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SOLITRON DEVICES INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

May 27, 2014

You should read the following discussion in conjunction with the "Financial Statements and Supplementary Data" section of this Annual Report on Form 10-K. You also should review and consider the risks relating to the Company's business, operations, financial performance, and cash flows presented earlier under "Risk Factors."

INTRODUCTION

The Company designs, develops, manufactures and markets solid-state semiconductor components and related devices primarily for the military and aerospace markets. The Company manufactures a large variety of bipolar and MOS power transistors, power and control hybrids, junction and power MOFSET's, field effect transistors and other related products. Most of the Company's products are custom made pursuant to contracts with customers whose end products are sold to the United States government. Other products, such as JAN transistors, diodes and SMD voltage regulators, are sold as standard or catalog items.

The following table is included solely for use in comparative analysis of income before extraordinary items to complement Management's Discussion and Analysis of Financial Condition and Results of Operations:

(Dollars in Thousands) Years Ended February 28, 2014 28, 2013 Net Sales $ 8,650$ 8,424 Cost of sales 6,389 6,585 Gross profit 2,261 1,839 Selling, general and administrative expenses 1,543 1,284 Operating income 718 555 Environmental Expenses - (7 ) Interest income 28 33 Other income, net 163 254 Provision for Income taxes (13 ) (11 ) Net Income $ 896$ 824 TRENDS AND UNCERTAINTIES:



During the fiscal year ended February 28, 2014, the Company's book-to-bill ratio was approximately 1.06 as compared to approximately 1.20 for the fiscal year ended February 28, 2013 reflecting a decrease in the volume of orders booked. The Company does not believe that, in most years, the year-to-year change in the book-to-bill ratio indicates a specific trend in the demand for the Company's products. Generally, the intake of orders over the last twenty four months has varied greatly as a result of the fluctuations in the general economy, variations in defense spending on programs the Company supports, and the timing of contract awards by the Department of Defense and subsequently by its prime contractors, which is expected to continue over the next twelve to twenty four months. The Company continues to identify means intended to reduce its variable manufacturing costs to offset the potential impact of low volume of orders to be shipped. However, should order intake fall drastically below the level experienced in the last 12 to 24 months, the Company might be required to implement further cost cutting or other downsizing measures to continue its business operations.

SIGNIFICANT ACCOUNTING PRINCIPLES:

Cash and Cash Equivalents Cash and cash equivalents include demand deposits and money market accounts.



Earnings Per Common Share Earnings per common share is presented in accordance with ASC 260-10 "Earnings per Share." Basic earnings per common share is 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.

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Shipping and Handling Shipping and handling costs billed to customers by the Company 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 or market. 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's inventory valuation policy is as follows:

Raw material All material purchased, processed and/or used in the last two /Work in fiscal years is valued at the lower of its acquisition cost or process: market. All material not purchased/used in the last two fiscal years is fully reserved for. Finished goods: All finished goods with firm orders for later delivery are valued (material and overhead) at the lower of cost or market. All finished goods with no orders are fully reserved. Direct labor Direct labor costs are allocated to finished goods and work in costs: process inventory based on engineering estimates of the amount of man-hours required from the different direct labor departments to bring each device to its particular level of completion. RESULTS OF OPERATIONS



2014 vs. 2013 Net sales for the fiscal year ended February 28, 2014 increased by approximately 3% to $8,650,000 versus $8,424,000 during the fiscal year ended February 28, 2013, as a result of an increase in the demand for the Company's products due to changes in defense spending on and priorities in military programs the Company supports, as well as increased delivery requirements by its customers.

Net bookings were more than net sales by approximately 6%. As a result, backlog increased from $7,685,000 as of February 28, 2013 to $8,170,000 as of February 28, 2014. The Company has experienced a decrease in the level of bookings of approximately 10% for the fiscal year ended February 28, 2014 as compared to the previous fiscal year primarily due to changes in defense spending on and priorities in military programs the Company supports.

During the fiscal year ended February 28, 2014, the Company shipped 99,428 units as compared with 157,313 units shipped during the fiscal year ended February 28, 2013. It should be noted that since the Company manufactures a wide variety of products with an average sales price ranging from less than one dollar to several hundred dollars, such periodic variations in the Company's volume of units shipped might not be a reliable indicator of the Company's performance.

Cost of sales for the fiscal year ended February 28, 2014 decreased to $6,389,000 from $6,585,000 for the fiscal year ended February 28, 2013 due to improved yields on finished goods, and decreases in raw material costs, depreciation expense and manufacturing supplies and expenses. Expressed as a percentage of sales, cost of sales decreased to approximately 74% for the fiscal year ended February 28, 2014, as compared to approximately 78% for the fiscal year ended February 28, 2013.

Gross profit for the fiscal year ended February 28, 2014 increased to $2,261,000 from $1,839,000 for the fiscal year ended February 28, 2013 due to improved yields on finished goods, an increase in net sales, and decreases in raw material costs, depreciation expense and manufacturing supplies and expenses. Expressed as a percentage of sales, gross profit increased to approximately 26% for the fiscal year ended February 28, 2014, as compared to approximately 22% for the fiscal year ended February 28, 2013.

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During the year ended February 28, 2014, selling, general and administrative expenses, as a percentage of sales, increased to approximately 18%, as compared to 15% for the year ended February 28, 2013. In terms of dollars, selling, general and administrative expenses increased approximately 20% to $1,543,000 for the fiscal year ended February 28, 2014 from $1,284,000 for the fiscal year ended February 28, 2013. This increase is primarily the result of increases in accounting fees, recruiting expenses and significant increases in legal fees due to a shareholder lawsuit, and costs associated with holding the annual meeting.

Operating income for the fiscal year ended February 28, 2014 was $718,000 as compared to an operating income of $555,000 for the fiscal year ended February 28, 2013. This increase was mainly attributable to higher sales and to the lower cost of sales discussed above.

Interest income for the fiscal year ended February 28, 2014 decreased to $28,000 from $33,000 during the fiscal year ended February 28, 2013. This decrease was attributable to lower earned interest rates on certificates of deposit.

Environmental expenses for the fiscal year ended February 28, 2014 decreased to $0 from $7,000 for the fiscal year ended February 28, 2013. This decrease was due to a lower amount due to USEPA under the Company's Ability to Pay Multi-Site Settlement Agreement with USEPA dated February 4, 2006 as described earlier under "Business - Environmental Liabilities."

Other income for the fiscal year ended February 28, 2014 decreased to $163,000 from $254,000 for the fiscal year ended February 28, 2013. Other income for the year ended February 28, 2014 consisted of $167,000 of income from the settlement of outstanding debt offset by $4,000 of expense due to receivables adjustments. Other income for the year ended February 28, 2013 consisted of $221,000 of income from the settlement of outstanding debt, plus $33,000 of income from receivables adjustments.

Net income for the fiscal year ended February 28, 2014 was $896,000 as compared to net income of $824,000 for the fiscal year ended February 28, 2013. This increase was mainly attributable to higher sales and to the lower cost of sales discussed above.

LIQUIDITY AND CAPITAL RESOURCES

Operating Activities Net cash provided by operating activities was $619,000 for the year ended February 28, 2014, principally reflecting net income of $896,000, an increase of $283,000 in inventory levels to meet customer demand, and a decrease to accounts payable-pre-petition of $270,000 as a result of settlements of debts.

Net cash used in operating activities was $660,000 for the year ended February 28, 2013, principally reflecting net income of $824,000, an increase of $1,051,000 in inventory levels to meet customer demand, and a decrease to accounts payable-pre-petition of $724,000 as a result of settlements of debts.

Investing Activities Net cash used in investing activities was $1,291,000 for the year ended February 28, 2014 principally reflecting the net purchase of investments in treasury bills and certificates of deposit with $1,087,000 of cash and the purchases of $204,000 of manufacturing equipment.

Net cash provided by investing activities was $1,240,000 for the year ended February 28, 2013 principally reflecting the net sales of $1,454,000 of investments in treasury bills and certificates of deposit offset by purchases of $214,000 of manufacturing equipment.

Financing Activities There was no cash used in or provided by financing activities for the year ended February 28, 2014.

Net cash used in financing activities was $268,000 for the year ended February 28, 2013 principally reflecting a $275,000 repurchase of the Company's common stock net of $7,000 of proceeds from stock option exercises by the Company's directors and employees.

Subject to the following discussion, the Company expects its sole source of liquidity over the next twelve months to be cash on hand and cash from operations. The Company anticipates that its capital expenditures required to sustain operations will be in excess of $300,000 for the next fiscal year and will be funded from cash on hand and cash from operations.

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Based upon (i) management's best information as to current national defense priorities, future defense programs, as well as management's expectations as to future defense spending, (ii) the market trends signaling a steady level of bookings, but with an increase in the cost of raw materials and operations that will result in the potential erosion of profit levels and continued price pressures due to intense competition, and (iii) the continued competition in the defense and aerospace market, the Company believes that it will have sufficient cash on hand and cash from continuing operations to satisfy its operating needs over the next 12 months. However, due to the level of current backlog, projected new order intake, the status of the general economy and the shift to Commercial Off-The-Shelf (COTS) products by the defense industry, the Company might operate at breakeven or at a small loss during part of the next fiscal year.

Over the long term, based on these factors and at the current level of bookings, costs of raw materials and services, profit margins and sales levels, the Company believes it will generate sufficient cash to satisfy its operating needs over the next twelve months. In the event that bookings in the long-term decline significantly below the level experienced during the previous two fiscal years, the Company may be required to implement further cost-cutting or other downsizing measures to continue its business operations. Such cost-cutting measures could inhibit future growth prospects. In appropriate situations, the Company may seek strategic alliances, joint ventures with others or acquisitions in order to maximize marketing potential and utilization of existing resources and provide further opportunities for growth.

At February 28, 2014 and February 28, 2013, the Company had cash and cash equivalents of $625,000 and $1,297,000, respectively. The cash decrease was primarily due to an increase in the amount invested in Treasury bills/Certificate of Deposit ("CDs"). At February 28, 2014 and February 28, 2013, the Company had investments in Treasury bills/CDs of $6,261,000 and $5,173,000, respectively. The increase in investments was primarily due to the investment of free cash from operations.

At February 28, 2014, the Company had working capital of $11,128,000 as compared with a working capital at February 28, 2013 of $10,168,000. The increase was primarily due to increases in investments in treasury bills and certificates of deposit and inventory and to a decrease in customer deposits.

See "Environmental Liabilities" and "Properties" in Part I, Items 1 and 2, for more information.

OFF-BALANCE SHEET ARRANGEMENTS

The Company has not engaged in any off-balance sheet arrangements.

BOOKINGS AND BACKLOG

During the fiscal year ended February 28, 2014, the Company's net bookings were $9,134,000 in new orders as compared with $10,114,000 for the year ended February 28, 2013, reflecting a decrease in bookings of approximately 10%. The Company's backlog increased to $8,170,000 at February 28, 2014 as compared with $7,685,000 as of February 28, 2013, reflecting an increase of approximately 6% in backlog. In the event that bookings in the long-term decline significantly below the level experienced in the past 24 to 36 months, the Company may be required to implement additional cost-cutting and other downsizing measures to continue its business operations. Such cost-cutting measures could inhibit future growth prospects and current productivity.

See Part I, Item 1, "Business - Marketing and Customers".

FUTURE PLANS

To increase liquidity, the Company plans to (a) continue improving operating efficiencies, (b) reduce overhead expenses, (c) develop alternative lower cost packaging technologies and lower cost packaging suppliers, (d) develop products utilizing its current manufacturing technologies geared toward market segments it is currently not serving on a significant level or not at all, and (e) replace aging manufacturing equipment with new equipment to improve efficiency.

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The Company also plans to continue its efforts in selling commercial semiconductors and power modules and to develop appropriate strategic alliance arrangements. If these plans are successful, the Company intends to aggressively pursue sales of these products which could require the Company to invest in the building up of inventories of finished goods and invest in capital equipment (assembly and test) to replace older generation equipment and to support new product manufacturing. Any financing necessary to fund these initiatives could come from equipment leasing, among other financing alternatives. Despite its intentions, the Company cannot assure you that any of the above described plans will be successful in increasing liquidity, reducing costs or improving sales.

INFLATION

The rate of inflation has not had a material effect on the Company's revenues and costs and expenses, and it is not anticipated that inflation will have a material effect on the Company in the near future. However, sharp increases in the cost of precious metals has had an adverse impact on the Company's cost of raw materials.

SEASONALITY

The Company's bookings of new orders and sales are largely dependent on congressional budgeting and appropriation activities and the cycles associated therewith. The Company has historically experienced a decreased level of bookings during the summer months as a result of a slowdown in the level of budgeting and appropriation activities.

FORWARD-LOOKING STATEMENTS

Some of the statements in this Annual Report on Form 10-K are "forward-looking statements," as that term is defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements regarding our business, financial condition, results of operations, strategies or prospects. You can identify forward-looking statements by the fact that these statements do not relate strictly to historical or current matters. Rather, forward-looking statements relate to anticipated or expected events, activities, trends or results. Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties. Many factors could cause our actual activities or results to differ materially from the activities and results anticipated in forward-looking statements. These factors include those described under the caption "Risk Factors" in this Annual Report on Form 10-K, including those identified below. We do not undertake any obligation to update forward-looking statements, except as required by law.

Some of the factors that may impact our business, financial condition, results of operations, strategies or prospects include:

Our complex manufacturing processes may lower yields and reduce our revenues. Our business could be materially and adversely affected if we are unable to obtain qualified supplies of raw materials, parts and finished components on a timely basis and at a cost-effective price. We are dependent on government contracts, which are subject to termination, price renegotiations and regulatory compliance, which can increase the cost of doing business and negatively impact our revenues. Changes in government policy or economic conditions could negatively impact our results. Our inventories may become obsolete and other assets may be subject to risks. Environmental regulations could require us to incur significant costs. Our business is highly competitive, and increased competition could reduce gross profit margins and the value of an investment in our Company. Downturns in the business cycle could reduce the revenues and profitability of our business. Our operating results may decrease due to the decline of profitability in the semiconductor industry. Uncertainty of current economic conditions, domestically and globally, could continue to affect demand for our products and negatively impact our business. Cost reduction efforts may be unsuccessful or insufficient to improve our profitability and may adversely impact productivity. We may not achieve the intended effects of our new business strategy, which could adversely impact our business, financial condition and results of operations. Our inability to introduce new products could result in decreased revenues and loss of market share to competitors; new technologies could also reduce the demand for our products. Loss of, or reduction of business from, substantial clients could hurt our business by reducing our revenues, profitability and cash flow. A shortage of three-inch silicon wafers could result in lost revenues due to an inability to build our products. 21



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The nature of our products exposes us to potentially significant product liability risk. We depend on the recruitment and retention of qualified personnel, and our failure to attract and retain such personnel could seriously harm our business. Provisions in our charter documents and rights agreement could make it more difficult to acquire our Company and may reduce the market price of our stock. Natural disasters, like hurricanes, or occurrences of other natural disasters whether in the United States or internationally may affect the markets in which our common stock trades, the markets in which we operate and our profitability. Failure to protect our proprietary technologies or maintain the right to use certain technologies may negatively affect our ability to compete. We cannot promise that we will have sufficient capital resources to make necessary investments in manufacturing technology and equipment. We may make substantial investments in plant and equipment that may become impaired. While we attempt to monitor the credit worthiness of our customers, we may be at risk due to the adverse financial condition of one or more customers. Our international operations expose us to material risks, including risks under U.S. export laws. Security breaches and other disruptions could compromise the integrity of our information and expose us to liability, which could cause our business and reputation to suffer. The price of our common stock has fluctuated widely in the past and may fluctuate widely in the future. Compliance with new regulations regarding the use of "conflict minerals" could limit the supply and increase the cost of certain metals used in manufacturing our products.


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