SOLITRON DEVICES INC

SOLITRON DEVICES, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

1. THE COMPANY AND OPERATIONS

Solitron Devices, Inc., a Delaware corporation (“Solitron,” the “Company,” “we,” “us,” or “our”), designs, develops, manufactures, and markets solid-state semiconductor components and related devices primarily for the military and aerospace markets. The Company was incorporated under the laws of the State of New York in 1959 and reincorporated under the laws of the State of Delaware in August 1987.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The unaudited consolidated condensed financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. All intercompany accounts and transactions have been eliminated in consolidation.

The unaudited financial information furnished herein reflects all adjustments, consisting of normal recurring items that, in the opinion of management, are necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods. The results of operations for the three and nine months ended November 30, 2023 are not necessarily indicative of the results to be expected for the year ended February 29, 2024.

The information included in this Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended February 28, 2023.

Use of estimates

The consolidated financial statements are prepared in accordance with GAAP. Preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable. The Company could have reasonably used different accounting estimates. This applies in particular to inventory and valuation allowance for deferred tax assets. Actual results could differ significantly from our estimates. To the extent that there are material differences between these estimates and actual results, the Company’s future financial statement presentation, financial condition, results of operations and cash flows will be affected. The Company believes COVID-19 had a negative impact on the Company’s bookings and net sales in fiscal 2023. The Company believes COVID-19 had a negative impact to net sales in the first quarter of fiscal 2024 due to bookings being negatively affected in fiscal 2023.

Cash and Cash Equivalents

Cash and cash equivalents include demand deposits and money market accounts. The Company considers any short-term, highly liquid investments with maturities of three months or less as cash and cash equivalents.

Short-term Investments, Held-to-Maturity Investments

Short-term investments consisted of certificates of deposit and U.S. Treasury securities. The U.S. Treasury securities are classified as held to maturity, mature in less than*twelve** *months, and are reported at amortized cost which approximates fair value of $0 as of November 30, 2023 due to maturity, and $986,000 as of February 28, 2023.

Investment in Marketable Securities

Investment in Marketable Securities includes investments in common stocks and bonds. Investments in securities are reported at fair value with changes in unrecognized gains or losses included in other income on the consolidated condensed statements of operations.

The following table summarizes investments in marketable securities at:

At November 30, 2023 and February 28, 2023, the deferred tax liability related to unrealized gains and losses on short-term investments was approximately $33,000 and $229,000, respectively.

Fair Value of Financial Instruments

Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures”, defines “fair value” as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also sets forth a valuation hierarchy of the inputs (assumptions that market participants would use in pricing an asset or liability) used to measure fair value. This hierarchy prioritizes the inputs into the following three levels:

The table below shows the Company’s marketable securities as of November 30, 2023 and February 28, 2023:

The carrying amounts of the Company’s short-term financial instruments, including accounts receivable, accounts payable, accrued expenses and other liabilities approximate their fair value due to the relatively short period to maturity for these instruments. The carrying value of long-term debt approximates fair value since the related rates of interest approximate current market rates.

Accounts Receivable

Accounts receivable consists of unsecured credit extended to the Company’s customers in the ordinary course of business. The Company reserves for any amounts deemed to be uncollectible based on past collection experiences and an analysis of outstanding balances, using an allowance account. Any expected losses related to trade receivables as of November 30, 2023 and February 28, 2023 were determined to be immaterial. The accounts receivable balance as of November 30, 2023, February 28, 2023, and February 28, 2022 was $2,728,000, $784,000, and $1,591,000, respectively.

Shipping and Handling

Shipping and handling costs billed to customers are recorded in net sales. Shipping costs incurred by the Company are recorded in cost of sales.

Inventories

Inventories are stated at the lower of cost and net realizable value. Cost is determined using the “first-in, first-out” (FIFO) method. The Company buys raw material only to fill customer orders. Excess raw material is created only when a vendor imposes a minimum quantity buy in excess of actual requirements. Such excess material will usually be utilized to meet the requirements of the customer’s subsequent orders. If excess material is not utilized after two fiscal years, it is fully reserved. Any inventory item once designated as reserved is carried at zero value in all subsequent valuation activities.

The Company does not classify a portion of inventories as non-current since we cannot reasonably estimate based on the length of our operating cycle which items will or will not be used within twelve months.

The Company’s inventory valuation policy is as follows:

Property, Plant, Equipment, and Leasehold Improvements

Property, plant, and equipment is recorded at cost. Major renewals and improvements are capitalized, while maintenance and repairs that do not extend their expected life are expensed as incurred. Depreciation is provided on a straight-line basis over the estimated useful lives of the related assets. Leasehold improvements are amortized over the shorter of the lease term or the lives of the related assets:

Concentrations of Credit Risk

Financial instruments, which potentially subject the Company to concentration of credit risk, consist principally of cash and account receivables. The Company places its cash with high credit quality institutions. At times, such amounts may be in excess of the Federal Deposit Insurance Corporation (“FDIC”) insurance limits. The Company has not experienced any losses in such accounts and believes that it is not exposed to any significant credit risk on the accounts. As of November 30, 2023, all non-interest bearing checking accounts were FDIC insured to a limit of $250,000. Deposits in excess of FDIC insured limits were approximately $573,000 at November 30, 2023, as compared to $129,000 at February 28, 2023. With respect to the account receivables, most of the Company’s products are custom made pursuant to contracts with customers whose end-products are sold to the United States Government. The Company performs ongoing credit evaluations of its customers’ financial condition and maintains allowances for potential credit losses. Actual losses and allowances have historically been within management’s expectations.

Net Income (Loss) Per Common Share

Net income (loss) per common share is presented in accordance with ASC 260-10 “Earnings per Share.” Basic earnings per common share are computed using the weighted average number of common shares outstanding during the period. Diluted earnings per common share incorporate the incremental shares issuable upon the assumed exercise of stock options to the extent they are not anti-dilutive using the treasury stock method. The Company had no common stock equivalents outstanding during the three and nine months ended November 30, 2023 and November 30, 2022; therefore, there is no effect from dilution on earnings per share.

Revenue Recognition

The Company records revenue in accordance with ASC Topic 606, “Revenue from Contracts with Customers,”* *which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods and services to customers. Revenue is recognized at a point in time, generally upon shipment of products to customers.

The core principle of the guidance in ASC Topic 606 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

To achieve that core principle, the Company applied the following steps:

1. Identify the contract(s) with a customer.

The Company designs, develops, manufactures and markets solid-state semiconductor components and related devices. The Company’s products are used as components primarily in the military, aerospace and medical markets.

The Company’s revenues are from purchase orders and/or contracts with customers associated with manufacture of products. We account for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.

2. Identify the performance obligations in the contract.

The majority of the Company’s purchase orders or contracts with customers contain a single performance obligation, the shipment of products.

3. Determine the transaction price.

The transaction price reflects the Company’s expectations about the consideration it will be entitled to receive from the customer at a fixed price per unit shipped based on the terms of the contract or purchase order with the customer. To the extent our actual costs vary from the fixed price that was negotiated, we will generate more or less profit or could incur a loss.

4. Allocate the transaction price to the performance obligations in the contract.

5. Recognize revenue when (or as) the Company satisfies a performance obligation.

This performance obligation is satisfied when control of the product is transferred to the customer, which occurs upon shipment or delivery. The Company receives purchase orders for products to be delivered over multiple dates that may extend across reporting periods. The Company’s accounting policy treats shipping and handling activities as a fulfillment cost. The Company invoices for each delivery upon shipment and recognizes revenues at the fixed price for each distinct product delivered when transfer of control has occurred, which is generally upon shipment.

In addition, the Company may have a contract or purchase order to provide a non-recurring engineering service to a customer. These contracts are reviewed, performance obligations are determined, and we recognize revenue at the point in time in which each performance obligation is fully satisfied.

We recognize revenue on sales to distributors when the distributor takes control of the products ("sold-to" model). We have agreements with distributors that allow distributors a limited credit for unsaleable products, which we refer to as a "scrap allowance." Consistent with industry practice, we also have a "stock, ship and debit" program whereby we consider requests by distributors for credits on previously purchased products that remain in distributors' inventory, to enable the distributors to offer more competitive pricing. We have contractual arrangements whereby we provide distributors with protection against price reductions initiated by us after product is sold by us to the distributor and prior to resale by the distributor. In addition, we have a termination clause in one of our distributor agreements that would allow for a full credit for all inventory upon 60 days’ notice of terminating the agreement.

We recognize the estimated variable consideration to be received as revenue and record a related accrued expense for the consideration not expected to be received, based upon an estimate of product returns, scrap allowances, "stock, ship and debit" credits, and price protection credits that will be attributable to sales recorded through the end of the period. We make these estimates based upon sales levels to our customers during the period, inventory levels at the distributors, current and projected market conditions, and historical experience under the programs. Our estimates require the exercise of significant judgments. We believe that we have a reasonable basis to estimate future credits under the programs.

Related Party Transactions

The Company currently purchases and has purchased in the past die and wafers, as specified by the Company's customers, from ES Components. Dwight Aubrey, a director of the Company, is a minority owner of ES Components, and an immediate family member of Mr. Aubrey is the majority owner of ES Components. For the three and nine months ended November 30, 2023, the Company purchased $24,276 of die and $0 of used equipment and $57,312 of die and $0 of used equipment from ES Components, respectively. For the three and nine months ended November 30, 2022, the Company purchased $24,276 of die and $0 of used equipment and $109,892 of die and $0 of used equipment from ES Components, respectively. The Company has included the expenses related to die in cost of goods sold in the accompanying statement of operations. The Company occasionally makes sales to ES Components. For the nine months ended November 30, 2023 and November 30, 2022, sales were $0.

Stock Based Compensation

The Company records stock-based compensation in accordance with the provisions of ASC Topic 718, "Compensation-Stock Compensation," which establishes accounting standards for transactions in which an entity exchanges its equity instruments for goods or services. Under ASC Topic 718, the Company recognizes an expense for the fair value of outstanding stock options and grants as they vest, whether held by employees or others. No vesting of stock options or grants occurred during the three and nine months ended November 30, 2023 or November 30, 2022.

Recent Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments–* Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” *which significantly changes the impairment model for most financial instruments. Current guidance requires the recognition of credit losses based on an incurred loss impairment methodology that reflects losses once the losses are probable. Under the new standard, the Company will be required to use a current expected credit loss model (“CECL”) that will immediately recognize an estimate of credit losses that are expected to occur over the life of the consolidated financial instruments that are in the scope of this update, including trade receivables. The CECL model uses a broader range of reasonable and supportable information in the development of credit loss estimates. The Company adopted the new guidance on a modified retrospective basis beginning with its first fiscal quarter of 2024. The Company estimates its expected credit losses based on the expected losses on its receivables based on a variety of data, including current economic conditions in the Company’s industry and the credit status of the Company’s customers. The adoption of this guidance did not have a material impact on our consolidated financial statements.

The Company does not believe that any recently issued effective pronouncements, or pronouncements issued but not yet effective, if adopted, would have a material effect on the accompanying consolidated financial statements.

3. REVENUE RECOGNITION

As of November 30, 2023, and February 28, 2023, sales returns and allowances accrual activity is shown below:

As noted in Note 2 above, one of our distributor agreements has a termination clause that would allow for a full credit for all inventory upon 60 days’ notice of terminating the agreement. As of November 30, 2023, and February 28, 2023, the inventory balance at that distributor was believed to be $1,549,000 and $1,784,000, respectively. Based upon sales levels to and by the distributor during the period, inventory levels at the distributors, current and projected market conditions, and historical experience under the programs, we believe it is highly unlikely that the distributor would exercise termination. Should termination occur, we believe the products could be sold to other distributors or held in inventory for future sale.

The Company warrants that its products, when delivered, will be free from defects in material workmanship under normal use and service. The obligations are limited to replacing, repairing, or reimbursing for, at the option of the Company, any products that are returned within one year after the date of shipment. The Company does not reserve for potential warranty costs based on historical experience and the nature of its cost tracking system.

4. INVENTORIES

As of November 30, 2023, inventories consisted of the following:

As of February 28, 2023, inventories consist of the following:

Wafer bank inventory (completed wafers that are available to be consumed in the Company’s products), net of reserves, totaled approximately $369,000 as of November 30, 2023 and $589,000 as of February 28, 2023. As of November 30, 2023,100% of the wafer bank inventory consisted of wafers manufactured between calendar year 2018 and 2022. We do not expect all of our wafer inventory to be consumed within twelve months; however, since it is not possible to know which wafers will or will not be used, we classify all our inventory as current.

5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

As of November 30, 2023, and February 28, 2023, accrued expenses and other current liabilities consisted of the following:

6. DISAGGREGATION OF REVENUE AND MAJOR CUSTOMERS

Revenues from domestic and export sales are attributed to a global geographic region according to the location of the customer’s primary manufacturing or operating facilities. Revenues from domestic and export sales to unaffiliated customers for the three months ended November 30, 2023 and November 30, 2022, respectively, are as follows:

Revenues from domestic and export sales to unaffiliated customers for the nine months ended November 30, 2023 and November 30, 2022, respectively are as follows:

For the three months ended November 30, 2023 and November 30, 2022, approximately 64% and 68%, respectively, of the Company’s sales are attributable to contracts with customers whose products are sold to the United States government. The remaining 36% and 32%, respectively of sales are for non-military, scientific and industrial applications, or to distributors where we do not have end user information.

For the nine months ended November 30, 2023 and November 30, 2022, approximately 78% and 78%, respectively, of the Company’s sales are attributable to contracts with customers whose products are sold to the United States government. The remaining 22% and 22%, respectively of sales are for nonmilitary, scientific and industrial applications, or to distributors where we do not have end user information.

Customers who contributed ten percent or more of revenues for the three months ended November 30, 2023 and November 30, 2022, respectively are as follows:

Customers who contributed ten percent or more of revenues for the nine months ended November 30, 2023 and November 30, 2022, respectively are as follows:

7. MAJOR SUPPLIERS

Suppliers who accounted for 10% or more of purchases of production materials for the three months ended November 30, 2023 and November 30, 2022, respectively are as follows:

Suppliers who accounted for 10% or more of the cost of production materials for the nine months ended November 30, 2023 and November 30, 2022, respectively are as follows:

8. ACQUISITION OF MICRO ENGINEERING, INC.

Effective September 1, 2023 (the “Closing Date”) the Company entered into a Stock Purchase Agreement (the “Purchase Agreement”) by and among the Company, Micro Engineering, Inc., a Florida corporation (“MEI”) and the shareholders of MEI (collectively, the “MEI Shareholders”), pursuant to which the Company agreed to purchase all the outstanding capital stock of MEI for a purchase price of $3,000,000, subject to adjustment, in addition to the potential earn-out payments, as described in more detail in the paragraph that follows (the “Acquisition”). As a result of the Acquisition, MEI, which is engaged in the production and sale of electronic components primarily for the medical industry in the State of Florida, became a wholly-owned subsidiary of the Company.

In addition, under the Purchase Agreement the Company agreed to the following potential earn-out payments as additional consideration for the Acquisition: for each of (1) the period beginning on the Closing Date and ending on December 31, 2023, (2) the calendar year ending on December 31, 2024, (3) the calendar year ending December 31, 2025, and (3) the period beginning on January 1, 2026 and ending on the third anniversary of the Closing Date, the Company agreed to pay the MEI Shareholders 7.5% of the gross revenue actually received and collected by the Company during the applicable period from MEI’s existing customers as of the Closing and related to sales by the Company of Company products that were in existence as of the Closing. The estimated fair value of the contingent consideration as of November 30, 2023 was $1,189,000.

During the fiscal third quarter ended November 30, 2023, the Company incurred $200,000 of transaction-related expenses for the acquisition of MEI, which have been expensed in the consolidated condensed statement of operations.

The Company accounted for the acquisition as a business combination under Accounting Standards Codification (“ASC”)805, Business Combinations. At the date of the acquisition and of this Quarterly Report on Form10-Q, management hasnot yet finalized its valuation analysis. The fair values of the assets acquired, as set forth below, are considered provisional and subject to adjustment as additional information is obtained through the purchase price measurement period (a period of up toone year from the closing date). Deferred taxes are being reviewed and analyzed to determine their realizability and are subject to change. Intangible assets recorded represent customer relationship assets which we estimate to have a three year life and the value may change based on the final valuation report. Any prospective adjustments would change the fair value allocation as of the acquisition date. The Company is still in the process of reviewing underlying models, assumptions and discount rates used in the valuation of provisional goodwill and intangible assets. The following table summarizes the provisional fair value of the assets acquired and liabilities assumed on the date of acquisition, and is as follows:

Pro Forma Condensed Combined Financial Information (Unaudited) (In thousands)

The following presents the Company’s unaudited pro forma financial information for the three and nine months ended November* 30, 2023and 2022,* respectively, giving effect to the acquisition of MEI as if it had occurred at March1, 2022.Included in the pro forma information is: adjustments to recognize transaction-related costs related to the acquisition of MEI and fair value adjustment to inventory as if acquired during the quarter endedFebruary 28, 2022.

The pro forma financial information is for informational purposes only and doesnot purport to present what the Company’s results would actually have been had the transaction actually occurred on the dates presented or to project the combined company’s results of operations or financial position for any future period. The consolidated condensed statements of operations for the three months ended November 30, 2023 includes net sales of $1,412,000 from MEI and operating loss of $287,000.

9. COMMITMENTS AND CONTINGENCIES

Finance leases:

During fiscal 2021 the Company entered into a 36-month finance lease for $27,000 of computer equipment. The Company does not consider the lease to be material to the Company’s consolidated financial statements. As of November 30, 2023, and February 28, 2023, the carrying value of the asset was $0 and $3,000, respectively, and was included in Property, plant and equipment on the consolidated condensed balance sheets.

In connection with the Acquisition of MEI, the Company also entered into a Lease Agreement pursuant to which it agreed to lease the facility occupied by MEI, consisting of approximately 10,926 square feet of useable office and production space in Orange County, Florida for $10,650 per month. The Lease Agreement has an initial term ofthree years, with two five-year renewal options. The Lease Agreement also provides the Company with an option to purchase the leased property for $1,750,000 at any time before the six-month anniversary of the Lease Agreement. If the Company does not exercise this purchase option prior to its expiration, the monthly rent will increase to $15,000 per month, such increased rent will also be applied retroactively to the initial six months of the lease term.

Under ASC 842-10-25-2 there are five criteria to determine if a lease is a finance lease, one of those criteria is if a purchase option is reasonably certain to be exercised. Currently, the purchase option is likely to be exercised thus we have treated the lease as a finance lease and included the purchase price of $1,750,000 as a current liability.

Contingencies:

We may from time to time become a party to various legal proceedings arising in the ordinary course of business. As of November 30, 2023, we had no known material current, pending, or threatened litigation.

10. NOTES PAYABLE

On April 16, 2021, the Company closed on the acquisition of a facility and real estate located in West Palm Beach, Florida for a purchase price of $4,200,000 pursuant to the Commercial Contract entered into on March 1, 2021. In connection with the acquisition, the Company obtained mortgage financing from Bank of America, N.A. (the “Bank”) in the amount of $2,940,000 to fund that portion of the total purchase price, and entered into the Master Credit Agreement, a Note, a Mortgage, Assignment of Rents, Security Agreement and Fixture Filing and Financial Covenant Agreement (the “FCA”). The loan accrues interest at a fixed rate of 3.8% per year and matures on April 15, 2031. Beginning on May 15, 2021 the Company began making monthly installments of $17,593 consisting of principal and interest. The payment and performance of the loan is secured by a security interest in the property acquired. The Master Credit Agreement contains certain representations and warranties, undertakings and events of default customary for these types of agreements. Additionally, under the terms of the FCA, the Company has agreed to maintain a fixed charge coverage ratio of at least 1.15:1.0, calculated at the end of each fiscal year, using the results of the twelve-month period ending with that reporting period, and has agreed to maintain on a consolidated basis a minimum of no less than $1,000,000 of unrestricted, unencumbered liquid assets.

On June 29, 2022, the Company received notification from the Bank that it had elected to suspend certain financial and reporting requirements set forth in the FCA. Specifically, the Bank elected on a going forward basis to suspend measurement of any of the following financial covenants to the extent they are included in Section 2.1, ‘Financial Covenants’ of the FCA: Tangible Net Worth; Debt Service Coverage Ratio; Fixed Charge Coverage Ratio; Asset Coverage Ratio; Funded Debt to EBITDA; and/or Liquidity. In addition, the Bank elected to suspend the requirements in the FCA, if any, for the submission of financial statements and information by the Company on a periodic basis as specified in Section 2.4, ‘Financial Information’ of the FCA. The Bank reserves the right in its sole discretion to require the Company to resume delivery of financial statements and other information and to evidence compliance with the financial covenant requirements as currently provided in the FCA.

11. STOCKHOLDERS’ EQUITY

Repurchase Program

The Board of Directors has authorized a stock repurchase program of up to $1.0 million of its outstanding common stock. Purchases under the program may be made through the open market or privately negotiated transactions as determined by the Company’s management, and in accordance with the requirements of the Securities and Exchange Commission. The timing and actual number of shares repurchased will depend on variety of factors including price, corporate and regulatory requirements and other conditions.

The Company did not repurchase any shares under the stock repurchase program during the nine months ended November 30, 2023 or November 30, 2022.