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SURGE COMPONENTS INC - Quarter Report: 2023 August (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended August 31, 2023

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _______ to _______

 

Commission File No. 000-27688

 

SURGE COMPONENTS, INC.

(Exact name of registrant as specified in its charter)

 

Nevada   11-2602030
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)
     

95 East Jefryn Boulevard

Deer Park, New York

  11729
(Address of principal executive offices)   (Zip Code)

 

(631) 595-1818
(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer Accelerated Filer
Non-accelerated Filer Smaller reporting company
  Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐  No ☒

 

Securities registered pursuant to Section 12(b) of the Act: None

 

The registrant’s common stock outstanding as of October 16, 2023, was 5,569,521 shares of common stock. The registrant’s common stock trades on the OTC Markets under the stock symbol “SPRS.”

 

 

 

 

 

SURGE COMPONENTS, INC

 

TABLE OF CONTENTS

 

  Page
PART I - FINANCIAL INFORMATION  
   
Item 1. Financial Statements 1
   
Consolidated Balance Sheets as of August 31, 2023 (unaudited) and November 30, 2022 1
   
Consolidated Statements of Operations for the nine and three months ended August 31, 2023 and August 31, 2022 (unaudited) 3
   
Consolidated Statements of Comprehenive Income for the nine and three months ended August 31, 2023 and August 31, 2022 (unaudited) 4
   
Consolidated Statements of Changes in Shareholders Equity for the nine months ended August 31, 2023 and August 31, 2022 (unaudited) 5
   
Consolidated Statements of Cash Flows for the nine months ended August 31, 2023 and August 31, 2022 (unaudited) 6
   
Notes to Consolidated Financial Statements (unaudited) 8
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 19
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
   
Item 4. Controls and Procedures 23
   
PART II - OTHER INFORMATION  
   
Item 1. Legal Proceedings 24
   
Item 1A. Risk Factors 24
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 24
   
Item 3. Defaults Upon Senior Securities 24
   
Item 4. Mine Safety Disclosures 24
   
Item 5. Other Information 24
   
Item 6. Exhibits 25
   
SIGNATURES 26

 

i

 

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS.

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Balance Sheets

 

   August 31,
2023
   November 30,
2022
 
   (unaudited)     
ASSETS        
Current assets:        
Cash  $5,957,085   $8,690,040 
Marketable Securities   3,974,283    
-
  
Accounts receivable - net of allowance for doubtful accounts of $173,565 and $173,565   7,288,225    7,230,635 
Inventory, net   5,642,745    6,408,551 
Prepaid expenses and income taxes   335,038    470,847 
Total current assets   23,197,376    22,800,073 
           
Fixed assets – net of accumulated depreciation and amortization of $1,740,041 and $1,687,525   176,334    196,999 
Operating Lease Right of Use Asset   1,284,526    1,362,305 
Deferred income taxes   238,289    229,098 
Other assets   34,299    34,299 
Total assets  $24,930,824   $24,622,774 

 

See notes to consolidated financial statements

 

1

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Balance Sheets

(Continued)

 

   August 31,
2023
   November 30,
2022
 
   (unaudited)     
LIABILITIES AND SHAREHOLDERS’ EQUITY        
Current liabilities:        
Accounts payable  $3,636,254   $4,147,595 
Operating lease liabilities, current maturities   292,509    309,216 
Accrued expenses and taxes   699,811    899,259 
Accrued salaries   525,930    598,519 
Total current liabilities   5,154,504    5,954,589 
Operating lease liabilities net of current maturities   1,124,060    1,164,722 
           
Total liabilities   6,278,564    7,119,311 
           
Commitments and contingencies   
 
    
 
 
           
Shareholders’ equity:          
Preferred stock - $.001 par value, 5,000,000 shares authorized:   
 
    
 
 
Series C–100,000 shares authorized, 10,000 and 10,000 shares issued and outstanding, redeemable, convertible, and a liquidation preference of $5 per share   10    10 
Series D – 75,000 shares authorized, none issued or outstanding, voting, convertible, redeemable.   
 
    
 
 
Common stock - $.001 par value, 50,000,000 shares authorized, 5,569,521 and 5,541,342 shares issued and outstanding   5,569    5,541 
Additional paid-in capital   17,710,532    17,613,060 
Accumulated other comprehensive income – unrealized gain on marketable debt securities   3,596    
-
 
Accumulated equity (deficit)   932,553    (115,148)
Total shareholders’ equity   18,652,260    17,503,463 
           
Total liabilities and shareholders’ equity  $24,930,824   $24,622,774 

 

See notes to consolidated financial statements.

 

2

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Operations

(Unaudited)

 

   Nine Months Ended
August 31,
   Three Months Ended
August 31,
 
   2023   2022   2023     2022 
Net sales  $28,248,853   $40,375,448   $8,857,859   $13,955,954 
                     
Cost of goods sold   20,382,092    29,412,362    6,561,858    10,327,025 
                     
Gross profit   7,866,761    10,963,086    2,296,001    3,628,929 
                     
Operating expenses:                    
Selling and shipping expenses   2,259,745    2,501,208    748,920    823,133 
General and administrative expenses   4,106,287    4,767,820    1,316,604    1,395,580 
Depreciation and amortization   52,516    58,799    17,505    20,728 
                     
Total operating expenses   6,418,548    7,327,827    2,083,029    2,239,441 
                     
Income before other income (expense) and income taxes   1,448,213    3,635,259    212,972    1,389,488 
                     
Other income (expense):                    
                     
Other income   62,144    28,925    32,878    27,401 
Interest expense   
-
    (386)   -    (74)
                     
Other income (expense)   62,144    28,539    32,878    27,327 
                     
Income before income taxes   1,510,357    3,663,798    245,850    1,416,815 
                     
Income taxes   457,656    894,212    112,570    181,392 
                     
Net income   1,052,701    2,769,586    133,280    1,235,423 
Dividends on preferred stock   5,000    5,000    2,500    2,500 
                     
Net income available to common shareholders  $1,047,701   $2,764,586   $130,780   $1,232,923 
                     
Net income per share available to common shareholders:                    
                     
Basic  $.19   $.50   $.02   $.22 
Diluted  $.18   $.48   $.02   $.21 
                     
Weighted Shares Outstanding:                    
                     
Basic   5,556,049    5,532,043    5,569,521    5,541,342 
Diluted   5,752,611    5,733,616    5,766,084    5,742,915 

 

See notes to consolidated financial statements

 

3

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Comprehensive Income

(Unaudited)

 

   Nine Months Ended
August 31,
   Three Months Ended
August 31,
 
   2023   2022   2023     2022 
Net income  $1,052,701   $2,769,586   $133,280   $1,235,423 
                     
Other comprehensive income:                    
                     
Unrealized gain on marketable debt securities   3,596    
-
    3,596    
-
 
                     
Net comprehensive income  $1,056,297   $2,769,586   $136,876   $1,235,423 

 

See notes to Consolidated financial statements

 

4

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Changes in Shareholders’ Equity-unaudited

Nine months ended August 31, 2022 and August 31, 2023

 

  

Shares C

Shares

   Preferred
Amount
   Common
Shares
   Amount   Additional
Paid in
Capital
   Other
Comprehensive
Income
   Accumulated
Deficit
   Total 
Balance – December 1,2021   10,000   $10    5,515,342   $5,515   $17,023,454   $
            -
   $(3,846,294)  $13,182,685 
Preferred Stock Dividends   -    
-
    -    
-
    
-
    
-
    (5,000)   (5,000)
Issuance of shares as Compensation   
-
    
-
    26,000    26    97,474    
-
    
-
    97,500 
Stock Option Exercise   -    
-
    -    
-
    492,132    
-
    
-
    492,132 
Net Income   -    
-
    -    
-
    
-
    
-
    2,769,586    2,769,586 
Balance – August 31, 2022   10,000   $10    5,541,342   $5,541   $17,613,060   $   $(1,081,708)  $16,536,903 

 

   Shares C
Shares
   Preferred
Amount
   Common
Shares
   Amount   Additional
Paid in
Capital
   Other
Comprehensive
Income
   Accumulated
Deficit
   Total 
Balance – December 1, 2022   10,000   $10    5,541,342   $5,541   $17,613,060   $
    -
   $(115,148)  $17,503,463 
Preferred Stock Dividends   -    
-
    -    
-
    
-
    
-
    (5,000)   (5,000)
Issuance of shares as Compensation   
-
    
-
    28,179    28    97,472    
-
    
-
    97,500 
Stock Option Issuance   -    
-
    -    
-
    
-
    3,596    
-
    3,596 
Net Income   -    
-
    -    
-
    
-
    
-
    1 052 701    1,052 701 
Balance – August 31, 2023   10,000   $10    5,541,342   $5,569   $17,710,532   $3,596   $932,553   $18,652,260 

 

See notes to consolidated financial statements.

 

5

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows

(Unaudited)

 

   Nine Months Ended 
   August 31,
2023
   August 31,
2022
 
CASH FLOWS FROM OPERATING ACTIVITIES:        
Net Income  $1,052,701   $2,769,586 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   52,516    58,799 
Deferred income taxes   (9,191)   201,597 
Allowance for doubtful accounts   
-
    23,072 
Stock Compensation   97,500    589,632 
           
CHANGES IN OPERATING ASSETS AND LIABILITIES:          
Accounts receivable   (57,590)   (941,871)
Inventory   765,806    (1,692,057)
Prepaid expenses and income taxes   135,809    75,713 
Other assets   20,410    29,872 
Accounts payable   (511,341)   268,448 
Accrued expenses   (277,037)   (144,996)
           
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES   1,269,583    1,237,795 
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Acquisition of fixed assets   (31,851)   (48,351)
           
NET CASH FLOWS USED IN INVESTING ACTIVITIES  $(31,851)  $(48,351)

 

6

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows

(Continued)

 

   Nine Months Ended 
   August 31,
2023
   August 31,
2022
 
CASH FLOWS FROM FINANCING ACTIVITIES:        
         
Acquisition of marketable securities  $(3,970,687)  $
-
 
           
Repayment of financing lease obligations   
-
    (6,948)
           
NET CASH FLOWS USED IN FINANCING ACTIVITIES   (3,970,687)   (6,948)
           
NET CHANGE IN CASH   (2,732,955)   1,182,496 
           
CASH AT BEGINNING OF PERIOD   8,690,040    6,511,588 
           
CASH AT END OF PERIOD  $5,957,085   $7,694,084 
           
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:          
           
Income taxes paid  $672,248   $617,291 
           
Interest paid  $
-
   $386 
           
NONCASH INVESTING AND FINANCING ACTIVITIES:          
Accrued dividends on preferred stock  $5,000   $5,000 

 

See notes to consolidated financial statements.

 

7

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE A – ORGANIZATION, DESCRIPTION OF COMPANY’S BUSINESS AND BASIS OF PRESENTATION

 

Surge Components, Inc. (“Surge”) was incorporated in the State of New York and commenced operations on November 24, 1981 as an importer of electronic products, primarily capacitors and discrete semi-conductors selling to customers located principally throughout North America. On June 24, 1988, Surge formed Challenge/Surge Inc. (“Challenge”), a wholly-owned subsidiary to engage in the sale of electronic component products and sounding devices from established brand manufacturers to customers located principally throughout North America.

 

In May 2002, Surge and an officer of Surge founded and became sole owners of Surge Components, Limited (“Surge Limited”), a Hong Kong corporation. Under current Hong Kong law, Surge Limited is required to have at least two shareholders. Surge owns 999 shares of the outstanding common stock and the officer of Surge owns 1 share of the outstanding common stock. The officer of Surge has assigned his rights regarding his 1 share to Surge. Surge Limited started doing business in July 2002. Surge Limited operations have been consolidated with the Company. Surge Limited is responsible for the sale of Surge’s products to customers located in Asia.

 

On August 31, 2010, the Company changed its corporate domicile by merging into a newly-formed corporation, Surge Components, Inc. (Nevada), which was formed in the State of Nevada for that purpose. Surge Components Inc. is the surviving entity.

 

In February 2019, the Company converted into a Delaware corporation. The number of authorized shares of common stock was decreased to 50,000,000 shares.

 

In December 2021, the Company changed its corporate domicile to Nevada.

  

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

(1) Principles of Consolidation:

 

The consolidated financial statements include the accounts of Surge, Challenge, and Surge Limited (collectively the “Company”). All material intercompany balances and transactions have been eliminated in consolidation.

 

The accompanying interim consolidated financial statements have been prepared without audit in accordance with the instructions to Form 10Q for interim financial reporting and the rules and regulations of the Securities and Exchange Commissions. In the opinion of management, all adjustments and disclosures necessary for a fair presentation of these financial statements have been included. The results and trends in these interim consolidated financial statements for the nine months ended August 31, 2023 and August 31, 2022 may not be representative of those for the full fiscal year or any future periods.

 

(2) Accounts Receivable:

 

Trade accounts receivable are recorded at the net invoice value and are not interest bearing. The Company considers receivables past due based on the payment terms. The Company reviews its exposure to accounts receivable and reserves specific amounts if collectability is no longer reasonably assured. The Company also reserves a percentage of its trade receivable balance based on collection history and current economic trends that might impact the level of future credit losses. The Company re-evaluates such reserves on a regular basis and adjusts its reserves as needed. Based on the Company’s operating history and customer base, bad debts to date have not been material.

  

(3) Revenue Recognition:

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers: Topic 606.” This ASU replaces nearly all existing U.S. generally accepted accounting principles guidance on revenue recognition. The standard prescribes a five-step model for recognizing revenue, the application of which will require significant judgment by the Company. The Company adopted the standard using the modified retrospective approach in its fiscal year beginning December 1, 2017. The preponderance of the Company’s contracts with customers are standard ship and bill arrangements where revenue is recognized at the time of shipment.

 

8

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

(3) Revenue Recognition (continued):

 

Revenue is recognized for products sold by the Company when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed and determinable, collectability is reasonably assured and title and risk of loss have been transferred to the customer. This occurs when product is shipped from the Company’s warehouse.

 

For direct shipments, revenue is recognized when product is shipped from the Company’s supplier. The Company has a long-term supply agreement with one of our suppliers. The Company purchases the merchandise from the supplier and has the supplier directly ship to the customer through a freight forwarder. Title passes to customer upon the merchandise being received by a freight forwarder. Direct shipments were approximately $1,972,000 and $2,787,000 for the nine months ended August 31, 2023 and August 31, 2022 respectively.

 

The Company also acts as a sales agent to certain customers in North America for one of its suppliers. The Company reports these commissions as revenues in the period earned. Commission revenue totaled $135,130 and $159,796 for the nine months ended August 31, 2023 and August 31, 2022 respectively.

 

The Company performs ongoing credit evaluations of its customers and maintains reserves for potential credit losses.

 

The Company and its subsidiaries currently have agreements with several distributors. There are no provisions for the granting of price concessions in any of the agreements. Revenues under these distribution agreements were approximately $6,358,000 and $10,592,000 for the nine months ended August 31, 2023 and August 31, 2022 respectively.

 

(4) Inventories:

 

Inventories, which consist solely of products held for resale, are stated at the lower of cost (first-in, first-out method) or net realizable value. Products are included in inventory when the Company obtains title and risk of loss on the products, primarily when shipped from the supplier. Inventory in transit principally from foreign suppliers at August 31, 2023 was $781,564. The Company at August 31, 2023, has a reserve against slow moving and obsolete inventory of $341,063. From time to time the Company’s products are subject to legislation from various authorities on environmental matters.

 

(5) Depreciation and Amortization:

 

Fixed assets are recorded at cost. Depreciation is generally calculated on a straight line method and amortization of leasehold improvements is provided for on the straight-line method over the estimated useful lives of the various assets as follows:

 

Furniture, fixtures and equipment   5 - 7 years
Computer equipment   5 years
Leasehold Improvements   Estimated useful life or lease term, whichever is shorter

 

Maintenance and repairs are expensed as incurred while renewals and betterments are capitalized.

 

(6) Concentration of Credit Risk:

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of accounts receivable. The Company maintains substantially all of its cash balances in a limited number of financial institutions. At August 31, 2023 and November 30, 2022, the Company’s uninsured cash balances totaled $5,343,944 and $7,375,544, respectively.

 

9

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

(7) Income Taxes:

 

The Company’s deferred income taxes arise primarily from the differences in the recording of net operating losses, allowances for bad debts, inventory reserves and depreciation expense for financial reporting and income tax purposes. A valuation allowance is provided when it has been determined to be more likely than not that the likelihood of the realization of deferred tax assets will not be realized. See Note I.

 

The Company follows the provisions of the Accounting Standards Codification topic, ASC 740, “Income Taxes” (ASC 740). There have been no unrecognized tax benefits and, accordingly, there has been no effect on the Company’s financial condition or results of operations as a result of ASC 740.

 

The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company is no longer subject to U.S. federal tax examinations for years before fiscal years ending November 30, 2019, and state tax examinations for years before fiscal years ending November 30, 2018. Management does not believe there will be any material changes in our unrecognized tax positions over the next twelve months.

 

The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of ASC 740, there was no accrued interest or penalties associated with any unrecognized benefits, nor was any interest expense recognized during the nine months ended August 31, 2023 and August 31, 2022.

 

(8) Cash Equivalents:

 

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.

 

(9) Use of Estimates:

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

(10) Marketing and promotional costs:

 

Marketing and promotional costs are expensed as incurred and have not been material to date. The Company has contractual arrangements with several of its distributors which provide for cooperative advertising rights to the distributor as a percentage of sales. Cooperative advertising is reflected as a reduction in revenues and has not been material to date.

 

(11) Fair Value of Financial Instruments:

 

The carrying amount of cash balances, accounts receivable, accounts payable and accrued expenses approximate their fair value based on the nature of those items. Estimated fair values of financial instruments are determined using available market information and appropriate valuation methodologies. Considerable judgment is required to interpret the market data used to develop the estimates of fair value, and accordingly, the estimates are not necessarily indicative of the amounts that could be realized in a current market exchange.

 

(12) Marketable securities and other investments

 

Our marketable securities are stated at fair value in accordance with ASC Topic 321, Investments- Equity Securities. Any changes in the fair value of the Company’s marketable debt securities are included in the statement of other comprehensive income. The market value of the securities is determined using prices as reflected on an established market. Realized and unrealized gains and losses are determined on an average cost basis. The marketable securities are investments predominately in Treasury bills treasury notes which are being invested until such time the funds are needed for operations and reflected as available for sale debt securities. 

 

The value of these marketable securities at August 31, 2023 and November 30, 2022 is as follows:

 

   August 31,   November 30, 
   2023   2022 
Cost  $3,970,687   $
       -
 
Gross unrealized gain   3,596    
-
 
Gross unrealized loss   
-
    
-
 
Fair value  $3,974,283   $
-
 

 

10

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

(13) Shipping Costs

 

The Company classifies shipping costs as a component of selling expenses. Shipping costs totaled $1,572 and $2,719 for the nine months ended August 31, 2023 and August 31, 2022 respectively.

 

(14) Earnings Per Share

 

Basic earnings per share includes no dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. The difference between reported basic and diluted weighted-average common shares results from the assumption that all dilutive stock options and convertible preferred stock exercised into common stock. Total potentially dilutive shares excluded from diluted weighted shares outstanding at August 31, 2023 and August 31, 2022 totaled 263,438 and 258,427, respectively.

 

(15) Stock Based Compensation

 

Stock Based Compensation to Employees

 

The Company accounts for its stock-based compensation for employees in accordance with Accounting Standards Codification (“ASC”) 718. The Company recognizes in the statement of operations the grant-date fair value of stock options and other equity-based compensation issued to employees and non-employees over the related vesting period.

 

Stock Based Compensation to Other than Employees

 

The Company accounts for equity instruments issued in exchange for the receipt of goods or services from other than employees in accordance with ASC 718. Costs are measured at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably determinable. The value of equity instruments issued for consideration other than employee services is determined on the earlier of a performance commitment or completion of performance by the provider of goods or services. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.

 

(16) Leases:

 

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (“Topic 842”). Topic 842 requires the entity to recognize the assets and liabilities for the rights and obligations created by leased assets. Leases will be classified as either finance or operating, with classification affecting expense recognition in the income statement.

 

On December 1, 2019, the Company adopted Topic 842 applying the optional transition method, which allows an entity to apply the new standard at the adoption date with a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. As a result of adopting Topic 842, the Company recognized assets and liabilities for the rights and obligations created by operating leases totaling approximately $290,000.

 

The Company determines if a contract contains a lease at inception based on whether it conveys the right to control the use of an identified asset. Substantially all of the Company’s leases are classified as operating leases. The Company records operating lease right-of-use assets within “Other assets” and lease liabilities are recorded within “current and noncurrent liabilities” in the consolidated balance sheets. Lease expenses are recorded within “General and administrative expenses” in the consolidated statements of operations. Operating lease payments are presented within “Operating cash flows” in the consolidated statements of cash flows.

 

11

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

(16) Leases (continued):

 

Operating lease right-of-use assets and lease liabilities are recognized based on the net present value of future minimum lease payments over the lease term starting on the commencement date. The Company generally is not able to determine the rate implicit in its leases and, as such, applies an incremental borrowing rate based on the Company’s cost of borrowing for the relevant terms of each lease. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term. Lease terms may include an option to extend or terminate a lease if it is reasonably certain that the Company will exercise such options. The Company has elected the practical expedient to not separate lease components from non-lease components, and also has elected not to record a right-of-use asset or lease liability for leases which, at inception, have a term of twelve months or less. Variable lease payments are recognized in the period in which the obligation for those payments is incurred.

 

NOTE C – FIXED ASSETS

 

Fixed assets consist of the following:

 

   August 31,   November 30, 
   2023   2022 
Furniture and Fixtures  $327,971   $327,971 
Leasehold Improvements   1,070,044    1,062,449 
Computer Equipment   518,360    494,104 
Less-Accumulated Depreciation   (1,740,041)   (1,687,525)
Net Fixed Assets  $176,334   $196,999 

 

Depreciation and amortization expense for the nine months ended August 31, 2023 and August 31, 2022 were $52,516 and $58,799, respectively.

 

NOTE D – FINANCING LEASE OBLIGATIONS

 

The Company is obligated under financing leases for telephone equipment. The Company leases equipment under two capital lease arrangements with NEC Financial Services. Pursuant to the leases, the lessor retains actual title to the leased property until the termination of the lease, at which time the equipment can be purchased for one dollar for each lease. The terms of the leases are 60 months with a combined monthly payment of $815, respectively. The assumed interest rates on the leases are 9.342%. The leases terminated in 2022.

 

12

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE E – LOANS PAYABLE

 

In February 2017, the Company obtained a line of credit with a bank for up to $3,000,000 (the “Credit Line”). Borrowings under the Credit Line are due upon demand and accrue interest at the greater of the prime rate or the LIBOR rate plus two percent (and may be increased by three percent in the event the Company fails to (i) repay all amounts due on the Credit Line upon demand or (ii) comply with any terms or conditions relating to the Credit Line). The Credit Line is collateralized by substantially all the assets of the Company. As of August 31, 2023, the balance on the Credit Line was $0. As of August 31, 2023, the Company was in compliance with the covenant for the debt service coverage ratio for the Credit Line.  Effective July 1, 2023, the use of the LIBOR rate was discontinued and replaced with the secured overnight financing rate (SOFR).

 

NOTE F – ACCRUED EXPENSES

 

Accrued expenses consist of the following:

 

   August 31,   November 30, 
   2023   2022 
Commissions  $265,976   $366,766 
Preferred stock dividends   166,569    161,569 
Other accrued expenses   267,266    370,924 
           
   $699,811   $899,259 

 

NOTE G – RETIREMENT PLAN

 

In June 1997, the Company adopted a qualified 401(k) retirement plan for all full-time employees who are twenty-one years of age and have completed twelve months of service. The plan allows total employee contributions of up to fifteen percent (15%) of the eligible employee’s salary through salary reduction. The Company makes a matching contribution of twenty percent (20%) of each employee’s contribution for each dollar of employee deferral up to five percent (5%) of the employee’s salary. Net assets for the plan, as estimated by Axa Equitable, Inc., which maintains the plan’s records, were approximately $1,752,000 at November 30, 2022. Pension expense for the nine months ended August 31, 2023 and August 31, 2022 was $26,751 and $898, respectively.

 

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SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE H – SHAREHOLDERS’ EQUITY

 

[1] Preferred Stock:

 

In February 1996, the Company amended its Certificate of Incorporation to authorize the issuance of 1,000,000 shares of preferred stock in one or more series. In August 2010, the number of preferred shares authorized for issuance was increased to 5,000,000 shares.

 

In November 2000, the Company authorized 100,000 shares of preferred stock as Non-Voting Redeemable Convertible Series C Preferred Stock (“Series C Preferred”). Each share of Series C Preferred is automatically convertible into 10 shares of our common stock upon shareholder approval. If the Series C Preferred were converted into common stock on or before April 15, 2001, these shares were entitled to cumulative dividends at the rate of $.50 per share per annum commencing April 15, 2001 payable on June 30 and December 31 of each year. In November 2000, 70,000 shares of the Series C Preferred were issued in payment of financial consulting services to its investment banker and a shareholder of the Company.

 

Dividends aggregating $166,569 have not been paid for the semi-annual periods ended December 31, 2001 through the semi-annual payment due December 31, 2022. The Company has accrued these dividends. At August 31, 2023, there are 10,000 shares of Series C Preferred issued and outstanding.

 

In October 2016, the Company authorized 75,000 shares of preferred stock as Voting Non-Redeemable Convertible Series D Preferred Stock (“Series D Preferred”). None of the Series D Preferred Stock is outstanding as of August 31, 2023.

   

[2] 2015 Incentive Stock Plan

 

In November 2015, the Company adopted and the shareholders ratified, the 2015 Incentive Stock Plan (“2015 Stock Plan”). The 2015 Stock Plan provides for the grant of options to officers, employees, directors or consultants to the Company to purchase an aggregate of 1,500,000 common shares.

 

In April 2021, a total of 26,786 shares were issued to the Company’s officers as a part of their 2021 bonus compensation under the 2015 stock plan. The Company recorded a cost of $75,000 relating to the issuance of these shares in the second quarter of 2021.

 

In March 2022, a total of 26,000 shares were issued to the Company’s officers as part of their bonus compensation under the 2015 stock plan. The Company recorded a cost of $97,500 relating to the issuance of these shares in the second quarter of 2022.

 

In March 2022, the Company granted stock options to (a) four non-employee directors to each purchase 20,000 shares of common stock, (b) one non-employee-director to purchase 30,000 shares of common stock, and (c) two Company officers to each purchase 40,000 shares of common stock at an exercise price of $3.55 per share, the market price of the common stock on the date of the grant. These options vest immediately and expire five years from the grant date. The Company recorded a cost of $492,132 related to the granting of these options.

 

In April 2023, a total of 28,179 shares were issued to the Company’s officers as part of their bonus compensation under the 2015 stock plan. The Company recorded a cost of $97,500 relating to the issuance of these shares in the second quarter of 2023.

 

14

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE H – SHAREHOLDERS’ EQUITY (Continued)

 

[2] 2015 Incentive Stock Plan (continued)

 

Activity in the Company’s stock plans for the period ended August 31, 2023 is summarized as follows:

 

   Shares   Weighted
Average
Exercise
Price
 
Options outstanding December 1, 2022   360,000   $2.54 
Options issued in the nine months ended August 31, 2023   
-
   $
-
 
Options exercised in the nine months ended August 31, 2023   
-
   $
-
 
Options cancelled in the nine months ended August 31, 2023   
-
   $
-
 
Options outstanding at August 31, 2023   360,000   $2.54 
Options exercisable at August 31, 2023   360,000   $2.54 

 

The intrinsic value of the exercisable options at August 31, 2023 totaled $304,300. At August 31, 2023 the weighted average remaining life of the stock options is 2.71 years. At August 31, 2023, there was no unrecognized compensation cost related to the stock options granted under the plan.

 

[3] Compensation of Directors

 

Compensation for each non-employee director is $3,000 per month (and $4,000 per month for a non-employee director that serves as the chairman of more than two committees of the Board of Directors).

 

NOTE I – INCOME TAXES

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes using the enacted tax rates in effect in the years in which the differences are expected to reverse.

 

The Company’s deferred income taxes are comprised of the following:

 

   August 31,   November 30, 
   2023   2022 
Deferred Tax Assets        
Depreciation  $31,317   $35,771 
Allowance for bad debts   36,651    36,651 
Inventory   83,875    81,523 
Deferred rent   34,022    28,523 
Other   52,424    46,630 
           
Total deferred tax assets   238,289    229,098 
Valuation allowance   
-
    
-
 
Deferred Tax Assets  $238,289   $229,098 

 

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SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE I – INCOME TAXES (Continued)

 

A valuation allowance for the deferred tax assets relates principally to the uncertainty of the utilization of deferred tax assets and was calculated in accordance with the provisions of ASC 740, which requires that a valuation allowance be established or maintained when it is “more likely than not” that all or a portion of deferred tax assets will not be realized.

 

The Company’s income tax expense consists of the following:

 

   Nine Months Ended 
   August 31,
2023
   August 31,
2022
 
Current:        
Federal  $322,894   $520,869 
States   125,571    171,746 
    448,465    692,615 
           
Deferred:          
Federal   6,618    159,266 
States   2,573    42,331 
    9,191    201,597 
Provision for income taxes  $457,656   $894,212 

 

The Company files a consolidated income tax return with its wholly-owned subsidiaries. A reconciliation of the difference between the expected income tax rate using the statutory federal tax rate and the Company’s effective rate is as follows:

 

   Nine months ended 
   August 31,   August 31, 
   2023   2022 
U.S Federal Income tax statutory rate   21%   21%
State income taxes   5%   5%
Other   4%   (2)%
           
Effective tax rate   30%   24%

 

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SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE J – OPERATING LEASE COMMITMENTS

 

The Company leases its office and warehouse space through 2030 from a corporation that is partly owned by officers/shareholders of the Company (“Related Company”). Annual minimum rental payments to the Related Company approximated $194,000 for the year ended November 30, 2022, and increase at the rate of two per cent per annum throughout the lease term.

 

Pursuant to the lease, rent expense charged to operations differs from rent paid because of scheduled rent increases. Accordingly, the Company has recorded deferred rent. Rent expense is calculated by allocating to rental payments, including those attributable to scheduled rent increases, on a straight line basis, over the lease term.

 

The Company has a lease to rent office space and a warehouse in Hong Kong through June 2025. Annual minimum rental payments for this space are approximately $73,580.

 

The Company has a lease to rent additional warehouse space in Hong Kong through November 30, 2023. Annual minimum rental payments for this space are approximately $70,908.

 

The Company’s future minimum rental commitments at August 31, 2023 are as follows:

 

Twelve Months Ended August 31,

 

2024  $292,509 
2025   266,543 
2026   209,332 
2027   213,518 
2028   217,788 
2029 and after   467,644 
   $1,667,334 

 

Net rental expense for the nine months ended August 31, 2023 and August 31, 2022 were $342,702 and $334,512 respectively, of which $208,703 and $205,797 respectively, was paid to the Related Company.

 

NOTE K – EMPLOYMENT AND OTHER AGREEMENTS

 

In February 2016, the Company entered into revised employment agreements with two officers of the Company. Pursuant to these agreements, the base salary for one officer is $275,000 and the base salary for the other officer is $225,000. The agreements continue until terminated by either party.  In April 2021, the base salaries for the two officers were amended to $300,000 for one officer and $250,000 for the other officer.

 

The Company’s compensation committee may award these officers with bonuses and will review the base salary amounts for each of the officers on an annual basis to determine if any changes to the base salary amounts need to be made and may also award these officers with annual bonuses. Pursuant to the employment agreements, the officers are prohibited from engaging in activities which are competitive with those of the Company during their employment with the Company and for one year following termination. If the agreement is terminated other than for cause, the officer would be entitled to all base salary earned through the date of termination, accrued but unused vacation, all vested equity, and bonus amounts payable to the officer through the date of termination. The officers would also be entitled to receive an additional thirty-six months of annual compensation equal to the average of his base salary and bonus for the three calendar years prior to the date of termination, payable in accordance with the Company’s regular payroll practice over a 52-week period.

 

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SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE L – MAJOR CUSTOMERS

 

The Company had two customers who accounted for 20% and 17% of net sales for the nine months ended August 31, 2023 and two customers who accounted for 11% and 20% of net sales for the nine months ended August 31, 2022. The Company had one customer who accounted for 30% of accounts receivable August 31, 2023 and 23% of accounts receivable at August 31, 2022.

 

NOTE M – MAJOR SUPPLIERS

 

During the nine months ended August 31, 2023 and August 31, 2022 there was one foreign supplier accounting for 31% and 33% of total inventory purchased.

 

The Company purchases substantially all of its products overseas. For the nine months ended August 31, 2023, the Company purchased 34% of its products from Taiwan, 20% from Hong Kong, 28% from elsewhere in Asia and less than 1% overseas outside of Asia. The Company purchases the balance of its products in the United States.

 

NOTE N – EXPORT SALES

 

The Company’s export sales were as follows:

 

   Nine Months Ended 
   August 31,   August 31, 
   2023   2022 
Canada   4,566,475    7,022,916 
China   4,368,805    6,894,691 
Other Asian Countries   1,088,886    1,674,555 
South America   145,240    108,496 
Europe   843,719    1,803,648 

 

Revenues are attributed to countries based on location of customer.

 

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ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

This report contains forward-looking statements. All statements other than statements of historical facts contained herein, including statements regarding our future results of operations and financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Furthermore, we cannot at this time assess the affect that the global outbreak of the novel Coronavirus may have on the Company.

 

In some cases, forward-looking statements can be identified by terms such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words. These statements are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. We discuss many of the risks in greater detail under the heading “Risk Factors” in our most recent Annual Report on Form 10-K. Also, these forward-looking statements represent our estimates and assumptions only as of the date of the filing of this report. Except as required by law, we assume no obligation to update any forward-looking statements after the date of the filing of this report.

 

Overview

 

The Company operates with two sales groups, Surge Components (“Surge”) and Challenge Electronics (“Challenge”). Surge is a supplier of electronic products and components. These products include capacitors, which are electrical energy storage devices, and discrete semiconductor components, such as rectifiers, transistors and diodes, which are single function low power semiconductor products that are packaged alone as compared to integrated circuits such as microprocessors. The products sold by Surge are typically utilized in the electronic circuitry of diverse products, including, but not limited to, automobiles, audio products, temperature control products, lighting products, energy related products, computer related products, various types of consumer products, garage door openers, household appliances, power supplies and security equipment. These products are sold to both original equipment manufacturers, commonly referred to as OEMs, who incorporate them into their products, and to distributors of the lines of products we sell, who resell these products within their customer base. These products are manufactured predominantly in Asia by approximately sixteen independent manufacturers. We act as the master distribution agent utilizing independent sales representative organizations in North America to sell and market the products for one such manufacturer pursuant to a written agreement. When we act as a sales agent, our supplier who sold the product to the customer that we introduced to our supplier pays us a commission. The amount of the commission is determined on a sale by sale basis depending on the profit margin of the product. Commission revenue totaled $135,130 and $159,796 for the nine months ended August 31, 2023 and August 31, 2022 respectively.

 

Challenge is engaged in the sale of electronic components. In 1999, Challenge began as a division to sell audible components. We have been able to increase the types of products that we sell because some of our suppliers introduced new products, and we also located other products from new suppliers. Our core products include buzzers, speakers, microphones, resonators, alarms, chimes, filters, and discriminators. We now also work with our suppliers to have our suppliers customize many of the products we sell for many customers through the customers’ own designs and those that we work with our suppliers to have our suppliers redesign for them at our suppliers’ factories. We have an engineer on our staff who works with our suppliers on such redesigns and assists with the introduction of new product lines. We are continually looking to expand the line of products that we sell. We sell these products through independent representatives that earn a commission on the products we sell. We are also working with local, regional, and national distributors to sell these products to local accounts in every state. Challenge also at times handles the brokering of certain products, helping their customers find parts that regular suppliers can’t deliver.

 

19

 

 

The Company has a Hong Kong office to effectively handle the transfer business from United States customers purchasing and manufacturing in Asia after designing the products in the United States. This office has strengthened the Company’s global position, improving our capabilities and service to our customer base.

 

The world of business continues to change because of “disruptors,” which are significant changes in traditional business practices that did not previously exist. For example, customers continue to centralize purchasing from regional purchasing and are stretching their payment terms. These changes also include customers moving their manufacturing operations from North America to Asia, and the trend of globalization. Some of our customers have been involved in mergers and acquisitions, causing consolidation. This trend makes business more complicated and costly for the Company. The Company must have a presence in Asia to service and further develop the business. For these reasons, we established Surge Ltd., our Hong Kong subsidiary. Currency fluctuations may also have an effect on doing business outside of North America. Customers have moved to reduce their supply chain, which could adversely affect the Company. In some market segments, demand for electronic components has decreased, and in other segments, the demand is still strong. Some technologies have become obsolete, while customers develop new products using different kinds of components. One division in the Company has had success in designing new products for customers to help these customers products have better performance capabilities. This proactive approach separates the Company from selling commodity products to more customized products Management expects the remainder of 2023, continuing into 2024, to be a period of continued change, in regard to pandemic healing, inflation and general economic conditions, challenge, in regard to maintaining consistent flow of products during shortages of certain products, and growth as we see our customers return to full production pace. These challenges could affect the Company in negative ways, possibly reducing sales and or profitability. Because of a labor shortage, our customers engineering staff has been challenged, so getting our products approved has been and will continue to take longer to achieve. Additionally, the cost of raw materials has continued to increase, and due to that fact, our costs have increased. The Company in the first half of the year has been able to handle the brokering of certain semiconductor products, helping their customers to keep product lines up and running by locating products that their regular suppliers can’t deliver. In order for the Company to continue to grow, we will depend on, among other things, the continued growth of the electronics and semiconductor industries, our ability to withstand intense price competition, our ability to obtain new customers, our ability to retain and attract sales and other key personnel in order to expand our marketing capabilities, our ability to secure adequate sources of products, which are in demand on commercially reasonable terms, our success in executing and managing growth, including monitoring an expanded level of operations and systems, controlling costs, the availability of adequate financing, the continued supply of products from our factories, the ability to withstand higher transportation costs and longer travel times due to the backup at the ports and our ability to deal successfully, with new and future disruptors. The tariffs continue to impact the Company, although less now then previously. The general supply chain challenges present both a challenge and opportunity to the Company. The Company is cautiously optimistic about its ability to meet these challenges with continued growth unless the general economic conditions deteriorate. Financial news has been talking about the decreases in consumer demand which impacts negatively the demand for The Company’s products, as the customers are producing less of their products. These economic conditions could have a negative impact on sales into 2024. The combination of disruptors such as increased costs and longer lead times from factories to the Company could also have negative impacts on the business in the future. The tense relations between America and China could also impact the Company’s business. China could impose rules and laws that make it more difficult to do business in Hong Kong and China. The Company is taking steps to be well prepared in case of any actions from China that would cause us business disruption. For example, most of the Company’s factory partners have opened production facilities outside of China. As economic conditions have deteriorated, it has impacted the Company’s business. Customers have pushed back delivery dates, and in some cases required cancellations because they over ordered in 2022 creating a significant excess inventory. We are watching closely as customers adjust their inventory levels to reflect this new business demand, and the Company will respond accordingly. We expect that it could take four to six quarters for these customers to consume this excess inventory and start ordering products again which will reflect in the Company’s sales.

 

20

 

 

Critical Accounting Estimates

 

Accounts Receivable

 

The allowance for doubtful accounts is based on the Company’s assessment of the collectability of specific customer accounts and an assessment of international, political and economic risk as well as the aging of the accounts receivable. If there is a change in actual defaults from the Company’s historical experience, the Company’s estimates of recoverability of amounts due could be affected and the Company would adjust the allowance accordingly.

 

Revenue Recognition

 

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed and determinable, collectability is reasonably assured and title and risk of loss have been transferred to the customer. This occurs when product is shipped from the Company’s warehouse. For direct shipments from our suppliers to our customer, revenue is recognized when product is shipped from the Company’s supplier. The Company acts as a sales agent for certain customers buying direct from one of its suppliers. The Company reports these commissions as revenues in the period earned.

 

The Company performs ongoing credit evaluations of its customers and maintains reserves for potential credit losses.

 

Inventory Valuation

 

Inventories are recorded at the lower of cost or net realizable value. Write-downs of inventories to net realizable value are based on stock rotation, historical sales requirements and obsolescence as well as in the changes in the backlog. Reserves required for obsolescence were not material in any of the periods in the financial statements presented. If market conditions are less favorable than those projected by management, additional write-downs of inventories could be required. For example, each additional 1% of obsolete inventory would reduce operating income by approximately $60,000.

 

The Company does not have price protection agreements with any of its vendors and assumes the risk of changes in the prices of its products. The Company does not believe there to be a significant risk with regards to the lack of price protection agreements as many of its inventory items are purchased to fulfill purchase orders received.

 

Income Taxes

 

We have made a number of estimates and assumptions relating to the reporting of a deferred income tax asset to prepare our financial statements in accordance with generally accepted accounting principles. These estimates have a significant impact on our valuation allowance relating to deferred income taxes. Our estimates could materially impact the financial statements.

 

Results of Operations

 

Consolidated net sales for the nine months ended August 31, 2023 decreased by $12,126,595 or 30.0%, to $28,248,853 as compared to net sales of $40,375,448 for the nine months ended August 31, 2022. Consolidated net sales for the three months ended August 31, 2023 decreased by $5,098,095 or 36.5%, to $8,857,859 as compared to net sales of $13,955,954 for the three months ended August 31, 2022. We attribute the decrease to a decrease in business with new customers as well as a decrease in business with existing customers. We can also attribute the decrease to customers pushing out orders due to them over ordering in 2022. The customers have excess inventory that they need to consume before ordering those products. Additionally, many customers because of having this excess inventory have not launched new product development as their cash is tied up in the inventory. We can also attribute some of the decrease in sales to the decrease in revenue derived from brokering certain products in the nine months ended August 31, 2022 in the amount of approximately $3.6 million in the nine months ended August 31, 2022 but only $217,000 in the nine months ended August 31, 2023. In Brokering, the Company helps customers find parts that their regular suppliers can not deliver. This was the result of shortages of certain products in 2022. Net sales for the nine months ended August 31, 2023 and August 31, 2022 reflect $872,224 and $1,035,423, respectively of tariff costs that the Company was able to pass on to its customers.

 

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Our gross profit for the nine months ended August 31, 2023 decreased by $3,096,325 to $7,866,761, or 28.2%, as compared to $10,963,086 for the nine months ended August 31, 2022. Gross margin as a percentage of net sales increased to 27.8% for the nine months ended August 31, 2023 compared to 27.2% for the nine months ended August 31, 2022. Gross profit for the three months ended August 31, 2023 decreased by $1,332,928 to $2,296,001, or 36.7%, as compared to $3,628,929 for the three months ended August 31, 2022. Gross margin as a percentage of net sales decreased slightly to 25.9% for the three months ended August 31, 2023 compared to 26% for the three months ended August 31, 2022. We attribute the decrease in gross profit to a decrease in sales volume in the nine and three months ended August 31, 2023. We attribute the increase in gross margin as a percentage of net sales to the Company shipping out orders with a higher profit margin during the nine months ended August 31, 2023.We attribute the decrease in gross profit as a percentage of sales for the three months ended August 31, 2023 to the Company’s decrease in sales volume for some of its customers with higher profit margins and increase in sales volume for customers with a lower gross profit margin. Our industry will continue to receive pressure from customers for price reductions. Some of them further demand periodic price reductions on a quarterly or semi-annual basis, as opposed to annual fixed pricing. We work with electronic manufacturing service subcontractor customers who manufacture products for other customers who do not have their own manufacturing operations. At times we are not able to recover these price reductions from our suppliers. The Company has agreements with these subcontractor customers to provide periodic cost reductions through rebates in the amount of 5%. These reductions only affect future shipments of our products, and do not affect existing orders. These reductions can have a negative impact on our profit margins since they reduce the amount of commission we can earn. Even though this rebate can impact the Company’s gross profit margin, these subcontractor customers represent very significant potential growth for the Company, because they can help the Company become an approved supplier at the customers they manufacture for, and they purchase our components for these customers. We believe it would be very difficult for the Company to achieve business at these customers without the help of these subcontractor customers. During the nine months ended August 31, 2023, the Company was impacted by tariff costs on certain products imported from China, which went into effect as of July 6, 2018. The Company has been able to pass along a portion of these costs to its customers. The Company also moved some customer deliveries directly to Hong Kong in order to mitigate some of these costs. In the balance of 2023, the Company expects the effects of the tariffs to be similar to 2022.

 

Selling and shipping expenses for the nine months ended August 31, 2023 was $2,259,745, a decrease of $241,463 or 9.7%, as compared to $2,501,208 for nine months ended August 31, 2022. Selling and shipping expenses for the three months ended August 31, 2023 was $748,920, a decrease of $74,213, or 9.0%, as compared to $823,133 for three months ended August 31, 2022. We attribute the decrease for the nine months ended August 31, 2023 to a decrease in commission expenses, as well as freight out and messenger and delivery expenses. These decreases were offset by increases in salesman payroll due to the hiring of new regional sales managers, trade show expenses and travel expenses. We attribute the decrease for the three months ended August 31, 2023 to decreases in commission expense offset by increases in Salesman payroll, travel and trade show expenses as well as freight out expenses.

 

General and administrative expenses for the nine months ended August 31, 2023 was $4,106,287, a decrease of $661,533, or 13.9%, as compared to $4,767,820 for the nine months ended August 31, 2022. General and administrative expenses for the three months ended August 31, 2023 was $1,316,604, a decrease of $78,976 or 5.7% as compared to $1,395,580 for the three months ended August 31, 2022. The decrease for the nine months ended August 31 2023 is due primarily to decreases in health insurance and office expenses as well as officer salary and directors fees due to stock option grants in 2022, professional fees and temporary help expenses. These decreases were offset by increases in salaries, rent expenses as well as computer expenses and pension expenses, as well as general insurance and consulting expenses. The decreases for the three months ended August 31, 2023 can be attributed to decreases in officers salary, health insurance and general insurance as well as decreases in temporary help expenses, office expenses and bad debt expenses as partially offset by increases in salaries, rent expenses, computer expenses as well as professional fees and consulting expenses.

 

Depreciation expense for the nine months ended August 31, 2023 was $52,516, a decrease of $6,283, or 10.7%, as compared to $58,799 for the nine months ended August 31, 2022. Depreciation expense for the three months ended August 31, 2023 was $17,505, a decrease of $3,223, or 15.5%, as compared to $20,728 for the three months ended August 31, 2022. The decrease is due to lower company purchasing of new equipment during the nine months ended August 31, 2023.

 

Tax expense for the nine months ended August 31, 2023 was $457,656, a decrease of $436,556 as compared to a tax expense of $894,212 for the nine months ended August 31, 2022. Tax expense for the three months ended August 31, 2023 was $112,570, a decrease of $68,822 as compared to a tax expense of $181,392 for the three months ended August 31, 2022. The changes result from our decrease in net income for such periods.

 

As a result of the foregoing, net income for the nine months ended August 31, 2023 was $1,052,701, compared to a net income of $2,769,586 for the nine months ended August 31, 2022. The net income for the three months ended August 31, 2023 was $133,280, compared to a net income of $1,235,423 for the three months ended August 31, 2022.

 

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Liquidity and Capital Resources 

 

As of August 31, 2023 we had cash of $5,957,085, and working capital of $18,042,872. We believe that our working capital levels are adequate to meet our operating requirements during the next twelve months and beyond. The Company is exploring and evaluating opportunities for growth and expansion using the Company’s cash resources. The Company has historically held its cash in a limited number of financial institutions. In light of the collapse of the Silicon Valley Bank and Signature Bank, the Company is in the process of reevaluating alternative cash management strategies. In June 2023, the Company moved approximately $4,000,000 of its cash to Treasury Bills.

 

During the nine months ended August 31, 2023, we had net cash flow provided by operating activities of $1,269,583, as compared to net cash flow provided by operating activities of $1,237,795 for the nine months ended August 31, 2022. The increase in cash flow from operating activities totalling approximately $32,000 was primarily the result of lower net income and accounts payable and accrued expenses as offset by lower inventory levels.

 

We had net cash flow used in investing activities of $(31,851) for the nine months ended August 31, 2023, as compared to net cash flow used in investing activities of $(48,351) for the nine months ended August 31, 2022. We attribute the change to the Company purchasing less new equipment during the nine months ended August 31, 2023 than in 2022.

 

We had net cash flow used by financing activities of $(3,970,687) during the nine months ended August 31, 2023 as compared to $(6,948) provided by financing activities for nine months ended August 31, 2022. The increase in cash used for financing activities in the nine months ended August 31, 2023 was the result of the acquisition of marketable debt securities in the form of Treasury bills and notes issued by the United States Treasury.

 

As a result of the foregoing, the Company had a net decrease in cash of $2,732,955 for the nine months ended August 31, 2023, as compared to a net increase in cash of $1,182,496 for the nine months ended August 31, 2022.

 

The table below sets forth our contractual obligations, including long-term debt, operating leases and other long-term obligations, as of August 31, 2023:

 

       Payments due         
       0 – 12   13 – 36   37 – 60   More than 
Contractual Obligations  Total   Months   Months   Months   60 Months 
Financing Lease Obligations  $-   $-   $-   $-   $- 
Operating leases  $1,667,334    292,509    475,875    431,306    467,644 
Total obligations  $1,667,334   $292,509   $475,875   $431,306   $467,644 

 

Off Balance Sheet Arrangements

 

We do not have any off balance sheet arrangements.

  

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not applicable.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls and Procedures

 

The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934, as amended (“Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (“Commission”). Ira Levy, the Company’s principal executive officer and principal financial officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of August 31, 2023 and has concluded that, as of such date, our disclosure controls and procedures were effective.

 

Changes in Internal Controls

 

During the three months ended August 31, 2023 there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS.

 

There are no legal proceedings to which the Company or any of its property is the subject.

 

ITEM 1A. RISK FACTORS.

 

Not applicable.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Not applicable.

 

ITEM 5. OTHER INFORMATION.

 

None.

 

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ITEM 6. EXHIBITS.

 

Exhibit
Number
  Description
3.1   Articles of Incorporation of the Registrant (Incorporated by reference to Exhibit 3.3 to the Current Report on Form 8-K (File No. 000-27688) filed with the Securities and Exchange Commission on January 24, 2022).
     
3.2   Bylaws of Registrant (Incorporated by reference to Exhibit 3.4 to the Current Report on Form 8-K (File No. 000-27688) filed with the Securities and Exchange Commission on January 24, 2022).
     
4.1   Rights Agreement dated as of October 7, 2016 between Surge Components, Inc., as the Company, and Continental Stock Transfer & Trust Company, as Rights Agent, incorporated by reference to Exhibit 4.1 of the Current Report on Form 8-K filed by the Company with the Securities and Exchange Commission on October 7, 2016.
     
4.2   Amendment to the Rights Agreement dated as of October 6, 2019 between Surge Components, Inc., as the Company, and Continental Stock Transfer & Trust Company, as Rights Agent filed with Form 10-Q on October 15, 2019.
     
10.1   Rental Agreement between Great American Realty and Surge Components dated July 28, 2020 as filed with the Form 10Q on October 15, 2020.
     
10.2   Rental Agreement between Great American Realty and Challenge Electronics dated July 28, 2020 as filed with the Form 10Q on October 15, 2020.
     
31.1   Certification by principal executive officer and Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
32.1   Certification by principal executive officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
101.INS   Inline XBRL Instance Document.
     
101.SCH   Inline XBRL Taxonomy Extension Schema Document.
     
101.CAL   Inline XBRL Taxonomy Extension Calculation Linkbase Document.
     
101.DEF   Inline XBRL Taxonomy Extension Definition Linkbase Document.
     
101.LAB   Inline XBRL Taxonomy Extension Label Linkbase Document.
     
101.PRE   Inline XBRL Taxonomy Extension Presentation Linkbase Document.
     
104   Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  SURGE COMPONENTS, INC.
     
Date: October 16, 2023 By: /s/ Ira Levy
  Name:  Ira Levy
  Title: Chief Executive Officer
(Principal Executive Officer,
Principal Financial Officer and
Principal Accounting Officer)

 

 

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