SURGE COMPONENTS INC

In early January 2020, an outbreak of a respiratory illness caused by the coronavirus was identified in Wuhan, China. In response to the resulting pandemic, governments around the world took various preventative steps up to and including full or partial shutdowns. As a result of the drop in production in our suppliers and customers, the Company experienced order cancellations and order hold notices from customers. Although business has improved in the first half of 2021, the effects of the pandemic will have an ongoing impact on the Company’s business. The duration of this crisis and its impact on both the Company’s customers and supply chain is expected to have an impact on the consolidated results of operations, cash flows and financial condition, but cannot be reasonably estimated at this time. Additionally, the spread of COVID-19 and the related actions implemented by governments of the United States and elsewhere across the globe, may worsen again over time. Thus, the pandemic may have an impact on the Company’s operations, the future effect of which will largely depend on future developments which are highly uncertain and cannot be predicted at this time. The Company continues to monitor its operations and applicable government recommendations and requirements.

The world of business continues to change because of “disruptors,” which are significant changes in traditional business practices that did not previously exist. For example, customers continue to centralize purchasing from regional purchasing and are stretching their payment terms. These changes also include customers moving their manufacturing operations from North America to Asia, and the trend of globalization. Some of our customers have been involved in mergers and acquisitions, causing consolidation. This trend makes business more complicated and costly for the Company. The Company must have a presence in Asia to service and further develop the business. For these reasons, we established Surge Ltd., our Hong Kong subsidiary. Currency fluctuations may also have an effect on doing business outside of North America. Customers have moved to reduce their supply chain, which could adversely affect the Company. In some market segments, demand for electronic components have decreased, and in other segments, the demand is still strong. Some technologies have become obsolete, while customers develop new products using different kinds of components. Management expects 2021 to be a year of change, in regards to pandemic healing, challenge, in regards to maintaining consistent flow of products during shortages of certain products, and growth as we see our customers return to full production pace. These challenges could affect the Company in negative ways, possibly reducing sales and or profitability. Because of a labor shortage, our customers engineering staff has been challenged, so getting our products approved has been and will continue to be impacted.. The cost of raw materials have increased, and due to that fact, factories have increased our costs. While we are able to pass on some of those costs to our customers this could impact profitability for the remainder of 2021. 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, the continued supply of products from our factories, and our ability to deal successfully, with new and future disruptors. The tariffs continue to impact the Company. At this time there is a shortage of electronics components which could impact the Company’s growth. Due to the radical increase of demand as the pandemic has eased, our lead times have stretched which could impact sales.

In March 2020, The World Health Organization categorized COVID-19 as a pandemic and it continues to negatively impact the global economy. During the pandemic we did everything we could do to keep customers production running and to keep things as smooth and stable as possible, and we will continue to do so. The Company has experienced order cancellations and order hold notices from customers and we expect this could continue. While the worst effects of the pandemic may be behind us in the United States, the virus situation is still serious globally, and business with customers in different regions is impacted more or less based on the Covid status in that region. Although the Company’s business has improved in the first half of 2021 and our customers’ outlook for their business is stronger than it was previously, we cannot guaranty that the increase in subsequent quarters will continue as the coronavirus conditions may change. Additionally, the spread of COVID-19 and the related actions implemented by governments of the United States and elsewhere across the globe, may worsen again over time. Thus, the pandemic may have an impact on the Company’s operations, the future effect of which will largely depend on future developments which are highly uncertain and cannot be predicted at this time. The Company continues to monitor its operations and applicable government recommendations and requirements.

Our gross profit for the six months ended May 31, 2021 increased by $928,918 to $4,857,288, or 23.6%, as compared to $3,928,370 for the six months ended May 31, 2020. Gross margin as a percentage of net sales decreased to 27.4% for the six months ended May 31, 2021 compared to 29.2% for the six months ended May 31, 2020. Gross profit for the three months ended May 31, 2021 increased by $514,414 to $2,557,008, or 25.2%, as compared to $2,042,594 for the three months ended May 31, 2020. Gross margin as a percentage of net sales decreased to 26.7% for the three months ended May 31, 2021 compared to 30.7% for the three months ended May 31, 2020. We attribute the increase in gross margin to an increase in sales volume in the six and three months ended May 31, 2021. We attribute the decrease in gross margin as a percentage of sales to the fact that in our industry we 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%. The costs of material from our suppliers have also increased which resulted in the decrease in gross margin percentages. 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 six months ended May 31, 2021, the Company was impacted by tariff costs on certain products imported from China, which went into effect as of July 6, 2018. The Company has been able to pass along a portion of these costs to its customers. The Company is also moving some customer deliveries directly to Hong Kong in order to mitigate some of these costs.

Other income for the six months ended May 31, 2021 was $450,314, an increase of $429,336 compared to $20,978 for the six months ended May 31, 2020. Other income for the three months ended May 31, 2021 was $450,004, an increase of $429,544 compared to $20,460 for the three months ended May 31, 2020. We attribute the increase to Company receiving forgiveness for the Paycheck Protection Program (“PPP”)loan in the amount of $449,700 during the six months ended May 31, 2021, We can also attribute some of the increase to the increase in the cash balances for the six months ended May 31, 2021.