SURGE COMPONENTS, INC. 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") andChallenge 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 inAsia by approximately sixteen independent manufacturers. We act as the master distribution agent utilizing independent sales representative organizations inNorth America to sell and market the products for one such manufacturer pursuant to a written agreement. When we act as a sales agent, our supplierwho 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$83,982 and$67,452 for the three months endedFebruary 28, 2023 andFebruary 28, 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 engineers on our staffwho work 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 that regular suppliers can't deliver. The Company has aHong Kong office to effectively handle the transfer business fromUnited States customers purchasing and manufacturing inAsia after designing the products inthe United States . This office has strengthened the Company's global position, improving our capabilities and service to our customer base. The Company has also made progress in expanding its footprint inChina andEurope by hiring key sales managers in these areas. 18 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 fromNorth America toAsia , 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 inAsia to service and further develop the business. For these reasons, we establishedSurge Ltd. , ourHong Kong subsidiary. Currency fluctuations may also have an effect on doing business outside ofNorth America . Customers have moved to reduce their supply chain, which could adversely affect the Company. In some market segments, demand for electronic components have 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. Management expects 2023 to be a year of continued change, in regard to pandemic healing, inflation and general economic conditions, challenge, in regards 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 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. At this time there is a shortage of electronics components which could impact the Company's growth. 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 for certain consumer goods such as PC's and smartphones and the possibility of a recession in 2023. These economic conditions could have a negative impact on sales in 2023. 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 andChina could also impact the Company's business.China could impose rules and laws that make it more difficult to do business inHong Kong andChina . The Company is taking steps to be well prepared in case of any actions fromChina that would cause us business disruption. As economic conditions have deteriorated, it has impacted the Company's business. Customers have pushed back delivery dates, and in some cases required cancellations. We are watching closely as customers adjust their inventory levels to reflect this new business demand, and the Company will respond accordingly. InMarch 2020 , theWorld Health Organization categorized COVID-19 as a pandemic, and it continues to impact the global economy. During the pandemic we did everything we could do to keep customers production running and keep operations as smooth and stable as possible, and we will continue to do our best to do so. The Company has experienced order cancellations and order hold notices from customers, and we expect this could continue. While the worst effects of the pandemic may be behind us inthe United States , the virus situation is still serious globally, and business with customers in different regions is impacted based on the Covid status in that region. Additionally, the spread of COVID-19 and the related actions implemented by governments ofthe United States and elsewhere across the globe, may worsen again over time. Thus, the pandemic may have an impact on the Company's operations, the future effect of which will largely depend on future developments which are highly uncertain and cannot be predicted at this time. The Company continues to monitor its operations and applicable government recommendations and requirements. Critical Accounting Policies 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.
19
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 $63,000 .
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 three months ended February 28, 2023 decreased by
$1,324,852 or 12.6%, to $9,191,773 as compared to net sales of $10,516,625 for
the three months ended February 28, 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. Net sales for the three months ended
February 28, 2023 and February 28, 2022 reflect $394,793 and $338,076
respectively of tariff costs that the Company was able to pass on to its
customers.
Our gross profit for the three months ended February 28, 2023 decreased by
$314,597 to $2,649,068 , or 10.6% as compared to $2,963,665 for the three months
ended February 28, 2022 . Gross margin as a percentage of net sales increased to
28.8% for the three months ended February 28, 2023 compared to 28.2% in the
three months ended February 28, 2022 . We attribute the decrease in gross profit
to a decrease in sales volume in the three months ended February 28, 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 three months
ended February 28, 2023 . 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 commissions 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 three months ended February 28, 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 is also moving some customer deliveries
directly to Hong Kong in order to mitigate some of these costs. In the first
half of 2023, the Company expects the effects of the tariffs to be similarto 2022.
Selling and shipping expenses for the three months endedFebruary 28, 2023 was$771,539 , an increase of$70,561 , or 10.1%, as compared to$700,978 for three months endedFebruary 28, 2022 . We attribute the increase to an increase in salesman payroll, travel and entertainment expenses and freight out and offset by a decrease in salesman commission expenses and automobile expenses. 20
General and administrative expenses for the three months endedFebruary 28, 2023 was$1,300,463 , a decrease of$3,314 , or less than 1%, as compared to$1,303,777 for the three months endedFebruary 28, 2022 . The decrease is due primarily to decreases in professional fees, office expenses as well as public company expenses, offset by increases in utilities, other salaries, computer expenses as well as pension and maintenance expenses in the three months ended February
28, 2022. Depreciation expense for the three months endedFebruary 28, 2023 was$17,207 , a decrease of$1,563 , or 8.3%, as compared to$18,770 for the three months endedFebruary 28, 2022 . The decrease is due to the company purchasing less new equipment during the three months endedFebruary 28, 2023 .
Tax expense for the three months ended
As a result of the foregoing, net income for the three months endedFebruary 28, 2023 was$395,160 , compared to a net income of$671,753 for the three months endedFebruary 28, 2022 .
Liquidity and Capital Resources
As ofFebruary 28, 2023 we had cash of$10,193,074 , and working capital of$17,279,822 . We believe that our working capital levels are adequate to meet our operating requirements during the next twelve months. 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 theSilicon Valley Bank and Signature Bank, the Company is in the process of reevaluating alternative cash management strategies. During the three months endedFebruary 28, 2023 , we had net cash flow provided by operating activities of$1,525,733 , as compared to net cash flow used in operating activities of$(238,150) for the three months endedFebruary 28, 2022 . The increase in cash flow from operating activities resulted from a decrease in inventory, accounts receivable and less accounts payable offset by decreases in net income and deferred taxes and an increase in accrued expenses. We had net cash flow used in investing activities of$(22,699) for the three months endedFebruary 28, 2023 , as compared to net cash flow used in investing activities of$(21,008) for the three months endedFebruary 28, 2022 . We attribute the change to the Company purchasing new equipment during the three months endedFebruary 28, 2022 . We had net cash flow used by financing activities of$0 during the three months endedFebruary 28, 2023 as compared to$(2,196) used in financing activities for three months endedFebruary 28, 2022 .
As a result of the foregoing, the Company had a net increase in cash of
The table below sets forth our contractual obligations, including long-term debt, operating leases and other long-term obligations, as ofFebruary 28, 2023 : Payments due 0 - 12 13 - 36 37 - 60 More than Contractual Obligations Total Months Months Months 60 Months Financing Lease Obligations $ - $ - $ - $ - $ - Operating leases$ 1,689,579 275,303 410,488 427,072 576,716 Total obligations$ 1,689,579 $ 275,303 $ 410,488 $ 427,072 $ 576,716 21 Inflation
In the past two fiscal years, inflation has not had a significant impact on our business. However, any significant increase in inflation and interest rates could have a significant effect on the economy in general and, thereby, could affect our future operating results. Interest Rate Sensitivity
We are not subject to interest rate sensitivities.
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements.
© Edgar Online, source
