The following discussion 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" in our 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 for events or
circumstances after the date of the filing of this report.
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 $216,181 and
$387,492 for the nine months ended August 31, 2015 and August 31, 2014
Challenge engages in the sale of electronic components, including audible
components, alarms, chimes and battery related products. Challenge has increased
the types of products it sells because some of its suppliers introduced new
products, and it has also sourced other products from new suppliers. As a
result, we are continually trying to expand our product line. In 2002, we
started to import products and sold these under the Challenge name. We started
with a line of transducers, and then we added battery snaps, and coin cell
holders. Since 2002, we have increased our imported private label product mix to
include buzzers, speakers, microphones, resonators, filters, and discriminators.
Our suppliers customize many of the products we sell for many customers based on
the customers' own designs and those our suppliers redesign for them at our
suppliers' factories. We have an experienced design engineer on our staff with
more than thirty years of experience who works with our suppliers on such
redesigns. We continue to expand the product mix we sell. We sell these products
through independent representatives and are also are working with local,
regional, and national distributors to sell these products to local accounts in
We have a Hong Kong office to more 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 our global
capabilities and service to its customer base.
The reduced demand for electronic components has continued in 2015 due to
slowdowns in global growth and forecasted retail sales in North America and
significant pricing pressures that it experienced in 2014. Due to this worldwide
reduction in demand, we may be negatively impacted by reduced margins for our
products. Despite the reduced demand, we have continued to grow our revenues due
to specific customer projects and our management believes that we may be able to
continue growing our revenue.
In order for us 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 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 managing growth,
including monitoring an expanded level of operations and controlling costs.
Critical Accounting Policies
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 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.
Inventories are recorded at the lower of cost or market. Write-downs of
inventories to market 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 $33,000.
Because of the experience of the Company's management, including Ira Levy and
Steven Lubman, the Company believes that it knows the best prices to buy the
products it sells and as a result the Company generally waives rights to
manufacturers' inventory protection agreements (including price protection and
inventory return rights), and thereby bears the risk of increases in the prices
charged by manufacturers and decreases in the prices of products held in the
Company's inventory or covered by purchase commitments. If prices of components
which the Company holds in inventory decline, or if new technology is developed
that displaces products that the Company sells, the business could be materially
adversely affected. While the Company has experienced little impact from
customer design changes and slowdown, this can potentially increase due to
general economic conditions and customer-specific business conditions. If the
Company's customers experience these changes, the business could be adversely
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, 2015 increased by
$1,941,373 or 9.5%, to $22,428,219 as compared to net sales of $20,486,846 for
the nine months ended August 31, 2014. Consolidated net sales for the three
months ended August 31, 2015 increased by $790,816 or 10.5%, to $8,349,329 as
compared to net sales of $7,558,513 for the three months ended August 31, 2014.
We attribute the increase in net sales to an increase in business with new
customers as well as new business with existing customers, including shipments
to customers of new orders received at the end of 2014.
Our gross profit for the nine months ended August 31, 2015 increased by $317,901
or 5.9% to $5,712,605, as compared to $5,394,704 for the nine months ended
August 31, 2014. Gross profit for the three months ended August 31, 2015
increased by $45,541 or 2.3% to $2,006,704, as compared to $1,961,163 for the
three months ended August 31, 2014. Gross margin as a percentage of net sales
decreased to 25.5% for the nine months ended August 31, 2015 as compared to
26.3% for the nine months ended August 31, 2014. Gross margin as a percentage of
net sales decreased to 24.0% for the three months ended August 31, 2015 as
compared to 25.9% for the three months ended August 31, 2014. We attribute the
increase in gross profit to the increase in sales volume offset by the decrease
in profit margin percentage to certain customers having a high volume of sales
for products with a lower gross profit margin in the nine months ended August
31, 2015 as compared to the nine months ended August 31, 2014.
Profit margins have decreased for the nine months ended August 31, 2015 as
certain of our customers, who are some of the biggest buyers of components,
demand the lowest prices for our products. Some of these customers further
demand periodic price reductions on a quarterly or semi-annual basis, as opposed
to annual fixed pricing. In addition, many of our customers are electronic
manufacturing service subcontractors, who manufacture products for their
customers who do not have their own manufacturing operations. We have 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 does not affect such customers' existing orders. These
agreements negatively impact our profit margins since they reduce the amount of
commissions we can earn on our products. Nevertheless, these subcontractor
customers are important to us as they represent very significant potential
growth for us as they enable us to become approved suppliers for their
manufacturing customers, and they purchase our components for these customers.
We believe it would be very difficult for us to achieve business with such
manufacturing companies without these subcontractor customers. In addition,
because some of our products are commodities, our gross profit margins continue
to be pressured due to the competitive environment. We continue to take action
to mitigate the pressure on our gross profit margins.
Selling and shipping expenses for the nine months ended August 31, 2015 was
$1,758,278, an increase of $45,657, or 2.7%, as compared to $1,712,621 for the
nine months ended August 31, 2014. Selling and shipping expenses for the three
months ended August 31, 2015 was $591,208, an increase of $20,614, or 3.6%, as
compared to $570,594 for the three months ended August 31, 2014. The increase is
due to increases in salaries for our salespersons, advertising, freight and
catalog expenses as partially offset by decreases in commission expenses, auto,
shipping, travel and entertainment expenses.
General and administrative expenses for the nine months ended August 31, 2015
was $2,910,599, an increase of $350,418, or 13.7%, as compared to $2,560,181 for
the nine months ended August 31, 2014. General and administrative expenses for
the three months ended August 31, 2015 was $948,127, an increase of $118,318, or
14.3%, as compared to $829,809 for the three months ended August 31, 2014. The
increase is due to the hiring of additional employees and increased costs of
both health and general insurance, officers' salaries and warehouse expenses,
office expenses, professional fees, consulting expenses and public company
expenses as partially offset by decreases in rent, promotions, bank charges and
Depreciation expense for the nine months ended August 31, 2015 was $27,319, a
decrease of $8,687 or 24.1%, as compared to $36,006 for the nine months ended
August 31, 2014. Depreciation expense for the three months ended August 31, 2015
was $9,839, a decrease of $5,402 or 35.4%, as compared to $15,241 for the three
months ended August 31, 2014. The decrease is due to certain assets becoming
fully depreciated during the fiscal year ended November 30, 2014.
Investment income for the nine months ended August 31, 2015 was $6,610, an
increase of $3,374 or 104.3%, as compared to $3,236 for the nine months ended
August 31, 2014. Investment income for the three months ended August 31, 2015
was $2,305, an increase of $813 or 54.5%, as compared to $1,492 for the three
months ended August 31, 2014. This increase is primarily due to an increase in
the interest income we received on our account balances.
Income taxes for the nine months ended August 31, 2015 was $228,383, a decrease
of $100,139 or 30.5% as compared to income taxes of $328,522 for the nine months
ended August 31, 2014. Income taxes for the three months ended August 31, 2015
was $88,200, a decrease of $34,034 or 27.8% as compared to income taxes of
$122,234 for the three months ended August 31, 2014. The decrease is a result of
management's revised estimate of future taxable income and the related impact on
the reported deferred tax. This change in the valuation allowance is based on
management's 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. We review our 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,
2015 was $794,636, as compared to net income of $760,610 for the nine months
ended August 31, 2014. As a result of the foregoing, net income for the three
months ended August 31, 2015 was $371,635, as compared to net income of $424,777
for the three months ended August 31, 2014.
Liquidity and Capital Resources
As of August 31, 2015 we had cash of $6,431,607, and working capital of
$11,074,504. We believe that our working capital levels are adequate to meet our
operating requirements during the next twelve months.
We had net cash flow from operating activities of $170,876 for the nine months
ended August 31, 2015, as compared to net cash flow from operating activities of
$1,070,304 for the nine months ended August 31, 2014. The decrease in cash flow
from operating activities resulted from a decrease in changes in accounts
receivable, inventory, accrued expenses and prepaid expenses as partially offset
by increases in the changes in accounts payable.
We had net cash flow used in investing activities of $(57,580) for the nine
months ended August 31, 2015, as compared to net cash flow used in investing
activities of $(54,222) for the nine months ended August 31, 2014. The increase
resulted from purchasing new equipment during the nine months ended August 31,
We had net cash flow provided by financing activities of $143,750 for the nine
months ended August 31, 2015, as compared to net cash flow provided by financing
activities of $0 for the nine months ended August 31, 2014. The increase in net
cash flow provided by financing activities resulted from three non-executive
board members exercising options to acquire a total of 75,000 shares of common
stock and two employee directors exercising options to acquire a total of
500,000 shares of common stock.
As a result of the foregoing, we had a net increase in cash of $257,046 for the
nine months ended August 31, 2015, as compared to a net increase in cash of
$1,016,082 for the nine months ended August 31, 2014.
We will continue to evaluate opportunities to use any excess cash generated by
our operations, including investing in acquisitions, expanding our business and
repurchasing our common stock if permitted by our governing documents and
existing contracts while maintaining sufficient liquidity to support our
operational needs and fund future strategic growth opportunities.
The table below sets forth our contractual obligations, including operating
leases and other long-term obligations, as of August 31, 2015:
0 - 12 13 - 36 37 - 60 More than
Contractual Obligations Total Months Months Months 60 Months
Long-term debt $ - $ - $ - $ - $ -
Operating leases $ 1,016,356 230,186 402,539 368,116 15,515
Employment agreements $ 458,333 458,333 - - -
Total obligations $ 1,474,689 $ 688,519 $ 402,539 $ 368,116 $ 15,515
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.
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