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.
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." 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 $186,566 and
$267,019 for the fiscal year ended November 30, 2021 and November 30, 2020
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.
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.
16
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 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 2022 to be a year of continued change, in regards to pandemic
healing, 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 be impacted. The cost of raw materials
have increased, and due to that fact, factories have increased our costs. Our
year to date sales reflect strong growth and the Company has a strong backorder
with customers due to the increased demand for products and the fact that
customers are placing orders further into 2022 to cover their demand. 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, 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. Due to the radical increase of demand as the
pandemic has eased, our lead times have stretched which could impact sales. The
general supply chain challenges present both a challenge and opportunity to the
Company, now including transportation. The Company is cautiously optimistic
about its ability to meet these challenges with continued growth, unless the
general economic conditions deteriorate. The combination of new disruptors such
as increased costs and longer lead times from factories to the Company could
have negative impacts on the business in the future.
In March 2020, the World 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 in the United States, the virus situation is still
serious globally, and business with customers in different regions is impacted
more or less based on the Covid status in that region. Although the Company's
business has improved in the fiscal 2021 and our customers' outlook for their
business is stronger than it was previously, we cannot guarantee that the
increase in subsequent quarters will continue as the coronavirus conditions may
change. Additionally, the spread of COVID-19 and the related actions implemented
by governments of the 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.
17
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. Reserves related to stock
rotation and future sales requirements for specific inventory parts involve
subjective estimates to be made by management based on current and expected
market conditions. 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 $56,000.
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 fiscal year ended November 30, 2021 increased by
$8,111,595 or 25.6%, to $39,828,257 as compared to net sales of $31,716,662 for
the fiscal year ended November 30, 2020. We attribute the increase to an
increase in business with new customers as well as an increase in business with
existing customers. We can also attribute the increase in 2021 to the impact of
the coronavirus in Asia in the year ended November 30, 2020 since factories were
shut and demand was reduced during that period. Since then, factories in Asia
have reopened and demand has increased as customers also order products further
in advance due to supply issues. Net sales for the fiscal years ended November
30, 2021 and November 30, 2020 reflect $862,854 and $1,013,042, respectively of
tariff costs that the Company was able to pass on to its customers.
Our gross profit for the fiscal year ended November 30, 2021 increased by
$2,131,639 to $10,885,780, or 24.4%, as compared to $8,754,141 for the fiscal
year ended November 30, 2020. Gross margin as a percentage of net sales
decreased to 27.3% for the fiscal year ended November 30, 2021 compared to 27.6%
for the fiscal year ended November 30, 2020. The increase can be attributed to
the increase in sales volume as well as offset by certain products being sold at
a lower 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 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 Fiscal 2021, 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.
18
Selling and shipping expenses for the fiscal year ended November 30, 2021 was
$2,586,607, an increase of $166,622, or 6.9%, as compared to $2,419,985 for the
fiscal year ended November 30, 2020. We attribute the increase to increases in
selling expenses such as commission expenses, entertainment expenses, freight
out and auto expenses, offset by decreases in sales payroll and travel expenses.
General and administrative expenses for the fiscal year ended November 30, 2021
was $5,075,806, an increase of $264,110, or 5.5%, as compared to $4,811,696 for
the fiscal year ended November 30, 2020. The increase is due primarily to
increases in salaries and related payroll taxes, rental expenses, professional
fees and computer expenses as well as utilities and maintenance expenses and
temporary help expenses and settlement expenses, offset by decreases in
warehouse expense, health insurance expenses and directors fees.
Depreciation expense for the fiscal year ended November 30, 2021 was $70,098, an
increase of $32,195, or 84.9%, as compared to $37,903 for the fiscal year ended
November 30, 2020. The increase is due to the company purchasing new equipment
during the fiscal year ended November 30, 2021.
Other income for the fiscal year ended November 30, 2021 was $450,945, an
increase of $428,923 compared to $22,022 for the fiscal year ended November 30,
2020. We attribute the increase to Company receiving forgiveness for the
Paycheck Protection Program ("PPP") loan in the amount of $449,700 during the
fiscal year ended November 30, 2021.
Interest expense for the fiscal year ended November 30, 2021 was $1,166, a
decrease of $831, or 41.6% compared to $1,997 for the fiscal year ended November
30, 2020. We attribute the decrease to the Company not utilizing the line of
credit during the fiscal year ended November 30, 2021.
Tax expense for the fiscal year ended November 30, 2021 was $1,092,287, an
increase of $1,104,005 as compared to a tax benefit of $11,718 for the fiscal
year ended November 30, 2020. The changes result from our net income for such
periods and management's revised estimate of future taxable income and the
related impact on the reported deferred tax. The change in the valuation
allowance is based on management estimates of future taxable income. The degree
of variability inherent in the estimates of future taxable income is significant
and subject to change in the near term. The Company reviews its estimates of
future taxable income in each reporting period and adjustments to the valuation
allowance are reflected in the current operations.
As a result of the foregoing, net income for the fiscal year ended November 30,
2021 was $2,510,761, compared to a net income of $1,516,300 for the fiscal year
ended November 30, 2020.
Liquidity and Capital Resources
As of November 30, 2021 we had cash of $6,511,588, and working capital of
$12,288,319. 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.
During the fiscal year ended November 30, 2021, we had net cash flow provided by
operating activities of $2,327,043, as compared to net cash flow provided by
operating activities of $1,160,842 for the fiscal year ended November 30, 2020.
The increase in cash flow from operating activities resulted from increases in
net income, changes in stock compensation expense, deferred taxes, accounts
payable, and accrued expenses, as partially offset by an increase in inventory.
We had net cash flow used in investing activities of $(194,909) for the fiscal
year ended November 30, 2021, as compared to net cash flow used in investing
activities of $(19,386) for the fiscal year ended November 30, 2020. We
attribute the change to the Company purchasing more new equipment during the
fiscal year ended November 30, 2021.
We had net cash flow used in financing activities of $(8,475) during the fiscal
year ended November 30, 2021 as compared to $507,168 provided by financing
activities for the fiscal year ended November 30, 2020. We attribute the
decrease to proceeds from the exercising of stock options and the funding
received from the bank related to the Paycheck Protection Program during the
fiscal year ended November 30, 2020.
19
As a result of the foregoing, the Company had a net increase in cash of
$2,123,659 for the fiscal year ended November 30, 2021, as compared to a net
increase in cash of $1,648,624 for the fiscal year ended November 30, 2020.
The table below sets forth our contractual obligations, including long-term
debt, operating leases and other long-term obligations, as of November 30, 2020:
Payments due
0 - 12 13 - 36 37 - 60 More than
Contractual Obligations Total Months Months Months 60 Months
Capital Lease Obligations $ 8,561 $ 8,561 $ - $ - $ -
Operating leases $ 2,147,616 370,732 514,430 416,621 845,833
Total obligations $ 2,156,177 $ 379,293 $ 514,430 $ 416,621 $ 845,833
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.
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements.
© Edgar Online, source Glimpses
SURGE COMPONENTS, INC. 
