Quarterly Report for Quarter Ending August 31, 2026 (Form 10-Q)

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 $0 and $302,681 for the nine months ended August 31, 2026 and August 31, 2025 respectively.

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

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

The world of business continues to change because of "disruptors," which are significant changes in traditional business practices. 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 with customers and manufacturers in the U.S. as well as local Asian customers. The Surge sales division has a sales and marketing office and warehouse in Hong Kong and for these reasons, we established Surge Ltd., our Hong Kong subsidiary. The Surge divisions regional sales in their Europe office are growing well throughout the entire European continent and management looks forward to their continued growth. The Challenge Electronics sales division has opened up a sales and marketing office in Europe as well. Currency fluctuations may also have an effect on doing business outside of North America. Customers have moved to reduce their supply chain, which could adversely affect the Company. In some market segments, demand for electronic components has decreased, and in other segments, the demand is still strong. Some technologies have become obsolete, while customers develop new products using different kinds of components. The Challenge Electronics division in the Company has had success in designing new products for customers to better their products performance capabilities. This proactive approach separates the Company from selling only commodity products to also selling more customized products. The Company vies AI products as potential new business, and will make every effort to participate in that business segment. Management is cautiously optimistic about continued growth in second half 2026 but expects the remainder of 2026 to be a period of continued challenge, with regards to inflation and general economic conditions and AI demand, in maintaining consistent flow of products during shortages of certain products. These challenges could affect the Company in negative ways, possibly reducing sales and or profitability. Because of a labor shortage, our customers engineering staff has been challenged, so getting our products approved has been and will continue to take longer to achieve. Additionally, the cost of some raw materials has continued to increase, therefore our costs have increased. In some cases, the customers will accept the increase while in other cases the Company absorbs the cost increase. In order for the Company to continue to grow, we will depend on, among other things, the continued growth of the electronics and semiconductor industries, our ability to withstand intense price competition, our ability to obtain new customers, our ability to retain and attract high performing 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 cash flow, the continued supply of products from our factories, the ability to withstand higher transportation costs, tariffs, and longer travel times and our ability to deal successfully, with new and future disruptors. The tariffs continue to impact the Company, although much less now than previously. The general supply chain challenges present both a challenge and opportunity to the Company. The Company is cautiously optimistic about its ability to meet these challenges with continued growth unless the general global or electronics industry economic conditions deteriorate. Challenging economic conditions could have a negative impact on sales into 2027. Inflationary pressures impact consumers demand which can potentially reduce the overall business of our customers manufacturing and therefore less components are needed. The combination of possible disruptors such as increased costs and longer lead times from factories to the Company could also have negative impacts on the business in the future. The tense relations between America and China could also impact the Company's business. China could impose rules and laws that make it more difficult to do business in Hong Kong and China. The Company is taking steps to be well prepared in case of any actions from China or Iran that would cause us potential business disruptions, if any. For example, many of the Company's potential factory partners have opened production facilities outside of China. The current U.S. conflict with Iran also carries challenges in the cost of products and general global supply. As there are many challenges in this complicated and competitive market, there are also many great opportunities that the Company is involved in. Therefore, the Company continues to seek and develop opportunities for growth in 2026 and beyond.

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. Reserves related to stock rotation and future sales requirements for specific inventory parts involve subjective estimates to be made by management based on current and expected market conditions. If market conditions are less favorable than those projected by management, additional write-downs of inventories could be required. For example, each additional 1% of obsolete inventory would reduce operating income by approximately $57,000.

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 may 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, 2026 increased by $1,223,092 or 4.6%, to $27,645,586 as compared to net sales of $26,422,494 for the nine months ended August 31, 2025. Consolidated net sales for the three months ended August 31, 2026 decreased by $184,046 or 1.8%, to $10,089,985 as compared to net sales of $10,274,031 for the three months ended August 31, 2025. We attribute the increase for the nine months ended August 31, 2026 to an increase in business with new customers as well as an increase in business with existing customers We attribute the decrease for the three months ended August 31, 2026 to a decrease in volume of sales for certain customers during the three months ended August 31, 2026. Net sales for the nine months ended August 31, 2026 and August 31, 2025 reflect $443,759 and $700,253, 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, 2026 increased by $459,176 to $8,037,984, or 6.1%, as compared to $7,578,808 for the nine months ended August 31, 2025. Gross margin as a percentage of net sales increased to 29.1% for the nine months ended August 31, 2026 compared to 28.7% for the nine months ended August 31, 2025. Gross profit for the three months ended August 31, 2026 decreased by $(105,451) to $2,739,252, or 3.7%, as compared to $2,844,703 for the three months ended August 31, 2025. Gross margin as a percentage of net sales decreased to 27.1% for the three months ended August 31, 2026 compared to 27.7% for the three months ended August 31, 2025. The increase in gross profit and gross profit as a percentage of sales for the nine months ended August 31, 2026 can be attributed to the increase in sales volume and to certain products being sold at a higher profit margin. The decrease in gross profit and gross profit as a percentage of sales for the three months ended August 31, 2026 can be attributed to a decrease in business with existing customers as well as certain products with lower gross profit being sold during this period. 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. The Company was impacted by tariff costs on certain products imported from China, which went into effect as of July 6, 2018 as well as the new tariffs that went into effect as of February 4, 2025. 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. However, there can be no assurance that we will be able to pass along the new costs or the effects if any it will have on our revenue in the future.

Selling and shipping expenses for the nine months ended August 31, 2026 was $2,588,796, an increase of $535,303, or 26.1%, as compared to $2,053,493 for the nine months ended August 31, 2025. Selling and shipping expenses for the three months ended August 31, 2026 was $866,605, an increase of $145,331, or 20.1%, as compared to $721,274 for three months ended August 31, 2025. We attribute the increase to increases in the nine and three months ended August 31, 2026 to increases in selling expenses such as commission expenses, sales payroll, due to the hiring of additional sales personnel and travel and entertainment expenses, as well as auto expenses, freight out and trade show expenses.

General and administrative expenses for the nine months ended August 31, 2026 was $4,872,994, an increase of $117,503, or 2.5% as compared to $4,755,491 for the nine months ended August 31, 2025. General and administrative expenses for the three months ended August 31, 2026 was $1,613,912, an increase of $167,124, or 11.6%, as compared to $1,446,788 for the three months ended August 31, 2025. The increase for the nine months ended August 31, 2026 is due to increases in officers' salaries and other salaries, rent expenses as well as maintenance, office expenses. Additionally, increases in consulting and directors fees as well as public company expenses and pension expenses, partially offset primarily to decreases in non-cash stock based compensation of $460,734 in the nine months ending August 31, 2025, as well as decreases in warehouse, utilities and insurance expenses as well as decreases in computer expenses and professional fees and bank charges and bad debt expenses. The increase for the three months ended August 31, 2026 can be attributed to increases in officer salaries and other salaries as well as rent, maintenance, computer expenses, consulting expenses, directors fees, public company expenses and pension expenses as partially offset by decreases in utilities, general insurance, professional fees expenses and bad debt expenses,

Depreciation expense for the nine months ended August 31, 2026 was $33,537, a decrease of $19,350, or 36.6%, as compared to $52,887 for the nine months ended August 31, 2025. Depreciation expense for the three months ended August 31, 2026 was $16,917, a decrease of $(891), or 5.0%, as compared to $17,808 for the three months ended August 31, 2025.

Other income for the nine months ended August 31, 2026 was $360,882, an increase of $76,701 as compared to $284,181 for the nine months ended August 31, 2025. Other income for the three months ended August 31, 2026 was $148,148, an increase of $47,297 as compared to $100,851 for the three months ended August 31, 2025. We attribute the increase to an increase in income from investment in bonds and notes issued by the United States Treasury.

Tax expense for the nine months ended August 31, 2026 was $312,724, a decrease of $40,869 as compared to a tax expense of $353,593 for the nine months ended August 31, 2025. Tax expense for the three months ended August 31, 2026 was $169,434, a decrease of $118,045 as compared to a tax expense of $287,479 for the three months ended August 31, 2025. The changes result from our decrease in net income for the fiscal 2026 period.

As a result of the foregoing, the net income for the nine months ended August 31, 2026 was $590,815, compared to a net income of $647,525 for the nine months ended August 31, 2025. The net income for the three months ended August 31, 2026 was $220,532, compared to a net income of $472,205 for the three months ended August 31, 2025.

Liquidity and Capital Resources

As of August 31, 2026, we had cash of $4,715,674, marketable securities of $9,514,350, and working capital of $21,186,894. We believe that our working capital levels are adequate to meet our operating requirements during the next twelve months. The Company is exploring and evaluating opportunities for growth and expansion using the Company's cash resources.

During the nine months ended August 31, 2026, we had net cash flow provided by operating activities of $703,533, as compared to net cash flow provided by operating activities of $184,801 for the nine months ended August 31, 2025. The increase in cash flow from operating activities was primarily the result of increased cash flows from accounts payable and inventory and prepaid expenses as partially offset by a decrease in net income and cash flows from accounts receivable.

We had net cash flow used in investing activities of $(1,319,468) for the nine months ended August 31, 2026, as compared to net cash flow used in investing activities of $(1,568,942) for the nine months ended August 31, 2025. We attribute the change to increased purchases and sales by the Company of marketable debt securities in the form of Treasury bills and notes issued by the United States Treasury in the current period.

We had net cash flow from financing activities of $0 for the nine months ended August 31, 2026, as compared to $32,250 during the nine months ended August 31, 2025 due to cash proceeds from the exercise of stock options.

As a result of the foregoing, the Company had a decrease in cash of $(615,935) for the nine months ended August 31, 2026, as compared to a net decrease in cash of $(1,351,891) for the nine months ended August 31, 2025.

The table below sets forth our contractual obligations, including long-term debt, operating leases and other long-term obligations, as of August 31, 2026:

Inflation

In the past two fiscal years, inflation has not had a significant impact on our business. The Company has been able to pass along increases in purchasing costs to its customers. 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.