his/her own risks.
Solitron Devices is the a company that designs, develops, manufactures and markets solid-state semiconductor components and related devices, primarily for the military and aerospace markets. It manufactures a large variety of bipolar and metal oxide semiconductor, power transistors, power and control hybrids, junction and power MOS field effect transistors, field effect transistors and other related products. Most of the products are custom made pursuant to contracts with customers whose end products are sold to the United States government. Other products, such as Joint Army/Navy transistors, diodes and Standard Military Drawings voltage regulators, are sold as standard or catalogue items.
Customers
Based on the annual report of the company fiscal year 2011, for the last two years, the main products which account the large percentage of the revenue are Hybrids (>50%) and Power MOSFETS (20%). The customized products take around 90% of the total sales, being attributable to contracts with customers whose products are sold to the United States government. The rest of 10% of sales are for non-military, scientific and industrial applications. Custom products are typically sold to the United States government and defense or aerospace companies such as Raytheon Company (RTN, Financial), Lockheed Martin (LMT, Financial), Smith Industries, Harris Corporation (HRS, Financial), General Electric Aviation (GE), and Northrop Grumman Systems Corporation (NOC, Financial), 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.
In the most recent fiscal year, the company got total 106 customers, including 36 new customers. Raytheon accounted for 27% of total sales, BAE Systems Australia accounted for 12%, and Harris Corporation, 11%. Fifteen of the company’s customers accounted for 86% of sales. What we can see from here is that the customers are quite concentrated. Relatively small number of customers is what the company has been experiencing for years, and it expects to continue.
Suppliers
The company sources its raw material from multiple suppliers. It has a minimum of two suppliers for most of its material requirements. It purchases raw materials and finished packages from Egide USA, Platronic Sales, Coining Inc. etc. The company itself has reported that it has been obliged to pay higher prices due to declining a number of sources for components and packages, and the sharp rise in raw silicon wafers, precious metals and gold which were used in the finish of the packages).
Operating performance
We will have a look at the operating performance of Solitron Devices for the past 10 years.
As it can be seen, the gross margin, the operating margin and the net margin are at the rising trend. Even though the company reported the rising price in raw silicon wafers, precious metals and gold, the gross margin has been increasing for the past 10 years, standing at around 28.7%, more than double 10 years ago. The operating margin and the net margin stay around 14-15%.
The spike of net margin in the year 2006 is due to the forgiveness of debt settlement to be recorded as other income, including settling debt obligations to unsecured creditors and entering the Ability to Pay Agreement with the United States Environmental Protection Agency (USEPA).
Profitability
| 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | |
| Net Margin | -6.52 | 4 | 2.13 | 5.56 | 23.27 | 5.57 | 11.87 | 11.46 | 9.97 | 14.12 |
| Asset Turnover | 1.09 | 1.25 | 1.26 | 1.23 | 1.19 | 1.03 | 0.92 | 0.87 | 0.77 | 0.81 |
| Financial Leverage | 2.62 | 2.5 | 2.32 | 2.14 | 1.47 | 1.36 | 1.45 | 1.31 | 1.25 | 1.24 |
| Return on Equity | -17.64 | 12.77 | 6.47 | 14.62 | 47.56 | 8.11 | 15.38 | 13.01 | 9.83 | 14.25 |
The positive thing is that the net margin keeps increasing over time as we can see both from the graph above and this table, and the level of financial leverage is reducing overtime, standing at Asset/Equity of 1.24. However, it is offset by the asset turnover which will be lower over time, fluctuating at 0.7-1 for the last five years.
Financial Health
Solitron Devices are currently in very good shape when it comes to financial strength. The main item in its assets is cash and cash equivalents, taking 58.7% of the total assets, whereas the total liabilities in its balance sheet are around 19%. It has the operating lease, but the amount is not very significant; if we put the operating lease back to its balance sheet, the ratio of debt/asset would be around 22%. Half of the total liabilities is the obligation that the company has to make under the reorganization plan after the company filed voluntary petitions under the Federal Bankruptcy Code.
At the fiscal year of 2011, the company is scheduled to pay approximately $1 millions to holders of allowed unsecured claims in quarterly installments of approximately $7,000.
Free Cash Flow
For the last 10 years, the firm has been experiencing a fluctuating but increasing trend in both operating cash flow and free cash flows. The highest amount of net income in 2006 has been explained above, due to the other income recorded from the forgiveness of debt paid to unsecure debt holders and entrance into the agreement with USEPA.
Enterprise Value
The current market value at the time of writing is at $8.14 million, and the market price per share is $3.59. As of the fiscal year of 2011 (February), the amount of cash in the company is around $6.8 million, whereas the total liabilities (including operating lease) are at $2.7 million. Adjusting for that, the effective price paid for the company currently stands at $4 million.
Management
In the key executive team, there are several important roles incorporated in only one guy, who is Shevach Saraf, chairman of the board, chief executive officer, president, chief financial officer and treasurer. Mr. Shevach Saraf has been president of the company since November 1992, CEO of the company since December 1992, chairman since September 1993 and CFO since 2000. He has 46 years experience in operations and engineering management with electronics and electromechanical manufacturing companies.
According to their annual report filing on fiscal year of 2011, Mr. Shevach effectively owns nearly 27% of the total outstanding shares. There are two other individuals who hold 20.4% of the company, not the key executives or directors. GRT Capital Partners holds nearly 5.2%.
The concentration in the management of one guy, who takes the role of chairman, CEO, CFO and treasurer altogether raises questions. And there might be some potential risks if Mr. Shevach doesn’t have any contingency plan for his successor yet.
Competitors
Solitron Devices has numerous competitors across all of its product lines. Some of the major manufacturers of semiconductors manufactures some of the company’s products. A few major competitors have elected to withdraw from the military market altogether (e.g, On Semiconductors and Fairchild Semiconductor). Other competitors in the military market include International Rectifier (the Omnirel Division), Microsemi Corporation (the NES and APT Divisions), M.S. Kennedy Corporation (a wholly owned subsidiary of Anaren Inc.), Natel Engineering Company and Sensitron Semiconductor.
Below is some listed competitor comparison by Yahoo! Finance
| SODI | IRF | MCRL | MSCC | Industry | |
| Gross margin | 28.70% | 39.80% | 56.93% | 52.32% | 44.21% |
| Operating margin | 14.35% | 11.53% | 24.61% | 13.00% | 11.58% |
| Net margin | 14.11% | 13.73% | 16.82% | 3.14% | |
| P/E | 7.04 | 12.92 | 13.41 | 80.31 | 10.82 |
Source: Yahoo! Finance
To compare with its competitors and its industry in general, the table has shown that the gross margin of SODI to be the lowest in the industry and when comparing it to other competitors, however, it’s in the rising trend. The operating margin and the net margin seems to be on the upper side, higher than the industry. For the relative valuation, SODI seems to be the cheapest, even excluding the high cash balances and the low debt for now.
Valuation
For seven years from 2004 to 2011, the growth in free cash flows is around 10.5% compounded annually. We have two scenarios; one is the best case and the other is the worst case.
Worst case
| Assumptions | |
| Growth rate for the next 05 years | 5% |
| Discount rate | 10% |
| Terminal Growth rate after 5 years | 1% |
| USD thousands | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | Terminal year |
| Cash flows | 456 | 479 | 503 | 528 | 555 | 582 | 11,766 |
| PV of CF | 456 | 436 | 416 | 397 | 379 | 362 | 6,642 |
| NPV | 9,087 |
For the worst case, the growth rate for the next five years is only at 5%, and 1% for infinity. At that time the enterprise value of SODI would stand around $9.1 million; the market value should be $13.2 million.
Best case
| Assumptions | |
| Growth rate for the next 05 years | 8% |
| Discount rate | 10% |
| Terminal Growth rate after 5 years | 1% |
| USD thousands | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | Terminal year |
| Cash flows | 456 | 493 | 532 | 575 | 621 | 671 | 33,865 |
| PV of CF | 456 | 448 | 440 | 432 | 424 | 416 | 19,116 |
| NPV | 21,733 |
We adjust the growth rate for the next five years in free cash flow to 8% as representing our best case. For that, the enterprise value of SODI should be $21.7 million, meaning that the market value should be $25.8 million.
With both worst case and best case, I think SODI is a good business to own for the patient investor, when it increases its value to my calculated range. However, there are some potential downsides relating to the structure of management and the concentration of customers that might drag the company down. Any investors should take great care when taking any positions in this stock.
Disclosure: long SODI
It is not the recommendation for buying, holding and selling the stock. Any investor who wishes to do so should conduct his/her own research for his/her own actions, bearing his/her own risks.
