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Form 10-Q SURGE COMPONENTS INC For: Aug 31


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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, 2020

 

☐  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)

 

Delaware   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 9, 2020, was 5,437,526 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

 

 

  

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS.

  

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Balance Sheets

 

    August 31,     November 30,  
    2020     2019  
    (unaudited)        
ASSETS            
Current assets:            
Cash   $ 3,809,315     $ 2,739,305  
Accounts receivable – net of allowance for doubtful accounts of $142,934 and $132,221     5,930,075       5,129,792  
Inventory, net     3,726,531       3,593,231  
Prepaid expenses and income taxes     474,694       486,940  
                 
Total current assets     13,940,615       11,949,268  
                 
Fixed assets – net of accumulated depreciation and amortization of $2,334,151 and $2,305,724     111,711       120,752  
Operating Lease Right of Use Asset     1,702,391        
Deferred income taxes     1,005,433       1,185,740  
Other assets     22,607       22,607  
                 
Total assets   $ 16,782,757     $ 13,278,367  

 

See notes to consolidated financial statements

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Balance Sheets

(Continued)

 

    August 31,     November 30,  
    2020     2019  
    (unaudited)        
LIABILITIES AND SHAREHOLDERS’ EQUITY            
Current liabilities:            
Accounts payable   $ 3,915,861     $ 3,344,182  
Operating lease liabilities, current maturities     181,325        
Financing lease payable, current maturities     8,345       7,782  
Accrued expenses and taxes     557,014       581,201  
Accrued salaries     535,812       506,663  
                 
Total current liabilities     5,198,357       4,439,828  
Operating lease liabilities net of current maturities     1,535,292        
Financing lease payable, net of current maturities     10,771       17,102  
Note payable to bank     449,700        
Deferred rent           12,998  
                 
Total liabilities     7,194,120       4,469,928  
                 
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, 5,437,526 and 5,320,026 shares issued and outstanding     5,437       5,319  
Additional paid-in capital     16,948,532       16,666,465  
Accumulated deficit     (7,365,342 )     (7,863,355 )
                 
Total shareholders’ equity     9,588,637       8,808,439  
                 
Total liabilities and shareholders’ equity   $ 16,782,757     $ 13,278,367  

 

See notes to consolidated financial statements.

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Operations

(Unaudited)

 

    Nine Months Ended
August 31,
    Three Months Ended
August 31,
 
    2020     2019     2020     2019  
Net sales   $ 22,103,444     $ 24,957,943     $ 8,667,255     $ 8,085,849  
                                 
Cost of goods sold     15,913,093       17,749,039       6,405,274       5,670,293  
                                 
Gross profit     6,190,351       7,208,904       2,261,981       2,415,556  
                                 
Operating expenses:                                
Selling and shipping expenses     1,814,955       2,011,634       583,984       717,399  
General and administrative expenses     3,652,093       3,458,541       1,137,220       1,087,154  
Depreciation and amortization     28,428       28,878       9,523       9,626  
                                 
Total operating expenses     5,495,476       5,499,053       1,730,727       1,814,179  
                                 
Income before other income (expense) and income taxes     694,875       1,709,851       531,254       601,377  
                                 
Other income (expense):                                
Other income     21,540       245       562       242  
Interest expense     (1,566 )     (2,079 )     (477 )     (652 )
                                 
Other income (expense)     19,974       (1,834 )     85       (410 )
                                 
Income before income taxes     714,849       1,708,017       531,339       600,967  
                                 
Income taxes (benefit)     211,836       (126,683 )     (157,526 )     (78,304 )
                                 
Net income     503,013       1,834,700       688,865       679,271  
Dividends on preferred stock     5,000       5,000       2,500       2,500  
                                 
Net income available to common shareholders   $ 498,013     $ 1,829,700     $ 686,365     $ 676,771  
                                 
Net income per share available to common shareholders:                                
                                 
Basic   $ .09     $ .35     $ .13     $ .13  
Diluted   $ .09     $ .33     $ .12     $ .12  
                                 
Weighted Shares Outstanding:                                
                                 
Basic     5,355,281       5,280,735       5,405,733       5,309,335  
Diluted     5,512,948       5,463,928       5,563,400       5,492,527  

 

See notes to consolidated financial statements 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Changes in Shareholders’
Equity

 

Nine months ended August 31, 2020 and 2019

 

                            Additional              
    Series C Preferred     Common     Paid-In     Accumulated        
    Shares     Amount     Shares     Amount     Capital     Deficit     Total  
Balance – December 1, 2018     10,000     $ 10       5,262,128     $ 5,262     $ 16,577,772     $ (9,893,210 )   $ 6,689,834  
Preferred stock dividends                                   (5,000 )     (5,000 )
Issuance of shares as compensation                 47,207       46       88,704             88,750  
Net Income                                   1,834,700       1,834,700  
Balance – August 31, 2019     10,000     $ 10       5,309,335     $ 5,308     $ 16,666,465     $ (8,063,510 )   $ 8,608,284  

 

                            Additional              
    Series C Preferred     Common     Paid-In     Accumulated        
    Shares     Amount     Shares     Amount     Capital     Deficit     Total  
Balance – December 1, 2019     10,000     $ 10       5,320,026     $ 5,319     $ 16,666,465     $ (7,863,355 )   $ 8,808,439  
Preferred stock dividends                                   (5,000 )     (5,000 )
Issuance of shares as compensation                 42,500       43       216,892             216,935  
Stock option exercise                 75,000       75       65,175             65,250  
Net Income                                   503,013       503,013  
Balance – August 31, 2020     10,000     $ 10       5,437,526     $ 5,437     $ 16,948,532     $ (7,365,342 )   $ 9,588,637  

 

See notes to consolidated financial statements.

 

  

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows

(Unaudited)

 

    Nine Months Ended  
    August 31,     August 31,  
    2020     2019  
CASH FLOWS FROM OPERATING ACTIVITIES:            
Net Income   $ 503,013     $ 1,834,700  
Adjustments to reconcile net income to net cash provided by operating activities:                
Depreciation and amortization     28,428       28,878  
Deferred income taxes     180,307       (159,842 )
Allowance for doubtful accounts     10,713     33,190  
Stock Compensation     216,935       88,750  
                 
CHANGES IN OPERATING ASSETS AND LIABILITIES:                
Accounts receivable     (810,996 )     415,358  
Inventory     (133,300 )     (374,137 )
Prepaid expenses and income taxes     12,246       (292,140 )
Other assets     1,228       (9,224 )
Accounts payable     571,679       (826,209 )
Deferred rent           (8,961 )
Accrued expenses     (38 )     (132,292 )
                 
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES     580,215       598,071  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:                
Acquisition of fixed assets     (19,387 )     (7,221 )
                 
NET CASH FLOWS USED IN INVESTING ACTIVITIES   $ (19,387 )   $ (7,221 )

 

See notes to consolidated financial statements.

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows

(Continued)

 

    Nine Months Ended  
    August 31,     August 31,  
    2020     2019  
             
CASH FLOWS FROM FINANCING ACTIVITIES:            
             
Proceeds from exercise of stock options   $ 65,250     $  
Proceeds from notes payable to bank     449,700        
Repayment of financing lease obligations     (5,768 )     (5,817 )
                 
NET CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES     509,182       (5,817 )
                 
NET CHANGE IN CASH     1,070,010       585,033  
                 
CASH AT BEGINNING OF PERIOD     2,739,305       1,761,863  
                 
CASH AT END OF PERIOD   $ 3,809,315     $ 2,346,896  
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                
                 
Income taxes paid   $ 125,478     $ 97,389  
                 
Interest paid   $ 1,566     $ 2,079  
                 
NONCASH INVESTING AND FINANCING ACTIVITIES:                
Accrued dividends on preferred stock   $ 5,000     $ 5,000  

 

See notes to consolidated financial statements.

 

 

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.

 

NOTE B – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES

 

(1) Principles of Consolidation and Basis of Presentation:

 

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 unaudited interim condensed
consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (“U.S.
GAAP”) and the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information
and disclosures required by U.S. GAAP for complete consolidated financial statements have been condensed or omitted herein. The
interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements
and notes thereto included in the Company’s Form 10-K for the year ended November 30, 2019 filed with the SEC on
February 28, 2020. The unaudited interim condensed consolidated financial information presented herein reflects all normal adjustments
that are, in the opinion of management, necessary for a fair statement of the financial position, results of operations and cash
flows for the periods presented. The Company is responsible for the unaudited interim consolidated financial statements included
in this report. The results of operations of any interim period are not necessarily indicative of the results for the full
year.

 

(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 amounts 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.

 

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. 

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE B – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)

 

(3) Revenue Recognition (continued):

 

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 $1,330,000
and $2,402,000 for the nine months ended August 31, 2020 and August 31, 2019 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 $280,274 and $462,111 for the nine months ended August 31, 2020 and August 31, 2019 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 $4,729,000 and $4,961,000 for the nine months ended August 31,
2020 and August 31, 2019 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, 2020 was $540,853. The Company, at August 31, 2020 has a reserve against
slow moving and obsolete inventory of $250,565. 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.

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

  

NOTE B – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)

 

(6) Concentration of Credit Risk:

 

Financial instruments that potentially
subject the Company to concentrations of credit risk consist principally of cash and accounts receivable. The Company believes
that concentration with regards to accounts receivable is limited due to its customer base. The Company maintains substantially
all of its cash balances in a limited number of financial institutions. At August 31, 2020 and November 30, 2019, the Company’s
uninsured cash balances totaled $3,244,820 and $2,174,808, respectively.

 

(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, accrued
payroll 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, 2016, and state tax examinations for years before fiscal years
ending November 30, 2015. 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, 2020 and August 31, 2019. 

 

(8) Cash Equivalents:

 

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

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE B – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)

 

(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) Shipping Costs

 

The Company classifies shipping costs as
a component of selling expenses. Shipping costs totaled $2,654 and $4,573 for the nine months ended August 31, 2020 and August
31, 2019 respectively.

 

(13) Earnings Per Share

 

Basic earnings per share includes no dilution
and is computed by dividing net (loss) income available to common stockholders by the weighted average number of common shares
outstanding for the period. In the period with a profit, 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, 2020 and August 31, 2019 totaled 199,333
and 134,373, respectively.

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE B – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)

 

(14) 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.

 

(15) 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.

 

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.

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE C – FIXED ASSETS

 

Fixed assets consist of the following:

 

    August 31,     November 30,  
    2020     2019  
             
Furniture and Fixtures   $ 327,971     $ 327,971  
Leasehold Improvements     1,022,556       1,022,556  
Computer Equipment     1,095,335       1,075,949  
Less-Accumulated Depreciation     (2,334,151 )     (2,305,724 )
Net Fixed Assets   $ 111,711     $ 120,752  

 

Depreciation and amortization expense for
the nine months ended August 31, 2020 and August 31, 2019 was $28,428 and $28,878, 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 terminate in 2022.

 

Future minimum lease payments under these financing lease obligations
as of August 31, 2020 are as follows:

 

2020   $ 9,779  
2021   $ 9,779  
2022   $ 1,786  
         
Total   $ 21,344  
Less: interest portion     2,228  
Present value of net minimum lease payments   $ 19,116  
Less: current portion     8,345  
Non-current portion   $ 10,771  

 

Financing lease obligations mature as follows:      
       
Twelve Months Ended August 31:      
       
2020   $ 8,345  
2021   $ 9,158  
2022   $ 1,613  
         
Principal payments remaining   $ 19,116  

 

 

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 of the assets of the Company. As of August
31, 2020, the balance on the Credit Line was $0. As of August 31, 2020, the Company was in compliance with the debt covenants under
the Credit Line.

 

The Company in May 2020 received loan proceeds
in the amount of approximately $449,700 under the Paycheck Protection Program (“PPP”). The PPP, established as part
of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), provides for loans to qualifying businesses
for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest
are forgivable after twenty-four weeks as long as the borrower uses the loan proceeds for eligible purposes, including payroll,
benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness will be reduced if the borrower
terminates employees or reduces salaries during the period.

 

The unforgiven portion of the PPP loan
is payable over two years at an interest rate of 1%, with a deferral of payments for the first six months. The Company intends
to use the proceeds for purposes consistent with the PPP. While the Company currently believes that its use of the loan proceeds
will meet the conditions for forgiveness of the loan, we cannot assure you that we will not take actions that could cause the Company
to be ineligible for forgiveness of the loan, in whole or in part.

 

NOTE F – ACCRUED EXPENSES

 

Accrued expenses consist of the following:

 

    August 31,     November 30,  
    2020     2019  
             
Commissions   $ 238,188     $ 233,784  
Preferred stock dividends     151,569       146,569  
Other accrued expenses     167,257       200,848  
                 
    $ 557,014     $ 581,201  

 

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 Union Central,
Inc., which maintains the plan’s records, were approximately $1,486,000 at November 30, 2019. Pension expense for the nine
months ended August 31, 2020 and August 31, 2019 was $1,602 and $2,392, respectively.

 

 

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.

 

Between April 2001 and July 2015, 60,000
shares of the series C shares were repurchased or converted to common stock. Dividends aggregating $149,069 have not been paid
for the semi-annual periods ended December 31, 2001 through the semi-annual payment due December 31, 2019. The Company has accrued
these dividends. At August 31, 2020, 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, 2020.

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE H – SHAREHOLDERS’ EQUITY
(Continued)

 

[2] 2010 Incentive Stock Plan

 

In March 2010, the Company adopted, and
in April 2010 the shareholders ratified, the 2010 Incentive Stock Plan (“2010 Stock Plan”). The 2010 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 March 2019, one employee director exercised
options to acquire 25,000 shares of common stock at $0.87 per share.

 

[3] 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 May 2016 a total of 99,151 shares were
issued to the Company’s officers as part of their 2015 bonus compensation under the 2015 Stock Plan.

 

In May 2019, a total of 47,207 shares were
issued to the Company’s officers as part of their 2018 bonus compensation under the 2015 Stock Plan.

 

In April 2020, the Company awarded one
non-employee director 15,000 shares of its common stock under the 2015 Stock Plan. The Company recorded a cost of $21,150 related
to the issuance of these shares.

 

In April 2020, a total of 27,500 shares
were issued to one of the Company’s officers as part of their 2019 bonus compensation under the 2015 Stock Plan. The Company
recorded a cost of $41,250 relating to the issuance of these shares.

 

In April 2020, the Company granted stock
options to (a) four non-employee directors to each purchase 15,000 shares of common stock, (b) one non-employee-director to purchase
25,000 shares of common stock, and (c) two Company officers to each purchase 50,000 shares of common stock at an exercise price
of $1.41 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 $154,534 related to the granting of these options.

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE H – SHAREHOLDERS’ EQUITY
(Continued)

 

Activity in the Company’s stock plans for the period ended
August 31, 2020 is summarized as follows:

 

          Weighted  
          Average  
    Shares     Exercise
Price
 
             
Options outstanding December 1, 2019     147,000     $ 1.01  
Options issued in the nine months ended August 31, 2020     185,000     $ 1.41  
Options exercised in the nine months ended August 31, 2020     (75,000 )   $ (0.87 )
Options cancelled in the nine months ended August 31, 2020         $  
Options outstanding at August 31, 2020     257,000     $ 1.34  
                 
Options exercisable at August 31, 2020     257,000     $ 1.34  

 

The intrinsic value of the exercisable
options at August 31, 2020 totaled $7,200. At August 31, 2020 the weighted average remaining life of the stock options is 3.48
years. At August 31, 2020 there was no unrecognized compensation cost related to the stock options granted under the plan.

 

[4] Compensation of Directors

 

Compensation for each non-employee director
is $2,500 per month (and $3,500 per month for a non-employee director that serves as the chairman of more than two committees of
the Board of Directors).

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

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,  
    2020     2019  
Deferred Tax Assets            
Net operating loss   $ 1,287,289     $ 1,524,286  
Allowance for bad debts     29,921       27,121  
Inventory     60,746       60,746  
Other     85,562       65,353  
Depreciation     64,074       65,402  
Total deferred tax assets     1,527,592       1,742,908  
Valuation allowance     (522,159 )     (557,168 )
                 
Deferred Tax Assets   $ 1,005,433     $ 1,185,740  

 

The 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 valuation allowance decreased by $35,009
during the nine months ended August 31, 2020. This valuation is based on management estimates of future taxable income. Although
the degree of variability inherent in the estimates of future taxable income is significant and subject to change in the near term,
management believes, that the estimate is adequate. The estimated valuation allowance is continually reviewed and as adjustments
to the allowance become necessary, such adjustments are reflected in the current operations.

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

NOTE I – INCOME TAXES (Continued)

 

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

 

    Nine Months Ended  
    August 31,
2020
    August 31,
2019
 
             
Current:            
Federal   $     $ (38,519 )
States     31,529       71,678  
                 
      31,529       33,159  
Deferred:                
Federal     142,442       (126,275 )
States     37,865       (33,567 )
                 
      180,307       (159,842 )
                 
Provision for income taxes   $ 211,836     $ (126,683 )

 

The Company files a consolidated income
tax return with its wholly-owned subsidiaries and has net operating loss carryforwards of approximately $5,751,000 for federal
and state purposes, which expire through 2020. 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,  
    2020     2019  
U.S Federal Income tax statutory rate     21 %     21 %
Valuation allowance     4 %     (32 )%
State income taxes     5 %     4 %
Other            
Effective tax rate     30 %     (7 )%

 

 

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 partially owned by officers/shareholders of the Company (“Related Company”).
Annual minimum rental payments to the Related Company approximated $180,000 for the year ended November 30, 2019, 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.

 

In June 2019, the Company renewed its lease
to rent office space and a warehouse in Hong Kong for two years. Annual minimum rental payments for this space are approximately
$68,460.

 

In January 2019, the Company entered into
a lease to rent warehouse space in Hong Kong for two years. Annual minimum rental payments for this space are approximately $36,840.

 

The Company’s future minimum rental
commitments at August 31, 2020 are as follows:

 

Twelve Months Ended August 31,

 

2021   $ 258,528  
2022     193,390  
2023     197,258  
2024     201,203  
2025     205,227  
2026 and after   $ 1,108,281  
         
    $ 2,163,887  

 

Net rental expense for the nine months
ended August 31, 2020 and August 31, 2019 were $281,599 and $265,114 respectively, of which $200,156 and $197,418 respectively,
was paid to the Related Company.

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

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.

 

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.

 

NOTE L – MAJOR CUSTOMERS

 

The Company had two customers who accounted
for 17% and 15% of net sales for the nine months ended August 31, 2020 and two customers who accounted for 13% and 12% of net sales
for the nine months ended August 31, 2019. The Company had one customer who accounted for 16% of accounts receivable at August
31, 2020 and one customer who accounted for 11% of accounts receivable at August 31, 2019.

 

NOTE M – MAJOR SUPPLIERS

 

During the nine months ended August 31,
2020 and August 31, 2019 there was one foreign supplier accounting for 39% and 39% of total inventory purchased.

 

The Company purchases substantially all
of its products overseas. For the nine months ended August 31, 2020, the Company purchased 45% of its products from Taiwan,
16% from Hong Kong, 25% 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,  
    2020     2019  
Canada     2,945,773       3,311,535  
China     3,948,811       4,240,122  
Other Asian Countries     1,099,040       1,811,454  
South America     143,928       394,140  
Europe     843,747       931,916  

 

Revenues are attributed to countries based
on location of customer. 

 

NOTE O – SUBSEQUENT EVENTS

 

In early January 2020, an outbreak of a
respiratory illness caused by the Coronavirus was identified in Wuhan, China. As part of its effort to combat the virus, the government
of China has placed travel restrictions throughout parts of China. This has resulted in some of the Company’s customers and
suppliers being closed for an extended period or operating at significantly below their normal capacity and will also affect our
suppliers that source some of their materials from China. Conditions in China have improved. Some customers and suppliers are back
to full operation but others are taking longer. The duration and intensity of this global health emergency and related disruptions
is uncertain, although there has been some improvement globally, including Asia, America and Europe. The duration of this crisis
and its impact on both the Company’s customers and supply chain is expected to have a material impact on the consolidated
results of operations, cash flows and financial condition, but cannot be reasonably estimated at this time. As an update, the unprecedented
virus has grown significantly especially in America and has significantly impacted the Company’s customers. The Company has
experienced order cancellations and order hold notices from customers and expects this to continue. Although the coronavirus situation
is still very serious on a global basis, the Company’s business has improved in the third quarter, with sales increasing
and our customer’s outlook for their business stronger at this time. This increase in business cannot be guaranteed to continue
as it may be impacted by the coronavirus conditions, which change on an ongoing basis.

 

 

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
$280,274 and $462,111 for the nine months ended August 31, 2020 and August 31, 2019 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.

 

The world of business
is constantly changing 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 and Europe to service and further
develop the business. For these reasons, we established Surge Ltd., our Asia subsidiary, and hired a European salesman based in
London. 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 2020 to be a year of change and challenge, especially due to the coronavirus.
These challenges could affect the Company in negative ways, possibly reducing sales and or profitability. In order for the Company
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, and our ability to deal successfully, with new and future
disruptors. The global economic slowdown is impacted by the tariffs which may negatively impact the growth of our customers and
many of the manufacturing companies in China. However, at this time some of the Company’s products have become excluded from
tariffs, so the Company has not yet experienced a material adverse effect from the tariffs.

 

 

The Coronavirus is
impacting all of Asia, America and Europe and Surge Components seriously. Some of our customers and suppliers who had shut down
or slowed operations are back to normal but others are taking longer. We are hopeful that things will return to normal as soon
as possible. We are doing everything we can to keep customers production running and to keep things as smooth and stable as possible.
We do expect that this could have a negative impact on our sales until production is fully running. Our customers in China and
elsewhere have reduced their future purchases from us and will continue to reduce, if they are not able to complete the manufacturing
of their products due to the shortage of components from other suppliers. The Company has also experienced order cancellations
and order hold notices from customers and we expect this to continue. The duration of this crisis and its impact on both the Company’s
customers and supply chain had a negative impact on the nine month period ended August 31, 2020. The Company showed a decline in
revenue of 11% for the nine months ended August 31, 2020. We expect the virus to continue to have a material impact on the Company’s
consolidated results for the balance of Fiscal 2020. Although the coronavirus situation is still serious globally, the Company’s
business has improved in the third quarter and our customers’ outlook for their business is stronger than it was previously.
We cannot guaranty that the increase in the third quarter will continue as the coronavirus conditions may change but management
is very pleased with the third quarter results and cautiously optimistic about the remainder of Fiscal 2020.

 

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.

 

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 $38,000.

 

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, 2020 decreased by $2,854,499 or 11.4%, to $22,103,444 as compared to net sales of $24,957,943
for the nine months ended August 31, 2019. Consolidated net sales for the three months ended August 31, 2020 increased by $581,406
or 7.2%, to $8,667,255 as compared to net sales of $8,085,849 for the three months ended August 31, 2019. We attribute the decrease
in the nine months to a decrease in business with new customers as well as a decrease in additional business with existing customers.
We attribute the increase in sales for the three months ended August 31, 2020 to an increase in business from existing customers
partially due to their rebound from the Coronavirus as well as their business increasing. We can also attribute the decline in
sales for the nine months ended August 31, 2020 to the impact of the virus in China, This has had an impact on the Company’s
sales in that we did not receive enough inventory from our suppliers to cover customer orders as well as the fact that our customers
were not getting enough inventory from their other suppliers to complete their manufacturing and put some of our orders on hold.
Net sales for the nine months ended August 31, 2020 and August 31, 2019 reflect $840,399 and $978,807, respectively of tariff costs
that the Company was able to pass on to its customers.

 

Our gross profit for
the nine months ended August 31, 2020 decreased by $1,018,553 to $6,190,351, or 14.1%, as compared to $7,208,904 for the nine months
ended August 31, 2019. Gross margin as a percentage of net sales decreased slightly to 28% for the nine months ended August 31,
2020 compared to 28.9% for the nine months ended August 31, 2019. Gross profit for the three months ended August 31, 2020 decreased
by $153,575 to $2,261,981, or 6.4%, as compared to $2,415,556 for the three months ended August 31, 2019. Gross margin as a percentage
of net sales decreased to 26.1% for the three months ended August 31, 2020 compared to 29.9% for the three months ended August
31, 2019. The decrease in gross profit and profit margin can be attributed to the decrease in sales year to date due to the impact
of the coronavirus as well as the mix of products that the Company sold at lower margins. 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 nine months ended August 31, 2020, 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.

 

Selling and shipping
expenses for the nine months ended August 31, 2020 was $1,814,955, a decrease of $196,679, or 9.8% as compared to $2,011,634 for
the nine months ended August 31, 2019. Selling and shipping expenses for the three months ended August 31, 2020 was $583,984, a
decrease of $133,415, or 18.6%, as compared to $717,399 for the three months ended August 31, 2019. We attribute the decrease
to decreases in selling expenses such as commission expense, travel expenses and entertainment expenses, and auto expenses offset
by increases in salesman payroll, due to the hiring of a new salesperson and freight out expenses.

 

General and administrative
expenses for the nine months ended August 31, 2020 was $3,652,093, an increase of $193,552, or 5.6%, as compared to $3,458,541
for the nine months ended August 31, 2019. General and administrative expenses for the three months ended August 31, 2020 was $1,137,220,
an increase of $50,066, or 4.6%, as compared to $1,087,154 for the three months ended August 31, 2019.The increase is due primarily
to increases in salaries and related payroll tax expenses, rent expenses, general insurance, and bank charges as well as directors
fees and office expense and professional fees, as partially offset by decreases in utilities, telephone expenses, as well as maintenance
expenses, temporary help expenses, bad debt and computer expenses.

 

 

Depreciation expense
for the nine months ended August 31, 2020 was $28,428, a decrease of $450, or 1.6%, as compared to $28,878 for the nine months
ended August 31, 2019. Depreciation expense for the three months ended August 31, 2020 was $9,522, a decrease of $103, or 1.1%,
as compared to $9,626 for the three months ended August 31, 2019. The decrease is due the company purchasing less equipment during
the nine months ended August 31, 2020.

 

Other income for the
nine months ended August 31, 2020 was $21,540, an increase of $21,295 compared to $245 for the nine months ended August 31, 2019.
Other income for the three months ended August 31, 2020 was $562, an increase of $320 compared to $242 for the [three] months ended
August 31, 2019. We attribute the increase to Company receiving $20,000 for Covid-19 relief from the SBA as well as an increase
in the cash balances for the nine months ended August 31, 2020.

 

Interest expense for
the nine months ended August 31, 2020 was $1,566, a decrease of $513, or 24.7% compared to $2,079 for the nine months ended August
31, 2019. Interest expense for the three months ended August 31, 2020 was $477, a decrease of $175 or 26.8% compared to $652 for
the three months ended August 31, 2019. We attribute the decrease to the Company not utilizing the line of credit during the nine
months ended August 31, 2020.

 

Tax expense for the
nine months ended August 31, 2020 was $211,836 an increase $338,519 as compared to a tax benefit of $126,683 for the nine months
ended August 31, 2019. Tax benefit for the three months ended August 31, 2020 was $157,526 an increase of $79,222 as compared to
a tax benefit of $78,304 for the three months ended August 31, 2019. 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 nine months ended August 31, 2020 was $503,013, compared to a net income of $1,834,700 for the nine
months ended August 31, 2019. As a result of the foregoing, net income for the three months ended August 31, 2020 was $688,865,
compared to a net income of $679,271 for the three months ended August 31, 2019.

 

Liquidity and Capital Resources

 

As of August 31, 2020
we had cash of $3,809,315, and working capital of $8,742,258. We believe that our working capital levels are adequate to meet our
operating requirements during at least the next twelve months. The Company is exploring and evaluating opportunities for growth
and expansion using the Company’s cash resources.

 

During the nine months
ended August 31, 2020, we had net cash flow provided by operating activities of $580,215, as compared to net cash flow provided
by operating activities of $598,071 for the nine months ended August 31, 2019. The decrease in cash flow from operating activities
resulted from cash flows provided by net income, accounts payable, deferred income taxes and prepaid expenses as partially offset
by cash flows used in accounts receivable, inventory and accrued expenses.

 

We had net cash flow
used in investing activities of $(19,387) for the nine months ended August 31, 2020, as compared to net cash flow used in investing
activities of $(7,221) for the nine months ended August 31, 2019. We attribute the change to the Company purchasing more equipment
during the nine months ended August 31, 2020.

 

We had net cash flow
provided by financing activities of $509,182 during the nine months ended August 31, 2020 as compared to $(5,817) used in financing
activities for the nine months ended August 31, 2019. We attribute the increase to proceeds from the exercising of stock options
and the funding received from the bank related to the Paycheck Protection Program during the nine months ended August 31, 2020.

 

As a result of the
foregoing, the Company had a net increase in cash of $1,070,010 for the nine months ended August 31, 2020, as compared to a net
increase in cash of $585,033 for the nine months ended August 31, 2019. 

 

 

The table below sets
forth our contractual obligations, including long-term debt, operating leases and other long-term obligations, as of August 31,
2020:

 

          Payments due              
          0 – 12     13 – 36     37 – 60     More than  
Contractual Obligations   Total     Months     Months     Months     60 Months  
                               
Financing Lease Obligations   $ 19,116     $ 8,345     $ 10,771     $          –     $    –  
Operating Right of Use Leases   $ 2,161,887       258,528       390,648       406,430       1,106,281  
                                         
Total obligations   $ 2,181,003     $ 266,873     $ 401,419     $ 406,430     $ 1,106,281  

 

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.

  

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, 2020 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, 2020 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.

 

 

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.

 

 

ITEM 6. EXHIBITS.

 

Exhibit Number   Description
     
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

     
10.2  

Rental Agreement between Great American Realty and Challenge Electronics dated July 28, 2020

 

 

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 15, 2020 By: /s/ Ira Levy
  Name:  Ira Levy
  Title: Chief Executive Officer
(Principal Executive Officer,
Principal Financial Officer and
Principal Accounting Officer)

 

 

28

 

Exhibit 10.1

 

Exhibit 10.2

 

Exhibit 31.1

 

CERTIFICATION OF PRINCIPAL EXECUTIVE
OFFICER

AND PRINCIPAL FINANCIAL OFFICER

PURSUANT TO SECTION 302 OF THE

SARBANES-OXLEY ACT OF 2002

 

I, Ira Levy, certify that:

 

1. I have reviewed
this quarterly report on Form 10-Q of Surge Components, Inc.;

 

2. Based on my knowledge,
this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by
this report;

 

3. Based on my knowledge,
the financial statements, and other financial information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s
other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:

 

(a) Designed such disclosure
controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this report is being prepared;

 

(b) Designed such internal
control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;

 

(c) Evaluated the effectiveness
of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

(d) Disclosed in this
report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s
most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected,
or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s
other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting,
to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing
the equivalent functions):

 

(a) All significant
deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

(b) Any fraud, whether
or not material, that involves management or other employees who have a significant role in the registrant’s internal control over
financial reporting.

 

Date: October 15, 2020 By: /s/ Ira Levy
    Ira Levy
   

Chief Executive Officer

(Principal Executive Officer and

Principal Financial Officer)

 

 

Exhibit 32.1

 

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT
OF 2002

 

In connection with the Quarterly Report
of Surge Components, Inc. (the “Company”) on Form 10-Q for the period ended August 31, 2020 as filed with the Securities
and Exchange Commission on the date hereof (the “Report”), I, Ira Levy, Chief Executive Officer (principal executive
officer and principal financial officer) of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, that:

 

(1) The
Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2) The
information contained in the Report fairly presents, in all material respects, the financial condition and results of operations
of the Company.

 

     
Date: October 15, 2020 By: /s/ Ira Levy
    Ira Levy
   

Chief Executive Officer

(Principal Executive Officer and

Principal Financial Officer)

 

 

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