"Thank you for coming here young man.." - Joseph Schlig
"It's not an us verses them…you treat shareholders like barnacles on a ship waiting to be scraped off.." - Nate Tobik
"..I think part of the problem is you've lived under a rock for the past 20 years.." - Jeff
"I'm actually surprised at how many people the company brought.." - Alex
The meeting was held in the SunTrust building in Miami. I arrived with my proxy and was greeted by a number of lawyers at the door. They took my ID and gave me the voting form, I voted on the spot. I also received a set of "rules" for the meeting.
The rules of conduct set out the agenda, rules for voting, and then two contentious items. The first states that shareholders are allowed two questions that are to be no longer than one minute long. That's it, just two one minute questions or comments.
Before the meeting started I had the opportunity to introduce myself to most of the other shareholders present. There were nine shareholders present, not including management. Shareholders ranged from large holders such as Alex Toppan, and Ancora Advisors to smaller holders such as myself. Universally everyone was excited the company had finally put something on the calendar, with the hope we'd be allowed to openly ask management a few questions.
The company came in with a posse of advisors, including the auditor, lawyers, and Board members. As an aside, I had a chance to talk to the auditor before the meeting for a few minutes. I asked what it was like working with Saraf, considering he is the CFO/COO/C-anything. The auditor said he barely worked with him, instead he worked with the company's controller and accounting department, which he spoke highly of. I think this is reassuring, Saraf isn't a one man band running the entire show, although his hands are clearly deep into all aspects of the company's operations.
The company read some prepared statements, then opened the floor for questions stating they expected to wrap up in 20 minutes, clearly not long enough to air 20 years worth of questions.
I will summarize some of the questions and answers below, but I want to point out two important points from the meeting.
The first was a short comment/question that Jeff, from Ancora stated. Jeff stated that he'd interacted with the company multiple times, and each time became much more frustrating. He said he felt the company had been in hiding for 20 years and suddenly they were found out. They can't go back and hide, they need to deal with shareholders. He gave the company a B+/A- for operations, but a D for corporate governance. Jeff spoke for his firm, but in truth he spoke for all shareholders, he just vocalized the frustration we all have with the Board. Jeff also asked if the company planned on keeping their auditor more than six months. The auditor expected to stay around, but I'm sure all of their auditors had a similar expectation.
Jeff's main comment was that it was great the company was having a meeting in a nice office, but what will be different over the next year? Will we all be sitting in the same room looking at the same numbers? Unfortunately Saraf's answer didn't answer much of anything, instead he evaded the main question asked and answered with a non-answer.
The second item worth noting was what happened when the company tried to close the meeting down. Jeff Moore (ragnarisapirate.blogspot.com) asked if the Board would stick around for an informal conversation. He was flatly rejected, I protested along with other shareholders. Eventually the company's counsel asked if we could take a five minute break. After the break the Board came back in, Saraf gave a mini speech about how he wasn't going to give out inside information, insinuating that somehow that's what we were there for, which of course wasn't true.
The informal question and answer session was the highlight of the meeting. Management let their hair down and answered basic questions about the business, as well as a few questions regarding capital allocation.
I also had the chance to look through the shareholder register at the end of the meeting. This was eye-opening. The company has around 2000 record holders, 95% of them hold less than 1000 shares. Most of the company's record holding shareholders appear to be remainder creditors from their bankruptcy, holders such as Florida Power and Light with 2,000 shares. There were many South Florida supply companies listed on the register, along with many individuals with 100-200 shares or less.
Election Results
The company will be publishing an 8-k with the official election results, but this is what was announced at the meeting. Shareholders voted 1,917,570 shares in total, and voted:
- For Saraf
- For Gerrity
- For Kopperl
- Against Davis
- Against Schlig
- For ratification of the CPA
- For the Say on Pay
- Voted to evaluate pay once a year
Questions/Answers
A wide variety of questions were asked, where I remember the question I have it noted, otherwise these are just general answers and notes I took. Jeff, and Taylor (http://valueprax.wordpress.com/) might remember more, I'll let them fill in additional details. The answers are mixed with some commentary, none of these are direct quotes as far as I can tell.
- Is there a succession plan in place?
- There is a layer of management under the CEO, including the Controller, but otherwise all of the titles mentioned have no place in replacing the CEO. The answer was essentially no.
- What does the company plan on doing with their excess cash?
- The company likes to keep money in reserve.
- There are 72 (or 30 or 60, this number changed each time it was mentioned) before the EPA liability is completely eliminated. Saraf discussed how difficult it is to work with the EPA, he said it took 10 years to negotiate the initial payment plan, this was not for lack of trying. He said he has trouble getting them to return his calls, and hasn't been able to get a final date for satisfaction of the liability. Somewhere between 30 days, the number a director mentioned, and 72 the number Saraf mentioned.
- Much of the PP&E has been mostly depreciated or fully depreciated, does the equipment have years of service left?
- Yes, much of the fully depreciated equipment is very useful.
- Also worth noting the company is only operating at 50% capacity.
- The company also has a lot of empty warehouse space available.
- Sequestration has provided business opportunities, any conflict including a Middle East conflict would be a boom for business.
- The company would consider future buybacks.
- Why did auditors change?
- The company is required to change auditors every five years due to SEC regulations, that precipitated the switch.
- The most recent change was due to their former auditor merging with an auditing company that specialized in insurance instead of manufacturing.
- I didn't really buy the explanation of the change, especially considering most of the company's auditor changes were glossed over without any explanation.
- The company stated unequivocally that they will remain with this auditor, my view is this remains to be seen.
- Someone asked if the company could be more transparent, the company gave an evasive answer.
- The company stated that shareholders are allowed to contact directors directly, this is a change from the past where Saraf wanted all communication to go through him.
Informal meeting questions
- What type of marketing does the company employ?
- Word of mouth, no one attends industry events, the industry knows Solitron.
- The company is known as a niche supplier, they do their niche very well.
- The company's niche is a sunset technology, this was a strange answer. To a later question the company stated their product is unique and unlikely to ever go away.
- Jeff Moore asked what directors look for when they buy a stock for their own account. One director spoke and said he looks for a stock to go up, and at times looks for short term investments, and other times long term investments. Some shareholders joked that he should have said "I invested in the Barrons stock of the week."
- The military is willing to spend more on quality parts that meet qualifications.
- The military expects companies to earn a profit, Solitron charges for everything.
- DNA marking is a new requirement, each transistor is required to be stamped with a DNA stamp so a transistor can be uniquely identified, Solitron is stamping their chips and charges extra for it.
- The company might be required to test chips in some special gas chamber, the chamber is expensive, in the $500k range.
- The company's products are used in power supplies, there is no digital replacement, this answer is in contrast to the answer that the company's technology is a sunset technology.
- The company's packaging is unique, not sure what the point of this was.
- Some products are used to steer missiles.
- 90% of the company's products are customer designed, meaning the company employs no R&D.
- Of general note, a shareholder Doug explained afterward to me that the company doesn't sell anything unless the item has been ordered on contract yet. This means 100% of the company's inventory has been ordered on contract, the company builds nothing on spec. The company's inventory will all flow through to revenue.
- Gold is a significant factor in cost, copper a larger component. The management seemed worried about the cost, which is confusing because a few minutes later they stated they pass on all commodity costs.
- The company would consider an acquisition, possibly an upstream acquisition of a larger company to use all the NOLs.
- The company doesn't believe a buyback or dividend would have any effect on the stock price.
- Saraf doesn't appear to care much that the share price doesn't move.
- The company will only consider people for the Board who have industry experience.
- Foreign sales are through US certified partners, I was somewhat unclear on this aspect. It seemed that foreign sales aren't targeted to foreign buyers, but rather parts are sold to an American defense company, who then sends them to a foreign buyers.
- The company had a large and growing market in some part, but Chinese suppliers flooded the market cheaper.
- The company is facing an issue with wafer sizes, they currently use 3in wafers for production. The supply of 3in wafers is dwindling worldwide. Silicon manufacturers have moved to 5in and 8in wafers. Moving to larger wafers would require a $5-10m investment to completely re-tool the business.
- A note here, this was thrown up as a reason why the company doesn't want to distribute any cash, they "might" need it to re-tool. I talked to a shareholder after the meeting who pointed out that for how penny tight Saraf is it's unlikely he's going to dump all of their hard earned cash into re-tooling. This was most likely a red herring.
Conclusion
I enjoyed looking management in the eye and asking them questions. I think all shareholders were glad the company finally held a meeting. The problem is that management looked us in the eyes, nodded their heads, but in the end nothing will change. It's easy for them to entertain us for an hour and a half, but taking action is much different.
My biggest fear after the meeting is that the company could enter into a costly acquisition that's above what they can manage. My second biggest fear is that management will continue to have an us verses them mentality regarding shareholders, this isn't good for anyone, especially when management only owns around 10% of the shares outstanding.
Disclosure: Long Solitron
Greatly appreciate what you guys have done!!
ReplyDeleteA couple of quick comments:
- The situation with creditor shareholders is something I've suspected for some time. (This reminders me Blue Chip Stamps.)
- The re-tooling can be a real issue. When the world has moved into newer technologies, it becomes harder and harder to get parts and supports. (As an analogy: If your company's IT system runs on Novell Netware, good luck to find supports or suitable replacement PC.)
Nate,
ReplyDeleteA quick question. Did you mean even shareholders with nominee accounts were on their shareholder registry? I always thought you would only see "E-Trade Nominee A/C" on the registry, but not the real beneficial owners?
John,
DeleteThe only shareholders who appear on the register are ones who hold it in their own name, not Street name. There was one entry for CEDE & Company for all of the Street holders, it was close to 1.9m shares.
I talked to the lawyer, she said the official register doesn't have the beneficial holders, but once a month she gets a list of the look through holders of the stock from the DTC.
So what do you think Nate?
ReplyDeleteI've thought long and hard about this one, and in my mind I've concluded it's a quintessential "3 Hyphen Special":
1) Buggy-whip
2) Micro-cap
3) Value-trap
The fundamental problem is manager-shareholder alignment. The CEO and his cronies will draw nice salaries putting in their 9-to-5 until, over the next 10 years, the business slowly dissolves into the Ether as a result of Asia-driven assembly & test commoditization and obsolescence. This is why he wants a big bag of cash on his B/S. They will also inevitably dump a bunch of capex into new machinery to keep the lights on for a few more years... again, to keep the worker bees humming and the salaries flowing. I mean, it sounds like the CEO just about gave you guys the double middle fingers during the meeting -- I don't see how he will treat your B/S cash any differently.
These types of cheap clap-trap businesses always suck value investors in during bull markets, but I know how these stories end. I've read every single VIC idea and followed them through to today to see how the stocks and businesses performed. I just can't help but look at Quipp or Pacific Insight Electronics and not see an eery reflection of Solitron.
Anyway, regardless of how I think the business will do, I do hope you make $ on this. A Twitter pump a la FFI would be a nice 4x MoM outcome!
I actually think it's only one of those, #2. The business is fascinating, I learned a lot more at the meeting than I would have ever imagined.
DeleteThe company has a sustainable niche, most players in the market went out of business and Solitron picked up their business. What makes a company valuable to the military is the ability to execute, deliver quickly and produce quality products. Quality products is key, products cannot fail. Solitron has been able to produce the quality parts that they want.
Additionally they produce nothing on spec, and 90% of their parts are customer designed. So this is a sweet little company, every single part is produced at a profit, costs are always passed onto customers and the government guarantees a profit, apparently in the 10-15% range. Solitron has no money at risk on inventory and doesn't have to spend anything on R&D.
As to the concerns about China, since most of their parts are military rated they can't be sourced from China. They have to be developed by a company in the US with a specific certification, Solitron has this.
The CEO has a large salary, but the Board is actually compensated fairly, they earn $20k a year for their service. Much lower than the gravy train pay that most companies dole out.
As Jeff stated in the meeting, they get a B+ or so on operations, but corporate governance is terrible. The cash is a liability not an asset in their hands.
The biggest risk I see is a bad acquisition. I think Saraf sees the limits of his market and wants to break out. The guy is older, he's in his 70s, but looks like he's in his 80s, and I don't know if he could manage an acquisition like that right now. There's also no heir apparent lined up either.
I can add some color to your comment "every single part is produced at a profit, costs are always passed onto customers and the government guarantees a profit".
DeletePricing in the defense industry is its own world. Defense companies are guaranteed profit to a certain extent. When Solitron bids on a job, they price it at their historical cost to build similar products, then add a profit margin. The profit margin as I recall is limited to the 8-10% range, but don't quote me. There are DoD auditors who verify the pricing. The actual profit on the job depends on their ability to do it right the first time. In competitive bidding, all things being equal, the low cost supplier will win out.
Question - since you saw the register - how much is in the hands of interested parties that may actually be able to force a change - a few board members first and then a distribution of cash/prevention of a silly acquisition ... ?
ReplyDeleteBoard members own nothing, Schlig owned 3k shares I think, and Davis 11k shares, over 20 years on the Board that's peanuts. The two new directors own nothing either.
DeleteAs for the register, almost all registered holders owned less than 1k shares. If the company were to do a reverse split they could go dark and save SEC filing fees very easily. I think most registered holders keep the shares because it's easier than opening a brokerage to sell. Some with 5 or 10 shares would incur significant costs to sell.
Great post Nate. Very helpful for those of us that couldn't be there. Given what you said about the lack of change, I am really interested in seeing if the value and activist oriented shareholders have enough collective shares to create more leverage with this situation.
ReplyDeleteA few comments.
ReplyDelete1. Packaging is a key competitive advantage. Solitron components need to fit into larger designs. The parts need to be customer specified shapes, sizes and need to dissipate heat in effectively in defined directions.
2. Commodity costs are hard to control. The company submits fixed price proposals months or even years in advance of contract award. The price of gold or copper will change from the time of the proposal. Lately that has worked to the company's advantage. Although no one asked, I don't think the company hedges (at least I don't see it in the financials).
3. The us vs. them mentality was apparent in the removal of Dr. Davis from the board. In the Q&A session (after proxy voting was complete), Dr. Davis showed he was knowledgeable and a valuable asset to the company. But at the time we voted, who of us knew that? I hope that will motivate Mr. Saraf and the board to be more open to the shareholders and the general public. After all, we want to see the company prosper and become more valuable.
Thanks for the additional insights!
DeleteDoug,
DeleteIt was great meeting you, enjoy the rest of your travels! Thanks for the insight into their business model as well.
Nate
Thank you Nate!
ReplyDeleteOne note from an ex-auditor who works for the Big 4 still in another group, companies are not required to change their auditor every 5 years although this has been considered as a proposal in Europe and America always kicks it around.
ReplyDeleteThey are required to change the audit partner on the account every 5 years but not the audit firm itself.
Thanks for the insight, I was surprised at this as well. At first Schlig said three years, then their lawyer corrected him and said five years.
DeleteIt makes more sense that just the partner is required to be switched and not the entire firm.
Sorry for the delay, yes that was just wrong and somewhat misleading on his part...any questions on this or any other accounting issues as always feel free to hit me up.
Deleteljvikings@gmail.com
Nate, thanks for going, participating and posting. I am learning a lot (vicariously). Great stuff. If I was a BOD for Solitron.... I think I would look at my responsibilities a little differently. Accountability to the shareholders was most likely not on their radar a year ago....it is now.
ReplyDeleteAgreed, I think Saraf believed this would all blow over, but it hasn't and the heat is now stronger than when we started. I'm excited to see how this turns out.
DeleteNate,
ReplyDeleteAny idea what % of shareholders are like-minded owners like yourself? Interested to learn more about what you were able to glean from your review of the shareholder registrar.
Thanks,
G
I think the best measure is probably the number of votes against Schlig and Davis, which is clearly a majority.
DeleteI know off the top of my head the names of people who own about 30% of the shares, and we all seem to be on the same page. Given the vote history it wouldn't surprise me if there's another 10-15% or more who agree who I don't know.
Thanks for the quick reply.
DeleteAnother question for you - what is your end game with a company like this? Do you believe intrinsic value is much higher still from the current price, which is 50% higher than where you originally bought? If you do, do you have plans to continue to agitate for change so that value is realized within a reasonable time horizon (ie not simply waiting for Saraf's retirement)?
I agree with the comments below that a formalized group would run into issues with SEC regs, but if you know 30% of shareholders already, and think an additional 10-15% would agree with your positions, it seems like you're awfully close to being able to push any agenda you want.
Best,
G
Here is my thought, this is my endgame theory:
Delete1) The company pays some token dividend, maybe $.01-.05 per share a quarter or something.
2) The company engages in some sort of an upstream acquisition with a much larger company, this uses the NOLS
3) Saraf gets a payday from the acquisition, and can work for a while if he wants, and then retire without needing a successor.
I think this is still worth 50% more. When I first looked at this I valued the cash at 100% and the operations at maybe 50%, valuing in the sense that I had confidence. After attending the meeting, talking to other shareholders I value the operations at 100% and maybe the cash at 50-75%.
I have no doubt the company could be sold today for FV if Saraf wanted to sell. They have a neat little niche, and they execute well. The question mark is what do they do with the cash, do they listen to shareholders and give some back, or do they spend it on something we don't agree with?
I think you're right about shareholders being in control here, we are close, but management ultimately has the ATM card unfortunately.
Nate
ReplyDeleteFirst of all Kudos to you for doing this and trying to hammer some good judgment into management.
I think that this is the crucial step in value investing that many people miss. Sure Buffett was able to find a lot of these stocks in the 1950s trading for fractions of book value and still profitable but he was also able to go down to the managers and tell them his expectations. Now the problem is here that they may still not listen.
Have you ever pondered developing a loose association of like minded value investors and pooling resources. Heck if you had enough people who could buy $100,000 in stock you could quickly be heard loud and clear at some of these meetings. Waiting for value to emerge in a situation like this is akin to waiting for a random black swan event like the death of a CEO- yes it will eventually happen but if it happens in 15 years it makes this a mediocre investment. I mean the value in these situations is often so obvious- its not about assessing some intangible - if we were able to push managers with some muscle these would be no brainers ---A loose partnership that could pool resources for these situations makes a lot of sense ... I for one would be willing to join....(there outta be a website for this kind of thing) sort of like crowd funding
Joe Giustino
It's an interesting idea, and it's been tried before.
DeleteI ran across this when reviewing old VIC ideas (the idea was the first idea posted to VIC -- look-up Comshare).
The fund was called eRaider. This was all I was able to come up with in Google:
http://www.mfwire.com/article.asp?storyID=7661&template=article&bhcp=1
Part of the problem with your idea is that there are SEC rules against forming such "groups" -- these rules stem from the public outcry (well, actually management outcry) against corporate activism during the 1980's. Oliver Stone's Wall Street and so forth. Activism didn't have a good name after Boesky, Icahn, Perelman, etc. finished off the 80's.
Anon nailed it, there are rules against groups. In the case of Solitron a group could invalidate their NOLs because in the eyes of the SEC the group is working together and could constitute a change in ownership.
DeleteMight be a naive question.. With less sources for their wafers, has management explored buying out a small supplier? Another idea would be to buy the wafers for say 3-5 years and then replenish each year's use? Seems better than retooling at some point for 5-10MM?
ReplyDeleteDoes anyone know how a buyback of shares could affect the change of control provision and the companies NOL's?
ReplyDelete