Item 1. Business.
References to "we," "us," "our", "our company" and "the company" refer to Surge Components, Inc. ("Surge" or the "Company") and, unless the context indicates otherwise, includes Surge's wholly-owned subsidiaries, Challenge/Surge, Inc. ("Challenge"), and Surge Components, Limited ("Surge Limited”).
We were incorporated under the laws of the State of New York on November 24, 1981, and re-incorporated in Nevada on August 26, 2010. Surge, a supplier of electronic products and components, i.e. capacitors, diodes, PC Boards completed an initial public offering of its securities in 1984 and a second offering of its securities in August 1996. Challenge, a New York corporation formed in 1988 and a wholly-owned subsidiary of Surge, supplies audible products, including buzzers, speakers, and microphones. Surge's and Challenge's principal executive offices are located at 95 East Jefryn Boulevard, Deer Park, New York 11729; and the telephone number is (631) 595-1818.
The Company reincorporated in Nevada because Nevada is a nationally-recognized leader in adopting and implementing comprehensive and flexible corporation laws that are frequently revised and updated to accommodate changing legal and business needs.
The following shows some of the material differences between the New York Business Corporation Law ("NYBCL") and the Nevada Revised Statues ("NRS"). The chart does not address each difference between the NYBCL and the NRS, but focuses on some of those differences with the Company believes are more relevant to the existing shareholders.
In July 1996, the Company filed a Form 8-A/A pursuant to which it sought to register under Section 12(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Units (consisting of the Company’s common stock and Class A Warrants), Common Stock and Class A Warrants. In April 2004, after the expiration of the Class A Warrants and the Units, the Company filed a Form 15 to terminate the registration of its Common Stock and Class A Warrants under Section 12(g) of the Exchange Act, or suspension of duty to file reports under Section 13 and 15(d) of the Securities 34 Act (“Deregistration”). However, the Company erroneously failed to seek deregistration of the Units. From 2004 through the date of this filing , none of the Company’s officers or directors sold any of the Company’s securities. To the Company’s knowledge from 2004 through 2010 only 3 shareholders, none of which were affiliates of the Company, sold or transferred an aggregate of 75,684 shares, which shares represented less than 1% of the Company’s issued and outstanding shares and met the requirements for sale under Rule 144 of Rules and Regulations of the Securities Act of 1933 as amended, because among other factors the Company has never been a shell company, the shares were held for over a year and the sellers were not affiliates of the Company at the time of the sale or transfer or during the preceding three months. From 2004 through the date of this filing, the Company held one meeting of its shareholders, in April 2010, however, only holders of Common Stock were solicited for votes. Since filing its General Form for Registration of Securities on Form 10, on August 20, 2010, the Company has made the filings required of it under the 34 Act for the period from August 20, 2010 though the date of this filing and as a result the Company believes that it continues to be eligible to have its Common Stock quoted on the OTCQB. Although the Company did not seek Deregistration of its Units it stopped filing reports under Sections 12(b) and 12(g) of the Exchange Act in April 2004 when it deregistered its Common Stock and Warrants. As a result of the Company’s not de-registering its Units, the Company may have violated the Exchange Act including Sections 12 and 13 of the Exchange Act and may be subject to enforcement action from the Securities and Exchange Commission as well as possible shareholder claims.
Our Common Stock was listed on the Nasdaq SmallCap Market (now known as the Nasdaq Capital Market) until November 2001. Our Common Stock was delisted in connection with certain questionable payments in the aggregate amount of $3,000,000 made by the Company during the year ended November 30, 2000 and the quarter ended February 28, 2001. Such payments were made to the wife of an employee of one of our suppliers in return for help obtaining components from that supplier and another distributor. According to management personnel responsible for making the payments, prior to making any payment, they disclosed the transaction to our legal counsel to determine whether payments to an employee of a supplier would be legal. Management personnel believed they had received reasonable assurances at the time, and thereafter, that such payments are not illegal, so long as the recipient of the payments received an IRS Form 1099, and all payments were made by check.
The costs of such payments were recorded in our books and records and financial statements as they were incurred. We duly issued a Form 1099 to the recipient of the payments, based upon the advice of our counsel. According to Steven Lubman, in mid-March 2001, he became aware of a document in a criminal proceeding unrelated to us in which the payments were described as kickbacks. This caused management to seek reconfirmation of the legal advice previously given. Legal counsel advised us by letter on or about March 22, 2001, that, since the payments had been described in a document in the unrelated criminal action as kickbacks, disclosure of the document should be made to our auditors, which was done. Such counsel stated in the letter that no conclusion had been reached that such payments were kickbacks. On April 19, 2001, we disclosed in a 10-QSB that the questionable payments had been made.
In addition, after receipt of the March 22 letter, the Board determined to investigate the payments and ask for the return of the payments. The Company requested that the $3 million be repaid, and we received $1 million.
In May 2001, another law firm, Mintz Levin Cohn Ferris Glovsky and Popeo, P.C., was engaged by the Company to assist in an investigation concerning the payments and to recommend policies to prevent any similar future payments. Due in part to the previously disclosed resignation of our outside counsel and such counsel's refusal to be interviewed as part of the investigation, we were unable to confirm what legal advice was rendered as to the making of such payments. The investigation did not uncover any additional payments similar to the previously disclosed "questionable payments".
By letters dated October 9, 2001 and January 17, 2002, we were contacted by the SEC regarding the potentially questionable payments, and were requested to voluntarily furnish various documents. By letters dated October 23, 2001 and November 28, 2001, we voluntarily responded and provided the SEC with such documents. On March 13, 2002, we provided a supplemental response to the SEC. We have not had any contact with, or received any letters from, the SEC concerning this matter since March 2002.
In November 2001, NASDAQ informed us that it had determined that the Company's securities would be delisted based on public interest concerns related to the potentially questionable payments and additionally for the failure of certain of our officers and directors to submit to an interview by NASDAQ regarding these payments.
The legal counsel which advised the Company as to the legality of the questionable payments no longer has any relationship to the Company. Ira Levy and Steven Lubman were the sole officers and directors of the Company who were asked and refused (based on the advice of counsel) to submit to the NASDAQ interviews. They are currently officers and directors of the Company.
We are registering our Common Stock because we want to furnish our common stock holders with current and periodic information on our Company though the Securities and Exchange Commission Edgar site. Additionally, by registering under the Securities Exchange Act of 1934, as amended a market maker could arrange for an application to be filed with FINRA for the public trading of our common stock on the OTC Bulletin Board. We have not yet had any discussions with any market makers about seeking to have our Common Stock quoted on the OTC Bulletin Board and there can be no assurance that any market makers will file an application on our behalf or that our shares of Common Stock will be quoted on the OTC Bulletin Board.
In May 2002, Surge and Ira Levy, our chief executive 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 Mr. Levy owns one share of the outstanding common stock. Mr. Levy has assigned his rights regarding his one share to Surge. Surge Limited started doing business in July 2002. The Company has opened this office and hired direct sales people in order to effectively handle the transfer business from United States customers purchasing and manufacturing in Asia after they do the design in America. This office has strengthened its global capabilities and service to its customer base.
In March 2000, Superus, a Delaware corporation was formed, to ultimately become a Delaware parent holding company though a proposed merger of Surge with and into Superus, which did not occur. Surge Components, Inc. owned 100% of Superus. Superus was a holding company which owned subsidiaries involved in two separate Internet technology businesses, Mailencrypt.com and Global Datatel. Revenue for the subsidiaries failed to materialize during the dot.com era. The Company desired to focus its business on other areas, and the Company stopped funding Superus; as a result, Superus went bankrupt. Superus filed for bankruptcy under Chapter 7 of the U.S. Bankruptcy Code. In June 2002, the trustee assigned to the case filed a report certifying, among other things, that the case had been fully administered and that there were no assets available for distribution to creditors. In December 2003, the Bankruptcy Court issued an Order approving the Trustee's Report and closing the case.
In December 2000, Surge launched a joint-venture limited liability company with Lelon, a Taiwan corporation, which joint venture ceased operating in 2006. The purpose of the joint venture was to provide a vehicle through which Surge would promote and sell Lelon products; Surge had a 55% interest in the joint venture and Lelon had a 45% interest. Surge and Lelon terminated the joint venture because they determined that, in order for the joint venture to succeed, the joint venture would require a greater level of involvement than the parties were willing to invest.
We are a supplier of electronic products and components. These products include capacitors, which are electrical energy storage devices, and discrete components, such as semiconductor 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 that we sell are typically utilized in the electronic circuitry of diverse products, including, but not limited to, automobiles, telecomm, audio, cellular telephones, computers, consumer electronics, garage door openers, household appliances, power supplies and security equipment. The products that we sell 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. The products that we sell are manufactured predominantly in Asia by approximately sixteen independent manufacturers. We do not have any binding long-term supply, distribution or franchise agreements with our manufacturers. We act as the exclusive sales agent utilizing independent sales representative organizations in North America to sell and market the products for one of such manufacturers pursuant to an oral agreement. As the exclusive sales agent for this manufacturer, we are solely responsible for marketing and selling its products in North America. When we act as a sales agent, the supplier who sold the product to the customer that we introduced to such supplier will pay us a commission. The amount of the commission is determined on a sale by sale basis depending on the profit margin of the product. Such commissions have not been material to date. For example, such commissions were equal to $212,502 and $229,177 for the years ended November 30, 2010 and 2009.
Challenge engages in the electronic components business. Challenge's revenues are principally derived from the sale of audible products. In 1999, Challenge began a division to sell audible components. This division since 2002 has grown by 88%.
From 1988 to 2001, Challenge was in the broker business. Under the broker business, Challenge would purchase name brand electronic components and products, typically from domestic manufacturers and authorized distributors, to fill specific customer orders. Challenge would purchases these components and products in the open market on the best available terms and generally would keep small inventories. In particular, Challenge would fill orders from customers which needed electronic components and products that were not readily available from their suppliers. Challenge’s broker business generated net sales of $2,923,000 in Fiscal 1998, $4,671,000 in Fiscal 1999, and $27,323,000 in Fiscal 2000. Challenge exited the broker business because, in 2001, an over-supply in the electronics components business reduced opportunities to operate profitably in the broker business. As a result, Challenge began to import products similarly to its parent company Surge, and to sell these products under the Challenge name.
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 clients, our ability to retain 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, and the availability of adequate financing.
Industry Background
The United States electronics distribution industry is composed of manufacturers, national and international distributors, as well as regional and local distributors. Electronics distributors market numerous products, including active components (such as transistors, microprocessors, integrated circuits and semiconductors), passive components (such as capacitors and audibles), and electro mechanical, interconnect (such as connectors and wire) and computer products. Surge focuses its efforts on the distribution of capacitors, discrete components, and audible products.
The electronics industry has been characterized by intense price cutting and rapid technological changes and development, which could materially adversely affect our future operating results. In addition, the industry has been affected historically by general economic downturns, which have had an adverse economic effect upon manufacturers and end-users of the products that we sell, as well as distributors. Furthermore, the life-cycle of existing electronic products and the timing of new product development and introduction can affect the demand for electronic components, including the products that we sell. Accordingly, any downturn in the electronics industry in general could adversely affect our business and results of operations. There are forces of change affecting the wholesale distribution industry, including the electronics industry. The industry is experiencing a strong move by U.S. manufacturers to design products in the United States, but then shift manufacturing and purchasing to Asia to benefit from this low cost labor region using their own factory or a subcontractor. Surge has responded to this trend by setting up a Hong Kong corporation, Surge Components, Limited, and hiring sales staff to better position the Company in the Asian markets.
Products
Surge supplies a wide variety of electronic components (some of which bear our private "Surge" label) which can be broadly divided into two categories-capacitors and discrete components. For Fiscal 2010 and Fiscal 2009, capacitors accounted for approximately 50% and 50% of Surge's sales respectively of which approximately 75% were Lelon capacitors (discussed below). Discrete components accounted for Surge's remaining sales in Fiscal 2010 and Fiscal 2009. Capacitors and discrete components can be categorized based on various factors, including function, construction, fabrication and capacity.
We sell, under the name of the manufacturer, Lelon Electronics, aluminum electrolytic capacitors, which are capacitors that store and release energy into a circuit incrementally and are used in various applications, including computers, appliances such as refrigerators and washer/dryers, and telecommunications devices. Our sales of products under the Lelon Electronics name accounts for approximately 40% of our total sales (and approximately 75% of our capacitor sales as noted above).
The principal products sold by Surge under the Surge name (except with respect to capacitors, which the Company also sells under the Lelon Electronics name as noted above) or by Challenge are set forth below.
Capacitors
A capacitor is an electrical energy storage device used in the electronics industry for varied applications, principally as elements of resonant circuits, coupling and bypass applications, blockage of DC current, frequency determining and timing elements, filters and delay-line components. All products are available in traditional leaded as well as surface mount (chip) packages. The product line of capacitors we sell includes:
Aluminum Electrolytic Capacitors- These capacitors, which are Surge's principal product, are storage devices used in power applications to store and release energy as the electronic circuitry demands. They are commonly used in power supplies and can be found in a wide range of consumer electronics products. Our supplier is one of the largest facilities for these products in Taiwan and China. This facilities are fully certified for the International Quality Standard ISO 9001 and QS9000, and TS16949, which means that it meets the strictest requirements established by the automotive industry and adopted throughout the world to ensure that the facility's manufacturing processes, equipment and associated quality control systems will satisfy specific customer requirements. This system is also intended and designed to facilitate clear and thorough record keeping of all quality control and testing information and to ensure clear communication from one department to another about the information (i.e., quality control, production or engineering). This certification permits us to monitor quality control/manufacturing process information and to respond to any customer questions.
Ceramic Capacitors- These capacitors are the least expensive, and are widely used in the electronics industry. They are commonly used to bypass or filter semiconductors in resonant circuits and are found predominantly in a wide range of low cost products including computer, telecom, appliances, games and toys.
Mylar Film Capacitors- These capacitors are frequently used for noise suppression and filtering. They are commonly used in telecommunication and computer products. Surge's suppliers in China have facilities fully certified for all of the above mentioned certifications.
Discrete Components- Discrete components, such as semiconductor rectifiers, transistors and diodes, are packaged individually to perform a single or limited function, in contrast to integrated circuits, such as microprocessors and other "chips", which contain from only a few diodes to as many as several million diodes and other elements in a single package, and are usually designed to perform complex tasks. Surge almost exclusively distributes discrete, low power semiconductor components rather than integrated circuits.
The product line of discrete components we sell includes:
Rectifiers- Low power semiconductor rectifiers are devices that convert alternating current, or AC power, into one directional current, or DC power, by permitting current to flow in one direction only. They tend to be found in most electrical apparatuses, especially those drawing power from an AC wall
outlet.
Surge offers a wide variety of rectifiers, including:
- Schottky barrier rectifiers;
- super-fast rectifiers;
- ultra-fast/high efficiency rectifiers;
- fast recovery rectifiers, the time within which the current recovers from spikes of voltage or current;
- fast recovery glass passivated rectifiers, a chip coated with a glass material to protect the component from thermal stress in a circuit;
- silicon rectifiers, which utilize silicon rectifying cells designed to withstand large currents and high voltages;
- soft recovery/fast switching rectifiers;
- high voltage rectifiers;
- bridge rectifiers, which connect multiple circuits in parallel;
- self packaged surface mount rectifiers, chip style without leads and used in miniaturization; and
- auto rectifiers.
All products are available in traditional leaded as well as surface mount (chip) packages. Surge's rectifier suppliers all have the afore mentioned certifications, giving us an opportunity to market the products that we sell to the automotive industry.
Transistors- These products send a signal to the circuit for transmission of waves. They are commonly used in applications involving the processing or amplification of electric current and electric signals, including data, television, sound and power. All products are available in traditional leaded as well as surface mount (chip) packages. Surge sells many types of ISO 9002 transistors, including:
- small signal transistors, designed for lower levels of current; and
- power transistors, designed for large currents to safely dissipate large amounts of power.
Diodes- Diodes are two-lead or surface mount components that allow electric current to flow in only one direction. They are used in a variety of electronic applications, including signal processing and direction of current.
All products are available in traditional leaded as well as surface mount (chip) packages. Diodes sold include:
- zener diodes;
- high speed switching diodes; and
- rectifiers, the most popular type of diode.
Circuit Protection Devices- Our circuit protection devices include transient voltage suppressors and metal oxide varistors, which protect circuits against switching, lightning surges and other uncontrolled power surges and/or interruptions in circuits. Transient voltage suppressors, which offer a higher level of protection for the circuit, are required in telecommunication products and are typically higher priced products than the metal oxide varistors, which are more economically priced and are used in consumer products. All products are available in traditional leaded as well as surface mount (chip) packages.
Audible Components- These include audible transducers, Piezo buzzers, speakers, and microphones, which produce an audible sound for, and are used in back-up power supplies for computers, alarms, appliances, smoke detectors, automobiles, telephones and other products which produce sounds. Challenge has initiated marketing relationships with certain Asian manufacturers of audible components to sell these products worldwide. All products are available in traditional leaded as well as surface mount (chip) packages.
New Products- We periodically introduce new products, which are intended to complement our existing product lines. These products are ones that are commonly used in the same circuit designs as other of the products that we sell and will further provide a one- stop-shop for the customer. Some of these products are common items used in all applications and others are niche items with a focus towards a particular application. These new products include fuses, printed circuit boards and switches. All products are available in traditional leaded as well as surface mount (chip) versions.
Inventory
In order to adequately service our customers' needs, we believe that it is necessary to maintain large inventories, which makes us more susceptible to price and technology changes. At any given time, we attempt to maintain a one-to-two month inventory on certain products in high demand for customers and at least one month for other products. Our inventory currently contains more than 100 million component units consisting of more than 3,000 different part numbers. The products that we sell range in sales price from less than one cent for a commercial diode to more than $2.00 for high power capacitors and semiconductors. As of November, 2010, we maintained inventory valued at $2,791,326.
Because of the experience of our management, Ira Levy and Steven Lubman, we believe that we know the best prices to buy the products we sell at and as a result we generally waive rights to manufacturers' inventory protection agreements (including price protection and inventory return rights), and thereby bear the risk of increases in the prices charged by our manufacturers and decreases in the prices of products held in our inventory or covered by purchase commitments. If prices of components, which we hold in inventory decline, or if new technology is developed that displaces products that we sell, our business could be materially adversely affected.
Challenge has obtained and is seeking to obtain product rights to certain brand name product lines and to establish direct relationships with those manufacturers for the audible products and fans. In late 1999 Challenge began to develop a new product division of speakers, fans and buzzers manufactured in Asia sold under the Challenge name, broadening our marketing of the products we sell.
Product Availability
Surge obtains substantially all of its products from manufacturers in Asia, while Challenge historically purchases its products both domestically and from Asia. However, in Fiscal 2010 and Fiscal 2009, Challenge purchased approximately 88% and 77%, respectively, of its products overseas as a result of Challenge's introduction of new product lines. Of the total goods purchased by Surge and Challenge in Fiscal 2010, those foreign manufactured products were supplied from manufacturers in Taiwan (55%), Hong Kong (12%), elsewhere in Asia (23%) and overseas outside of Asia (1%). Surge purchases its products from approximately sixteen different manufacturers.
Most of the facilities that manufacture products for Surge have obtained International Quality Standard ISO 9002 and other certifications. We typically purchase the products that we sell in United States currency in order to minimize the risk of currency fluctuations. In most cases, Surge utilizes two or more alternative sources of supply for each of its products with one primary and one complementary supplier for each product. Surge's relationships with many of its suppliers date back to the commencement of our import operations in 1983. We have established payment terms with our manufacturers of between 30 and 60 day open account terms.
We do not have any written long-term supply, distribution or franchise agreements with any of our manufacturers. We act as the sales agent in North America for one of our manufacturers, pursuant to an oral agreement. While we believe that we have established close working relationships with our principal manufacturers, our success depends, in large part, on maintaining these relationships and developing new supplier relationships for our existing and future product lines. Because of the lack of long- term contracts, we may not be able to maintain these relationships.
For Fiscal 2010 and Fiscal 2009, one of Surge's vendors, Lelon Electronics, accounted for approximately 52% and 46% of Surge's consolidated purchases. The loss of or a significant disruption in the relationship with Lelon Electronics, which is our major supplier, could have a material adverse effect on our business and results of operations until a suitable replacement could be obtained.
The Company has no formal or written agreement with Lelon Electronics regarding the supply of inventory for the Company’s customers. The Company purchases products under both the Company’s name and Lelon’s brand name for the Company’s inventory in order to supply the Company’s customers. For the majority of purchases from Lelon Electronics, the Company takes title to the products, houses them in the Company’s warehouse and sells directly to the Company’s customers. There is no right of return on the products purchased from Lelon and the Company accepts all credit risk with regards to sales of these products.
The components business has, from time to time, experienced periods of extreme shortages in product supply, generally as the result of demand exceeding available supply. When these shortages occur, suppliers tend to either increase prices or reduce the number of units sold to customers. We believe that because of our inventory and our relationships with our manufacturers, we have been able to mitigate the effect of any of these shortages in components. However, should there be shortages in the future, such shortages could have both a beneficial or an adverse effect upon our business. Conversely, due to poor market demand, there could be an excess of components in the market, causing stronger competition and an erosion of prices.
Marketing and Sales
Surge's sales efforts are directed towards Original Equipment Manufacturer (OEM) customers in numerous industries where the products that we sell have wide application. Surge currently employs twelve sales and marketing personnel, including two of its executive officers, who are responsible for certain key customer relationships. Our executive officers also devote a significant amount of time to developing and maintaining continuing relations with our key customers.
We use independent sales representatives or organizations, which often specialize in specific products and areas and have specific knowledge of and contacts in particular markets. As of November 30, 2010, we had representation agreements with approximately 30 sales representative organizations. Sales representative organizations, which are generally paid a 5% commission on net sales, are generally responsible in their respective geographic markets for identifying customers and soliciting customer orders. Pursuant to arrangements with our independent sales representatives, they are permitted to represent other electronics manufacturers, but are generally prohibited from carrying a line of products competitive with the products that we sell. These arrangements can be terminated on written notice by either party or if breached by either party. These organizations normally employ between one and twelve sales representatives. The individual sales representatives employed by the sales organizations generally possess an expertise which enhances the scope of our marketing and sales efforts. This permits us to avoid the significant costs associated with creating a direct marketing network. We have had relationships with certain sales organizations since 1988 and continue to engage new sales organizations as needed. We believe that additional sales organizations and representatives are available to us, if required.
We engage independent sales representative organizations in various regions throughout the world for marketing to OEM customers and distributors. We have initiated a formal national distribution program to attract more distributors to promote the products that we sell. We have a National Distribution Manager to develop and manage this program. We expect this market segment to contribute significantly to our sales growth over time.
Many OEMs require their suppliers to have a local presence and Surge's network of independent sales representatives are responsive to these needs. Surge formed a Hong Kong corporation, Surge Components, Limited and hired a regional sales manager to service the Hong Kong/Greater China region customers. Surge also opened a contracted warehouse space in Phoenix, Arizona to stock products for customers in the western region. This warehouse space was closed in 2004 due to the loss of the customer which the location served.
Other marketing efforts include generation and distribution of catalogs and brochures of the products we sell and attendance at trade shows. We have produced an exhibit for display at electronics trade shows throughout the year. The products that we sell have been exhibited at the electronic distribution show in Las Vegas, and we will continue our commitment and focus on the distribution segment of the industry by our visibility at the Electronic Distributor Trade Show.
Customers
The products that we sell are sold to distributors and OEMs in such diverse industries as the automotive, computer, communications, cellular telephones, consumer electronics, garage door openers, security equipment, audio equipment, telecomm products, computer related products, power supply products, utility meters and household appliances industries. We request our distributors to provide point of sales reporting, which enables us to gain knowledge of the breakdown of industries into which the products that we sell are sold. The Company had two customers, Honeywell and TTI, who accounted for 11% and 13% of net sales for the year ended November 30, 2010, respectively. Our discrete components are often sold to the same clients as our capacitors. These OEM customers typically accept samples for evaluation and, if approved, we work towards procuring the next orders for these items.
Typically, we do not maintain contracts with our customers and generally sell products pursuant to customer purchase orders. Although our customer base has increased, the loss of our largest customers as well as, to a lesser extent, the loss of any other material customer, could have a materially adverse effect on our operations during the short-term until we are able to generate replacement business, although we may not be able to obtain such replacement business. Because of our contracts and good working relationships with our distributors, we offer the OEMs, when purchasing through distributors, extended payment terms, just-in- time deliveries and one-stop shopping for many types of electronic products.
Competition
We conduct business in the highly competitive electronic components industry. We expect this industry to remain competitive. We face intense competition in both our selling efforts and purchasing efforts from the many companies that manufacture or distribute electronic components. Our principal competitors in the sale of capacitors include Nichicon, Panasonic, Illinois Capacitor, NIC, AVX, Murata, Epcos, United Chemicon, Rubycon, Vishay and Kemet. Our principal competitors in the sale of discrete components include Vishay, General Semiconductor Division, General Instrument Corp., OnSemi, Inc., Microsemi Corp., Diodes, Inc. and Littlefuse, and Copper Bussman Division. Our principal competition in the audible business include AVX, Murata, Panasonic, Projects Unlimited, International Components Corp. and Star Micronics. Many of these companies are well established with substantial expertise, and have much greater assets and greater financial, marketing, personnel, and other resources than we do. Many larger competing suppliers also carry product lines which we do not carry. Generally, large semiconductor manufacturers and distributors do not focus their direct selling efforts on small to medium sized OEMs and distributors, which constitute many of our customers. As our customers become larger, and as the market becomes more competitive, our competitors may find it beneficial to focus direct selling efforts on those customers, which could result in our facing increased competition, the loss of customers or pressure on our profit margins. We are finding increased competition from manufacturers located in Asia due to the increased globalization nature of the business. There can be no assurance that we will be able to continue to compete effectively with existing or potential competitors. Other factors that will affect our success in these markets include our continued ability to attract additional experienced marketing, sales and management talent, and our ability to expand our support, training and field service capabilities.
Customer Service
We have three full-time customer service employees whose time is dedicated largely to respond to customer inquiries such as price quote requests, delivery status of new or existing purchase orders, changes of existing order dates, quantities, dates, etc. We intend to increase our customer service capabilities, as necessary.
Foreign Trade Regulation
Most products sold by Surge are manufactured in Asia, including such countries as Taiwan, South Korea, Hong Kong, India, Japan and China. The purchase of goods manufactured in foreign countries is subject to a number of risks, including economic disruptions, transportation delays and interruptions, foreign exchange rate fluctuations, impositions of tariffs and import and export controls, and changes in governmental policies, any of which could have a material adverse effect on our business and results of operations. Potential concerns may include drastic devaluation of currencies, loss of supplies and increased competition within the region.
From time to time, protectionist pressures have influenced United States trade policy concerning the imposition of significant duties or other trade restrictions upon foreign products. We cannot predict whether additional United States customs quotas, duties, taxes or other charges or restrictions will be imposed upon the importation of foreign components in the future or what effect such actions could have on our business, financial condition or results of operations.
Our ability to remain competitive with respect to the pricing of imported components could be adversely affected by increases in tariffs or duties, changes in trade treaties, strikes in air or sea transportation, and possible future United States legislation with respect to pricing and import quotas on products from foreign countries. Our ability to remain competitive could also be affected by other governmental actions related to, among other things, anti-dumping legislation and international currency fluctuations. While we do not believe that any of these factors adversely impact our business at the present time, there can be no assurance that these factors will not materially adversely affect us in the future. Any significant disruption in the delivery of merchandise from our suppliers, substantially all of whom are foreign, could have a materially adverse impact on our business and results of operations.
Government Regulation
Various laws and regulations relating to safe working conditions, including the Occupational Safety and Health Act, are applicable to our company. We believe we are in substantial compliance with all material federal, state and local laws and regulations regarding safe working conditions. We believe that the cost of compliance with such governmental regulations is not material.
We are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some that may compete with us, are not subject to these prohibitions. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations. To the Company’s knowledge, none of our employees or other agents have engaged in such practices.
Environmental and Regulatory Compliance
We are subject to various environmental laws and regulations relating to the protection of the environment, including those governing the handling and management of certain chemicals used in electronic components.
We are subject to legislation, effective July 2006, eliminating lead in certain of the products the Company sells. As a result of the legislation, the Company had a one-time write down of its inventory of approximately $500,000. The Company is able to currently obtain products which comply with this law.
We do not believe that compliance with these laws and regulations will have a material adverse effect on our capital expenditures, earnings, or competitive position.
Patents, Trademarks and Proprietary Information
With respect to the products that we sell, we have no patents, trademarks or copyrights registered in the United States Patent and Trademark Office or in any state. Additionally to the best of our knowledge the manufacturers of the products that we sell do not have patents, trademarks or copyrights registered in the United States Patent and Trademark Officer or in any state. We rely on the know-how, experience and capabilities of our management personnel. Although we believe that the products do not and will not infringe patents or trademarks, or violate proprietary rights of others, it is possible that infringement of existing or future patents, trademarks or proprietary rights of others may occur. In the event that the products that we sell infringe proprietary rights of others, these products may have to be modified or redesigned by the manufacturer of these products. However, there can be no assurance that any infringing products will be able to be modified or redesigned in a way that does not infringe on the proprietary rights of others, which could have a material adverse effect upon our operations. In addition, there can be no assurance that we will have the financial or other resources necessary to enforce or defend a patent infringement or proprietary rights violation action. Moreover, if the products we sell infringe patents, trademarks or proprietary rights of others, we could, under certain circumstances, become liable for damages, which also could have a material adverse effect on our business.
Backlog
As of November 30, 2010, our backlog was approximately $5,969,000, as compared with $ 4,784,437, at November 30, 2009. Substantially all backlog is expected to be shipped by us within 90 to 180 days. Year to year comparisons of backlog are not necessarily indicative of future operating results.
Employees
As of January 5, 2011, Surge and Challenge employed 24 persons, two of whom are employed in executive capacities, seven are engaged in sales, two in engineering, three in purchasing, two in administrative capacities, three in customer service, two in accounting and three in warehousing. None of our employees are covered by a collective bargaining agreement, and we consider our relationship with our employees to be good.
Item 1A.
Item 1A.
Risk Factors
An investment in the Company’s Common Stock involves a high degree of risk. An investor should carefully consider the risks described below as well as other information contained in this report. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected, the value of our Common Stock could decline, and an investor may lose all or part of his or her investment.
Risks Related to our Business
We do not have written long-term supply contracts with manufacturers and we depend on a limited number of suppliers.
We do not have any written long-term supply, distribution or franchise agreements with any of our manufacturers. We act as the exclusive sales agent in North America for one of our manufacturers, pursuant to an oral agreement. While we believe that we have established close working relationships with our principal manufacturers, our success depends, in large part, on maintaining these relationships and developing new supplier relationships for our existing and future product lines. Because of the lack of long- term contracts, we may not be able to maintain these relationships. While we believe that there are alternative semiconductor and capacitor manufacturers whose replacement products may be acceptable to our customers, the loss of, or a significant disruption in the relationship with, one or more of our major suppliers would most likely have a material adverse effect on our business and results of operations.
We need to maintain large inventories in order to succeed; price fluctuations could harm us.
In order to adequately service our customers, we believe that it is necessary to maintain a large inventory of products. Accordingly, we attempt to maintain a one-to-two month inventory of those products we offer which are in high demand. As a result of our strategic inventory purchasing policies, under which we order in to obtain preferential pricing, waive the rights to manufacturers' inventory protection agreements (including price protection and inventory return rights), we bear the risk of increases in the prices charged by our manufacturers and decreases in the prices of products held in our inventory or covered by purchase commitments. If prices of components which we hold in inventory decline or if new technology is developed that displaces products which we sell, our business could be materially adversely affected.
We depend on certain customers.
For Fiscal 2010 approximately 24% of our net sales were derived from sales of two customers. Although our customer base has increased, the loss of our largest customers as well as, to a lesser extent, the loss of any other principal customer, would be expected to have a materially adverse effect on our operations during the short-term until we are able to generate replacement business, although we may not be able to obtain such replacement business.
We may not be able to compete against large competitors who have better resources.
We face intense competition, in both our selling efforts and purchasing efforts, from the many companies that manufacture or distribute electronic components and semiconductors. Our principal competitors in the sale of capacitors include Nichicon, Panasonic, Illinois Capacitor, NIC, AVX, Murata, Epcos, United Chemicon, Rubycon, Vishay and Kemet, General Semiconductor Division, General Instrument Corp., OnSemi, Inc., Microsemi Corp., Diodes, Inc. and Littlefuse, and Copper Bussman Division. Many of these companies are well established with substantial expertise, and have much greater assets and greater financial, marketing, personnel, and other resources than we do. Many larger competing suppliers also carry product lines which we do not carry. Generally, large semiconductor manufacturers and distributors do not focus their direct selling efforts on small to medium sized OEMs and distributors, which constitute most of our customers. As our customers become larger, however, our competitors may find it beneficial to focus direct selling efforts on those customers, which could result in our facing increased competition, the loss of customers or pressure on our profit margins. There can be no assurance that we will be able to continue to compete effectively with existing or potential competitors.
We will suffer if there is a shortage of components.
The components business has, from time to time, experienced periods of extreme shortages in product supply, generally as the result of demand exceeding available supply. When these shortages occur, suppliers tend to either increase prices or reduce the number of units sold to customers. We believe that because of our large inventory and our relationships with our manufacturers, we have not been adversely affected by shortages in certain discrete semiconductor components. However, in the future shortages may have an adverse effect upon our business.
Adverse effects of trade regulation and foreign economic conditions.
Approximately 91% of the total goods which we purchased in 2010 were manufactured in foreign countries, with the majority purchased from Taiwan-based companies manufacturing in Taiwan (55%) Hong Kong (12%), elsewhere in Asia (23%) and outside of Asia (1%). These purchases subject us to a number of risks, including economic disruptions, transportation delays and interruptions, foreign exchange rate fluctuations, imposition of tariffs and import and export controls and changes in governmental policies, any of which could have a materially adverse effect on our business and results of operations. In addition, the current economic conditions in Southeast Asia may severely impact our business. Potential concerns may include drastic devaluation of currencies, loss of supplies and increased competition within the region.
The ability to remain competitive with respect to the pricing of imported components could be adversely affected by increases in tariffs or duties, changes in trade treaties, strikes in air or sea transportation, and possible future United States legislation with respect to pricing and import quotas on products from foreign countries. For example, it is possible that political or economic developments in China, or with respect to the United States' relationship with China, could have an adverse effect on our business. Our ability to remain competitive could also be affected by other governmental actions related to, among other things, anti-dumping legislation and international currency fluctuations. While we do not believe that any of these factors have adversely impacted our business in the past, there can be no assurance that these factors will not materially adversely affect us in the future.
Electronics industry cyclicality may adversely affect our operations.
The electronics industry has been affected historically by general economic downturns, which have had an adverse economic effect upon manufacturers and end-users of capacitors and semiconductors. In addition, the life-cycle of existing electronic products and the timing of new product developments and introductions can affect demand for semiconductor components. Any downturns in the electronics distribution industry could adversely affect our business and results of operations.
Absence of patents, trademarks and proprietary information.
We have no patents, trademarks or copyrights registered in the United States Patent and Trademark Office or in any state. We rely on the know-how, experience and capabilities of our management personnel. Therefore, without trademark and copyright protection, we have no protection from other parties attempting to offer similar services. Although we believe that the products that we sell do not and will not infringe patents or trademarks, or violate proprietary rights of others, it is possible that infringement of existing or future patents, trademarks or proprietary rights of others may occur. In the event that the products that we sell infringe proprietary rights of others, the manufactures of the products that we sell may be required to modify the design of the products that we sell, change the name of these products and/or obtain a license. There can be no assurance that the manufactures will be able to modify or redesign the products in a way that does not infringe on the proprietary rights of others. Our failure to do any of the foregoing could have a material adverse effect upon our operations. In addition, there can be no assurance that we will have the financial or other resources necessary to enforce or defend a patent infringement or proprietary rights violation action. Moreover, if the products that we sell infringe patents, trademarks or proprietary rights of others, we could, under certain circumstances, become liable for damages, which also could have a material adverse effect on our business.
Failure to comply with the United States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.
We are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some that may compete with us, are not subject to these prohibitions. Although, to the Company’s knowledge, none of our employees or other agents have engaged in such practices. if our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.
Risks Related to our Common Stock
Our Common Stock is quoted on the Pink Sheets, which may limit the liquidity and price of our Common Stock more than if our Common Stock were quoted or listed on the Nasdaq Stock Market or a national exchange.
Our securities are currently quoted on the Pink Sheets, an inter-dealer electronic quotation and trading system or equity securities. Quotation of our securities on the Pink Sheets may limit the liquidity and price of our securities more than if our securities were quoted or listed on The Nasdaq Stock Market or a national exchange. Some investors may perceive our securities to be less attractive because they are traded in the over-the-counter market. In addition, as a Pink Sheets listed company, we do not attract the extensive analyst coverage that accompanies companies listed on other exchanges. Further, institutional and other investors may have investment guidelines that restrict or prohibit investing in securities traded on the Pink Sheets. These factors may have an adverse impact on the trading and price of our Common Stock.
The market price of our common stock may fluctuate significantly in response to the following factors, most of which are beyond our control:
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variations in our quarterly operating results;
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changes in general economic conditions and in the child health care product industry;
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changes in market valuations of similar companies;
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announcements by us or our competitors of significant new contracts, acquisitions, strategic partnerships or joint ventures, or capital commitments;
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loss of a major supplier or customer; and
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the addition or loss of key managerial and collaborative personnel.
Any such fluctuations may adversely affect the market price of our common stock, regardless of our actual operating performance. As a result, stockholders may be unable to sell their shares, or may be forced to sell them at a loss.
The application of the “penny stock” rules could adversely affect the market price of our common shares and increase an investor’s transaction costs to sell those shares.
The Securities and Exchange Commission (the “SEC”) has adopted rule 3a51-1 which establishes the definition of a “penny stock,” for the purposes relevant to us, as any equity security that has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, Rule 15g-9 requires:
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that a broker or dealer approve a person’s account for transactions in penny stocks; and
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the broker or dealer receive from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased.
In order to approve a person’s account for transactions in penny stocks, the broker or dealer must:
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obtain financial information and investment experience objectives of the person; and
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make a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.
The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the SEC relating to the penny stock market, which, in highlight form:
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sets forth the basis on which the broker or dealer made the suitability determination; and
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that the broker or dealer received a signed, written agreement from the investor prior to the transaction.
Generally, brokers may be less willing to execute transactions in securities subject to the “penny stock” rules. This may make it more difficult for investors to dispose of our common stock and cause a decline in the market value of our stock.
As an issuer of “penny stock,” the protection provided by the federal securities laws relating to forward looking statements does not apply to us.
Although federal securities laws provide a safe harbor for forward-looking statements made by a public company that files reports under the federal securities laws, this safe harbor is not available to issuers of penny stocks. As a result, the Company will not have the benefit of this safe harbor protection in the event of any legal action based upon a claim that the material provided by the Company contained a material misstatement of fact or was misleading in any material respect because of the Company’s failure to include any statements necessary to make the statements not misleading. Such an action could hurt our financial condition.
The market price for our common shares is particularly volatile given our status as a relatively unknown company with a small and thinly traded public float which could lead to wide fluctuations in our share price. Investors may be unable to sell their common shares at or above your purchase price, which may result in substantial losses to investors.
The market for our common shares is characterized by significant price volatility when compared to seasoned issuers, and we expect that our share price will continue to be more volatile than a seasoned issuer for the indefinite future. The volatility in our share price is attributable to a number of factors. First, as noted above, our common shares are sporadically and thinly traded. As a consequence of this lack of liquidity, the trading of relatively small quantities of shares by our shareholders may disproportionately influence the price of those shares in either direction. The price for our shares could, for example, decline precipitously in the event that a large number of our common shares are sold on the market without commensurate demand, as compared to a seasoned issuer which could better absorb those sales without adverse impact on its share price. Secondly, we are a speculative or “risky” investment due to our limited operating history and lack of profits to date, and uncertainty of future market acceptance for our potential products. As a consequence of this enhanced risk, more risk-adverse investors may, under the fear of losing all or most of their investment in the event of negative news or lack of progress, be more inclined to sell their shares on the market more quickly and at greater discounts than would be the case with the stock of a seasoned issuer. Many of these factors are beyond our control and may decrease the market price of our common shares, regardless of our operating performance. We cannot make any predictions or projections as to what the prevailing market price for our common shares will be at any time, including as to whether our common shares will sustain their current market prices, or as to what effect that the sale of shares or the availability of common shares for sale at any time will have on the prevailing market price.
We will incur increased costs as a result of being a public company, which could affect our profitability and operating results.
As a result of voluntarily registering our stock on Form 10, we will become obligated to file annual, quarterly and current reports with the SEC pursuant to the Securities Exchange Act of 1934, as amended. In addition, the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) and the new rules subsequently implemented by the SEC and the Public Company Accounting Oversight Board have imposed various new requirements on public companies, including requiring changes in corporate governance practices. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities of our more time-consuming and costly. We expect to spend between $125,000 and $150,000 in legal and accounting expenses annually to comply with our reporting obligations and Sarbanes-Oxley. These costs could affect profitability and our results of operations.
We have not paid dividends on our common stock in the past and do not expect to pay dividends for the foreseeable future. Any return on investment may be limited to the value of our common stock.
No cash dividends have been paid on the Company’s common stock. We expect that any income received from operations will be devoted to our future operations and growth. The Company does not expect to pay cash dividends on its common stock in the near future. Payment of dividends would depend upon our profitability at the time, cash available for those dividends, and other factors as the Company’s board of directors may consider relevant. If the Company does not pay dividends, the Company’s common stock may be less valuable because a return on an investor’s investment will only occur if the Company’s stock price appreciates.
The rights of the holders of common stock have been impaired by the issuance of preferred stock and may be further impaired by the potential future issuance of preferred stock.
We are authorized to issue up to 5,000,000 shares of blank check preferred stock of which 260,000 shares have been designated as Non-Voting Redeemable Convertible Series A Preferred Stock, of which no shares are issued and outstanding, 200,000 shares have been designated Voting Redeemable Convertible Series B Preferred Stock, of which 0 shares are issued and outstanding, and 100,000 shares have been designated Non-Voting Redeemable Convertible Series C Preferred Stock (“Series C Preferred Stock”), of which 32,700 shares are issued and outstanding. Holders of the Series C Preferred Stock are entitled to receive, upon liquidation, payment of $5.00 per share of Series C Preferred Stock prior to any payment to common shareholders. Holders of Series C Preferred Stock are entitled to dividends, if and when declared by the board of directors, at the rate of $0.50 per share per annum, prior to payment of dividends to common shareholders.
Furthermore, our board of directors has the right, without stockholder approval, to issue additional preferred stock with voting, dividend, conversion, liquidation or other rights which could adversely affect the voting power and equity interest of the holders of common stock, which could be issued with the right to more than one vote per share, and could be utilized as a method of discouraging, delaying or preventing a change of control. The possible negative impact on takeover attempts could adversely affect the price of our common stock. Although we have no present intention to issue any additional shares of preferred stock or to create any additional series of preferred stock, we may issue such shares in the future.
As a result of our failure to deregister our Units under the Exchange Act, we may be subject to enforcement action from the Securities and Exchange Commission as well as possible shareholder claims.
In July 1996, the Company filed a Form 8-A/A pursuant to which it sought to register under Section 12(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Units (consisting of the Company’s common stock and Class A Warrants), Common Stock and Class A Warrants. In April 2004, after the expiration of the Class A Warrants and the Units, the Company filed a Form 15 to terminate the registration of its Common Stock and Class A Warrants under Section 12(g) of the Exchange Act, or suspension of duty to file reports under Section 13 and 15(d) of the Securities 34 Act (“Deregistration”). However, the Company erroneously failed to seek deregistration of the Units. Although the Company did not seek Deregistration of its Units it stopped filing reports under Sections 12(b) and 12(g) of the Exchange Act in April 2004 when it deregistered its Common Stock and Warrants. As a result of the Company’s not de-registering its Units, the Company may have violated the Exchange Act including Sections 12 and 13 of the Exchange Act and may be subject to enforcement action from the Securities and Exchange Commission as well as possible shareholder claims.
Certain of our current officers and directors refused to submit to interviews with NASDAQ, which may prevent or make more difficult listing on a national securities exchange.
In November 2001, NASDAQ informed us that it had determined that the Company's securities would be delisted from the Nasdaq SmallCap Market, based on public interest concerns related to certain potentially questionable payments made by the Company during the year ended November 30, 2000 and the quarter ended February 28, 2001, and additionally for the failure of certain of our officers and directors to submit to an interview by NASDAQ regarding these payments (see “Business”). The officers and directors who were asked to and refused (based on the advice of counsel) to submit to the NASDAQ interviews (Ira Levy and Steven Lubman) are currently officers and directors of the Company. There can be no assurance that the failure of certain of our officers and directors to submit to the interviews will not negatively impact and/or prevent the Company’s ability to be listed on a national securities exchange, such as Nasdaq, even if the Company were to meet applicable listing qualifications.
We have a staggered board of directors, which could delay or prevent a change of control that may favor shareholders.
Our Board of Directors is divided into three classes and our Board members are elected for terms that are staggered. This could discourage the efforts by others to obtain control of the Company. The possible negative impact on takeover attempts could adversely affect the price of our common stock.
Item 1B.
Item 1B.
Unresolved Staff Comments
Not applicable.
Item 2.
Item 2.
Properties.
Our executive offices and warehouse facilities are located at 95 Jefryn Boulevard, Deer Park, New York, 11729. The Lessor is Great American Realty of Jefryn Blvd., LLC ("Great American"), an entity owned equally by Ira Levy, Surge's president, Steven Lubman, Surge's vice president and one of its former directors, Mark Siegel. Our lease is through September 31, 2020 and our monthly rent is $12,982. Our monthly rent will increase over the 10 year term, reaching $15,516 in the final year. We occupy approximately 23,250 square feet of office space and warehouse space. Each lease was negotiated in an arm's length transaction and the rental rate is typical for the type and location of Surge's and Challenge's facilities.
In June 2010, the Company entered into a lease to rent office space in Hong Kong for two years. Annual rental payments are approximately $20,000.
Item 3.
Item 3.
Legal Proceedings.
There are no legal proceedings to which the Company or any of its property is the subject.
Item 4.
Item 4.
[Reserved.]
PART II
Item 5.
Item 5.
Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The shares of our common stock are quoted on the over-the-counter “pink sheets” maintained by Pink Sheets LLC under the symbol “SPRS.PK”. Trading in our common stock is limited.
For the periods indicated, the following table sets forth the high and low bid prices per share of our common stock. These prices represent inter-dealer quotations without retail markup, markdown, or commission and may not necessarily represent actual transactions.
As of the date of the filing of this report, there are issued and outstanding 8,922,512 shares of Common Stock.
As of the date of the filing of this report, there are approximately 200 holders of record of our Common Stock.
As of the date of the filing of this report: (i) 600,000 shares of Common Stock are subject to outstanding options or warrants to purchase, or securities convertible into, Common Stock; (ii) 5,282,827 shares of Common Stock can be sold pursuant to Rule 144 under the Securities Act of 1933, as amended, and (iii) 0 shares of Common Stock are being, or has been publicly proposed to be, publicly offered by the Company.
There is no provision of the Company’s charter or by-laws that would have an effect of delaying, deferring or preventing a change in control of the Company and that would operate only with respect to an extraordinary corporate transaction involving the Company, such as a merger, reorganization, tender offer, sale or transfer of substantially all of its assets, or liquidation.
We have not declared any cash dividends on our Common Stock since inception and do not anticipate paying such dividends in the foreseeable future. We plan to retain any future earnings for use in our business operations. Any decisions as to future payment of cash dividends will depend on our earnings and financial position and such other factors as the Board of Directors deems relevant.
Equity Compensation Plan Information
The following table provides information as of November 30, 2010 with respect to the shares of common stock that may be issued under our existing equity compensation plans:
(1) Represents the Company's 2010 Incentive Stock Plan.
Recent Sales Of Unregistered Securities.
During the last three years, we have issued the following securities:
On May 6, 2010, we issued options to purchase 250,000 shares of our common stock to each of Ira Levy and Steven Lubman. The options vest one year after issuance.
On May 6, 2010, we issued 12,000 shares of common stock and options to purchase 25,000 shares of our common stock at an exercise price of $0.25 to each of our non-officer directors. The options vest one year after issuance.
On February 25, 2011, the Company issued options to purchase an aggregate of 85,000 shares of common stock at an exercise price of $1.15 to non-executive employees. The options vest over a three-year period.
In connection with the foregoing, the Company relied upon the exemption from securities registration afforded by Section 4(2)under the Securities Act of 1933, as amended (the “Securities Act”) for transactions not involving a public offering. No advertising or general solicitation was employed in offering the securities. The offerings and sales were made to a limited number of persons, all of whom were accredited investors, and transfer was restricted by the Company in accordance with the requirements of the Securities Act.
Issuer Repurchases of Equity Securities
None.
Item 6.
Item 6.
Selected Financial Data
Not Applicable.
ITEM 7.
ITEM 7. 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 in this registration statement, including statements regarding our future results of operations and financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.
In some cases, forward-looking statements can be identified by terms such as "may," "will," "should," "expects," "plans," "anticipates," "could," "intends," "target," "projects," "contemplates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of these terms or other similar words. These statements are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. We discuss many of the risks in greater detail under the heading "Risk Factors." Also, these forward-looking statements represent our estimates and assumptions only as of the date of the filing of this registration statement. Except as required by law, we assume no obligation to update any forward-looking statements after the date of the filing of this registration statement.
This report also contains estimates and other statistical data made by independent parties and by us relating to market size and growth and other industry data. This data involves a number of assumptions and limitations, and investors are cautioned not to give undue weight to such estimates. We have not independently verified the statistical and other industry data generated by independent parties and contained in this registration statement and, accordingly, we cannot guarantee their accuracy or completeness. In addition, projections, assumptions and estimates of our future performance and the future performance of the industries in which we operate are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors” and elsewhere in this report. These and other factors could cause results to differ materially from those expressed in the estimates made by the independent parties and by us.
Overview
We are a supplier of electronic products and components. These products include capacitors, which are electrical energy storage devices, and discrete components, such as semiconductor 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 that we sell are typically utilized in the electronic circuitry of diverse products, including, but not limited to, automobiles, cellular telephones, computers, consumer electronics, garage door openers, household appliances, power supplies and security equipment. The products that we sell 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. The products that we sell are manufactured predominantly in Asia by approximately sixteen independent manufacturers. We do not have any binding long-term supply agreements, with our suppliers. We act as the exclusive sales agent utilizing independent sales representative organizations in North America to sell and market the products for one such manufacturer pursuant to an oral agreement. When we act as a sales agent, the supplier who sold the product to the customer that we introduced to such supplier will pay us a commission. The amount of the commission is determined on a sale by sale basis depending on the profit margin of the product. Such commissions have not been material to date.
Challenge engages in the electronic components business. In 1999, Challenge began a division to sell audible components. Since 2002 this division has grown by 88%. 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. As a result we are continually trying to add to the types of products that we sell. In 2002 we started to import products similar to our parent company Surge, and sold these under the Challenge name. It started with a line of transducers, then we added battery snaps, and coin cell holders. In the past nine years we have increased our imported private label product mix to include buzzers, speakers, microphones, resonators, 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. Five years ago, we hired a design engineer on our staff that had thirty years experience with these types of products, who works with our suppliers on such redesigns. We continue to expand the line of products we sell, we now are selling alarms and chimes. We sell these products through independent representatives that make a 5-6% commission rate on the gross sale of the products we sell. We also are working with local, regional, and National distributors to sell these products to local accounts in every state. We do not have contractual authority from our manufactures to modify any of the products that we distribute.
As a result of voluntarily registering our stock, we have become obligated to file annual, quarterly and current reports with the SEC pursuant to the Securities Exchange Act of 1934, as amended. In addition, the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) and the new rules subsequently implemented by the SEC and the Public Company Accounting Oversight Board have imposed various new requirements on public companies, including requiring changes in corporate governance practices. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities of our more time-consuming and costly. We expect to spend between $125,000 and $150,000 in legal and accounting expenses annually to comply with our reporting obligations and Sarbanes-Oxley. These costs could affect profitability and our results of operations.
In 2002, the Company opened a Hong Kong office and hired direct sales people in order to effectively handle the transfer business from United States customers purchasing and manufacturing in Asia after they do the design in America. This office has strengthened its global capabilities and service to its customer base
The electronic components industry is currently experiencing a period of strong demand. In addition, management believes that manufacturers are not expanding production capacity because they are unsure of how long the period of strong demand will last. Management believes that demand for the electronic components will be strong through the beginning of 2011 before leveling off later in 2011.
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 clients, our ability to retain 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, and the availability of adequate financing.
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, revenue is recognized when product is shipped from the Company’s supplier. The Company acts as a sales agent for certain customers for 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 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. A significant portion (approximately $500,000) of the total amount of the reserves relate to a product line for which demand dropped significantly as a result of a change in an environmental law several years ago. 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 $28,000.
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.
Results of Operations
Consolidated net sales for the fiscal year ended November 30, 2010 increased by $9,288,099 or 75%, to $21,613,911 as compared to net sales of $12,325,812 for the fiscal year ended November 30, 2009. We attribute the increase to additional business with existing customers and new customers. The electronic components industry is currently experiencing a high demand in products and the Company is benefiting from that with an increase in volume.
Our gross profit for the fiscal year ended November 30, 2010 increased by $2,867,098, or 78%, as compared to the fiscal year ended November 30, 2009. Gross margin as a percentage of net sales increased to 30.3% for the fiscal year ended November 30, 2010 compared to 29.9% for the fiscal year ended November 30, 2009. We attribute the increase to new more profitable business and cutting costs, including an increase in the amount of purchase rebates earned from certain vendors. These purchase rebates result from rebates earned based on the amount of inventory purchased from suppliers.
Selling and shipping expenses for the fiscal year ended November 30, 2010 was $1,813,471, an increase of $723,275, or 66%, as compared to $1,090,196 for the fiscal year ended November 30, 2009.The increase is directly related to the increase in sales for the Company. Specifically the increase is due to additional sales commissions, selling expenses, such as travel and freight out expense.
General and administrative expenses for the fiscal year ended November 30, 2010 was $2,910,775, an increase of $898,136, or 45%, as compared to $2,012,639 for the fiscal year ended November 30, 2009. The increase is due to increased professional fees associated with the Company becoming a reporting company with the SEC and additional compensation in the amount of $424,022, approved by the Board, for the officers and directors of the Company.
Investment income for the fiscal year ended November 30, 2010 was $4,340, compared to $7,405 for the fiscal year ended November 30, 2009. We attribute the decrease of $3,065, or 41%, to lower interest rates in our money market accounts in 2010.
Interest expense for the fiscal year ended November 30, 2010 was $117,973, compared to $126,503 for the fiscal year ended November 30, 2009. We attribute the decrease of $8,530, or 7%, to less borrowings on our line of credit during 2010. Interest rates have been comparable for the last year.
Income taxes for the fiscal year ended November 30, 2010 were $82,672, compared to $5,364 for the fiscal year ended November 30, 2009. The difference is a result of federal corporate taxes incurred due to net operating loss limitations with the IRS tax code and increase in state income taxes.
As a result of the foregoing, net income for the fiscal year ended November 30, 2010 was $1,496,088, compared to the net income of $316,555 for the fiscal year ended November 30, 2009.
Liquidity and Capital Resources
As of November 30, 2010 we had cash of $883,331, and working capital of $4,242,768. We believe that our working capital levels and available financing are adequate to meet our operating requirements during the next twelve months.
During the fiscal year ended November 30, 2010, we had net cash flow from operating activities of $530,624, as compared to net cash from operating activities of $364,294 for the fiscal year ended November 30, 2009. The increase in cash flow from operating activities resulted from increase in the 2010 profit, increase in accounts receivable and inventory offset by increase in accounts payable. As a result of these increased revenues, the Company made a significant investment in additional inventory. The Company adjusts its inventory levels based upon the industry outlook and near term expectations of demand for the Company’s products.
We had net cash used in investing activities of $(19,860) for the fiscal year ended November 30, 2010, as compared to net cash used in investing activities of $(158,512) for the fiscal year ended November 30, 2009. This decrease was the result of the Company purchasing additional computer hardware in 2009.
We had net cash from financing activities of $(766,771) for the fiscal year ended November 30, 2010, as compared to net cash provided by financing activities of $29,393 for the fiscal year ended November 30, 2009. The decrease was the result of the decrease in borrowings in 2010 from our lender.
As a result of the foregoing, the Company had a net decrease in cash of $257,007 for the fiscal year ended November 30, 2010, as compared to a net increase in cash of $235,175 for the fiscal year ended November 30, 2009.
In July 2002, the Company obtained a financing commitment with an asset-based lender totaling $1,000,000 (the “Credit Line”). Borrowings under the Credit Line accrue interest at the greater of the prime rate plus two percent (2.0%) or 6.75%. The Company is required to make monthly interest only payments. The Company may repay all or a portion of the line of credit at any time. In addition, the Company is obligated to pay one-quarter of one percent (1/4 of 1%) annually as an unused line fee for the difference between $1,000,000 and the average daily balance of the Credit Line. The Credit Line is collateralized by substantially all the Company’s assets and contains various financial covenants pertaining to the maintenance of working capital and tangible net worth. At November 30, 2010, the Company was in compliance with the financial covenants.
Long-term debt, operating leases and other long-term obligations as of November 30, 2010 mature as follows:
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. In addition, the interest on the Company's line of credit is based upon the prime rate. Any significant increase in the prime rate could significantly impact our future operating results.
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not Applicable
Item
8.
Item
8. Financial Statements and Supplementary Information
Our financial statements, together with the independent registered public accounting firm's report of Seligson & Giannattasio, LLP, begin on page, immediately after the signature page.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A.
Controls and Procedures.
Evaluation of Disclosure Controls and Procedures.
We maintain "disclosure controls and procedures," as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act"), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
As of November 30, 2010, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in our periodic reports is recorded, processed, summarized and reported, within the time periods specified for each report and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report of Internal Control over Financial Reporting.
We are responsible for establishing and maintaining adequate internal control over financial reporting in accordance with Exchange Act Rule 13a-15. With the participation of our Chief Executive Officer and Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting as of November 30, 2010 based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that our internal control over financial reporting was effective as of November 30, 2010, based on those criteria. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.
Changes in Internal Controls.
During the three months ended November 30, 2010, there were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers, And Corporate Governance.
Our board of directors is classified into three classes, with the term of office of one class expiring each year. The term of Class A directors expires at the Company’s annual meeting of shareholders to be held in 2013, the term of Class B directors expires at the Company’s annual meeting of shareholders to be held in 2012, and the term of office of Class C directors expires at the Company’s annual meeting of shareholders to be held in 2011. Our executive officers and directors, and their ages, positions and offices with us are as follows:
Ira Levy has served as President, Chief Executive Officer and a director of Surge Components since its inception in November 1981, and as Chief Financial Officer since March 2010. From 1976 to 1981, Mr. Levy was employed by Capar Components Corp., an importer and supplier of capacitor and resistor products.
Steven J. Lubman has served as Surge Components’ Vice President, Secretary and a director since our inception in November 1981. From 1975 to 1981, Mr. Lubman was employed by Capar Components, Inc.
Alan Plafker has served as a director since June 2001. Since July 2000, Mr. Plafker has been the President and Chief Executive Officer of Member Brokerage Service LLC, a credit union service organization owned by Melrose Credit Union. Mr. Plafker has over 20 years of management experience in the insurance and credit union industries.
David Siegel has served as a director since 1983, as well as Chairman of the Board from 1983 to February 2000. Mr. Siegel also serves on the boards of directors of Nu Horizons and Micronetics, Inc., each of which is a publicly traded company. David Siegel is the father-in-law of Ira Levy.
Lawrence Chariton has served as a director since August 2001. For the last 31 years, Mr. Chariton has worked as a Sales Manager for Linda Shop, a retail jewelry business, and now does the same for Great American Jewelry, and is involved in charitable organizations benefiting the State of Israel. Mr. Chariton also is a director of New Island Hospital in Bethpage, Long Island. Mr. Chariton graduated from Hofstra University in 1979 with a Bachelor's Degree in accounting.
Gary M. Jacobs is the Chief Financial Officer of Chem Rx. He became Chief Financial Officer of Chem Rx on June 12, 2008. From May 2005 to June 2008, Mr. Jacobs was the Chief Financial Officer and Chief Operating Officer of Gold Force International, Ltd., a supplier of gold, silver and pearl jewelry to U.S. retail chains, and Karat Platinum LLC, a developer of an alternative to platinum. From July 2003 to April 2005, Mr. Jacobs served as President of The Innovative Companies, LLC, a supplier of natural stone. From October 2001 to February 2003, Mr. Jacobs served as Executive Vice President of Operations and Corporate Secretary of The Hain Celestial Group, Inc., a food and personal care products company. Mr. Jacobs also served as Executive Vice President of Finance, Chief Financial Officer and Treasurer of The Hain Celestial Group, Inc. from September 1998 to October 2001. Prior to that, Mr. Jacobs was the Chief Financial Officer of Graham Field Health Products, Inc., a manufacturing and distribution company. Mr. Jacobs was employed for 13 years as a member of the audit staff of Ernst & Young LLP, where he attained the position of senior manager. He is a certified public accountant and holds a Bachelor’s of Business Administration in Accounting from Adelphi University.
The Company believes that each of its directors has the experience, qualifications, attributes and skills that enable them to make a positive contribution to our board for the following reasons:
Both Mr. Levy and Mr. Lubman have been in the electronic components business for over 30 years and have a vast knowledge of this business. Mr. Levy’s and Mr. Lubman’s experience in and knowledge of the electronics components business led to the conclusion that Mr. Levy and Mr. Lubman should serve on the Company’s board given the Company’s business and structure. Their knowledge of our business enables them to bring keen insight to the board.
Alan Plafker has been an executive in the insurance industry for over 20 years and is knowledgeable in financial matters, including reviewing financial statements. Mr. Plafker’s experience in the insurance industry and knowledge of financial matters led to the conclusion that he should serve on the Company’s board, given the Company’s business and structure.
David Siegel serves on the boards of two other public companies and as such he is very familiar with the required public filings that a public company must make and as a result he is able to easily communicate with the company’s advisors, such as their attorneys. Mr. Siegel’s experience on the board of directors of two other public companies and ability to communicate with the Company’s advisers led to the conclusion that he should serve on the Company’s board, given the Company’s business and structure.
Lawrence Chariton experience as a sales manager of a jewelry store gives him experience in running a small business like ours. Mr. Chariton’s experience running a small business led to the conclusion that he should serve on the Company’s board, given the Company’s business and structure.
Gary Jacobs’s experience as a certified public accountant and Chief Financial Officer makes him extremely qualified to review and discuss the Company’s financial results and to make recommendations regarding the Company’s financial position. Mr. Jacobs’s experience as a certified public accountant and Chief Financial Officer led to the conclusion that he should serve on the Company’s board, given the Company’s business and structure.
Board Leadership Structure and Role in Risk Oversight
Although we have not adopted a formal policy on whether the Chairman and Chief Executive Officer positions should be separate or combined, we have traditionally determined that it is in the best interests of the Company and its shareholders to combine these roles. Mr. Levy has served as our Chairman since November 1981. Due to the small size and early stage of the Company, we believe it is currently most effective to have the Chairman and Chief Executive Officer positions combined.
Our board of directors is primarily responsible for overseeing our risk management processes on behalf of our board of directors. The board of directors receives and reviews periodic reports from management, auditors, legal counsel, and others, as considered appropriate regarding our company’s assessment of risks. The board of directors focuses on the most significant risks facing our company and our company’s general risk management strategy, and also ensures that risks undertaken by our Company are consistent with the board’s appetite for risk. While the board oversees our company’s risk management, management is responsible for day-to-day risk management processes. We believe this division of responsibilities is the most effective approach for addressing the risks facing our company and that our board leadership structure supports this approach.
Audit Committee Financial Expert.
The board of directors acts as the Company’s audit committee. The Company’s board directors has determined that Gary Jacobs is an audit committee financial expert. Mr. Jacobs is an independent director as that term is defined under the Nasdaq Marketplace Rules.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 requires that our officers and directors, and persons who own more than ten percent of a registered class of our equity securities, file reports of ownership and changes in ownership with the Securities and Exchange Commission and with any exchange on which the Company's securities are traded. Officers, directors and persons owning more than ten percent of such securities are required by Commission regulation to file with the Commission and furnish the Company with copies of all reports required under Section 16(a) of the Exchange Act. To our knowledge, based solely upon our review of the copies of such reports furnished to us, during the fiscal year ended November 30, 2010, all Section 16(a) filing requirements applicable to our officers, directors and greater than 10% beneficial owners were complied with, except that Form 3’s were not timely filed for Ira Levy, Steven J. Lubman, Lawrence Chariton, Alan Plafker, David Segal and Gary Jacobs, and have since been filed.
Code of Ethics
The Company intends to adopt a Code of Ethics in the near future.
Changes in Nominating Procedures
None.
Item 11.
Item 11.
Executive Compensation.
The following table sets forth information regarding compensation paid to our principal executive officer and any other executive officer whose total annual salary and bonus for the years ended November 30, 2010 and November 30, 2009 exceeded $100,000
Employment Agreements
* Includes $21,981 which Mr. Lubman is owed pursuant to his employment agreement, but which has not been paid, Mr. Lubman has agreed orally with the Company that this amount will be paid at such time as the Company is better able to afford such payment.. There is no written agreement with respect to this deferral.
(1)
Represents 250,000 options with an exercise price of $0.25 issued on May 6, 2010. The options vest one year after issuance and expire in May 2015. Please see Note F (3) to the financial statements
(2)
Includes $25,000 which was approved in May 2010.
The Company has entered into employment agreements (the “Levy Agreement” and the “Lubman Agreement”, individually, and collectively, the “Employment Agreements”) with Ira Levy and Steven Lubman (the “Executives ”), respectively, with terms through July 30, 2010 (renewable on each July 30 th for an additional one year period), which provides the Executives with a base salary of $225,000 (“ Base Salary ”).
The Company’s compensation committee may award Messrs. Levy and Lubman with bonuses. Pursuant to the employment agreements, Messrs. Levy and Lubman are prohibited from engaging in activities which are competitive with those of the Company during the employment and for one year following termination. The agreements further provide that in the event of a change of control, as defined, or a change in ownership of at least 25% of the issued and outstanding stock of the Company, and such issuance was not approved by either officer, or if they are not elected to the Board of Directors of the Company and/or are not elected as an officer of the Company, then the non-approving officer may elect to terminate his employment agreement. If he elects to terminate the agreement, he will receive 2.99 times his annual compensation (or such other amount then permitted under the Internal Revenue Code without an excess penalty), in addition to the remainder of his compensation under his existing employment contract. In addition, if the Company makes or receives a “firm commitment” for a public offering of Common Shares, each officer will receive a warrant to purchase, at a nominal value, up to 9.5% of the Company’s common stock, provided they do not voluntarily terminate employment.
The Employment Agreements provide for the following payments upon each of the following circumstances in which the Executives’ employment could end:
(a)
Payment upon termination due to disability - if either of the Employment Agreements is terminated by the Company by reason of any physical or mental illness so that the Executives are unable to perform the services required by them pursuant to the Employment Agreements for a continuous period of 4 months, or for an aggregate of 6 months during any consecutive 12 month period, then the Company shall pay to the Executives his Base Salary then in effect along with all other fringe benefits for a period of 1 year following the date of such termination.
(b)
Payment upon termination due to death - if either of the Employment Agreements is automatically terminated upon the death of the Executives, the Company shall pay to the Executive’s estate his Base Salary then in effect for a period of 1 year following the date of such termination.
(c)
Payment upon termination for “cause” - the Company is not obligated to make any further payments to the Executives upon their termination for “cause.” The term “cause” means any event that the Executives are guilty of (i) reckless disregard to perform his duties as set forth in each Executive’s respective Agreement, (ii) willful malfeasance, or (iii) any act of dishonesty by the Executives with respect to the Company.
(d)
Payment upon termination without “cause” -
(i)
if the Company terminates the Levy Agreement without “cause”, then the Company is obligated to pay Mr. Levy (i) any and all Base Salary and bonus amounts payable to Mr. Levy for the remainder of the term, (ii) the Company shall continue for the remainder of the term to permit Mr. Levy to receive or participate in all fringe benefits available to him pursuant to the Levy Agreement, provided, however, that any fringe benefits which Mr. Levy receives will be reduced by any payments or fringe benefits Mr. Levy receives during the remainder of the term from any other source of employment which is unaffiliated with the Company.
(ii)
If the Company terminates the Lubman Agreement without cause, the Company is obligated to pay Mr. Lubman any and all Base Salary and bonus amounts payable to Mr. Lubman for the greater of (x) the remainder of the term in effect immediately prior to such termination, or (y) 1 year from the remainder of the term, and the Company shall also continue for the remainder of the term to permit Mr. Lubman to receive or participate in all fringe benefits available to him pursuant to the Lubman Agreement, provided, however, that any fringe benefits which Mr. Lubman receives will be reduced by any payments or fringe benefits Mr. Lubman receives during the remainder of the term from any other source of employment which is unaffiliated with the Company.
(e)
Payment upon a “change of control” - if either of the Executives elects to terminate his employment in the event of a change of control, the Company shall pay the Executives, in addition to the remainder of their annual compensation, a “parachute payment” as said term is defined in Section 280G of the Internal Revenue Code of 1986, as amended (the “ Code ”) in an amount equal to 2.99 times the respective Executive’s annual compensation, including the Base Salary, bonus compensation and other remuneration and fringe benefits, if any. A “change in control” occurs when the Executives are not elected to the Board of Directors of the Company, and/or is not elected as an officer of the Company and/or there has been a change in the ownership following the Company’s 1996 public offering of at least 25% of the issued and outstanding stock of the Company, and such issuance was not approved by the Executives. No change in control, as defined in the Employment Agreements, has occurred.
Director Compensation for Year Ending November 30, 2010
The following table summarizes the compensation for our non-employee board of directors for the fiscal year ended November 30, 2010. All compensation paid to our employee directors is included under the summary compensation table above.
(1) Represents 12,000 shares of common stock issued on May 6, 2010. Please see Note F(5) to the financial statements.
(2) Represents 25,000 options with an exercise price of $0.25 issued on May 6, 2010. The options vest one year after issuance and expire in May 2015. Please see Note F(3) to the financial statements.
Outstanding Equity Awards at November 30, 2010
(1)
The options were issued on May 6, 2010 and vest one year after issuance.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth as of February 25, 2011, the number of shares of Common Stock held of record or beneficially (i) by each person who held of record, or was known by the Company to own beneficially, more than five percent of the outstanding shares of Common Stock, (ii) by each director and (iii) by all officers and directors as a group:
* Less than 1%
(1) Except as otherwise indicated, the address of each beneficial owner is c/o Surge Components, Inc., 95 East Jefryn Boulevard, Deer Park, NY 11729.
(2) Applicable percentage ownership is based on 8,922,512 shares of Common Stock outstanding as of February 25, 2011, together with securities exercisable or convertible into shares of Common Stock within 60 days of February 25, 2011 for each stockholder. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Shares of Common Stock that are currently exercisable or exercisable within 60 days of February 25, 2011 are deemed to be beneficially owned by the person holding such securities for the purpose of computing the percentage of ownership of such person, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person.
(3) Does not include 250,000 shares issuable upon exercise of options with an exercise price of $0.25, because the options are not exercisable within 60 days. Does not include 250,000 shares held of record by Ira Levy and beneficially owned by Steven Lubman pursuant to an oral agreement.
(4) Does not included 250,000 shares issuable upon exercise of options with an excersise price of $0.25, because the options are not exercisable within 60 days. Includes 250,000 shares held of record by Ira Levy and beneficially owned by Steven Lubman pursuant to an oral agreement.
(5) Does not include 25,000 shares issuable upon exercise of options with an exercise price of $0.25, because the options are not exercisable within 60 days.
(6) Includes 55,000 shares held by Hummingbird Value Fund, L.P. (“Hummingbird Value”), 335,356 shares held by The Tarsier Nanocap Value Fund, L.P. (“Tarsier”) and 65,750 shares held by certain managed accounts (the “Managed Accounts”). Mr. Sonkin is the managing member of Hummingbird Management, LLC (“Hummingbird Management”) and Hummingbird Capital, LLC (“Hummingbird Capital”), and the investment manager to the Managed Accounts. Hummingbird Management is the investment manager of each of Hummingbird Value and Tarsier. Hummingbird Capital is the general partner of each of Hummingbird Value and Tarsier.
The following table sets forth as of February 25, 2011, the number of shares of Series C Preferred Stock held of record or beneficially (i) by each person who held of record, or was known by the Company to own beneficially, more than five percent of the outstanding shares of Common Stock, (ii) by each director and (iii) by all officers and directors as a group:
As of February 25, 2011, there are 32,700 shares of Series C Preferred Stock issued and outstanding.
Item 13.
Item 13.
Certain Relationships And Related Transactions, and Director Independence.
Certain Relationships and Related Transactions
Surge and Challenge, each lease their current executive offices from, Great American Realty of Jefryn Blvd., LLC, an entity owned equally by Ira Levy, Surge’s, Chief Executive Officer, President and Secretary and Steven Lubman, our vice president and one other individual who is not an executive officer or director of the Company. Our lease is through September 2020 and our annual minimum rent payments were approximately $156,000 and $212,000 for fiscal 2010 and 2009, respectively.
In May 2002, Surge and Ira levy, an officer of Surge 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 Mr. Levy owns 1 share of the outstanding common stock. No payments have been made to Levy in connection with this share ownership. Mr. Levy 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. During fiscal 2010 and fiscal 2009, Surge Limited’s revenues were $4,400,000 and $2,510,000 respectively.
Director Independence
Lawrence Chariton, Alan Plafker, and Gary Jacobs are independent directors as that term is defined under the Nasdaq Marketplace Rules.
Item 14.
Item 14.
Principal Accounting Fees And Services
Audit Fees
Audit Fees represent the aggregate fees for professional services for the audit of our annual financial statements and review of financial statements included in our quarterly reports on Form 10-Q or services that are normally provided in connection with statutory and regulatory filings or engagements for those fiscal years. For the years ended November 30, 2010 and 2009, we paid Seligson & Giannattasio, LLP $99,000 and $99,000, respectively.
Tax Fees
For the years ended November 30, 2010 and 2009, we paid Seligson & Giannattasio, LLP $8,000 and $8,000, respectively, for tax related services.
All Other Fees.
For the years ended November 30, 2010 and 2009, we paid Seligson & Giannattasio, LLP $0 and $0, respectively, for all other services.
The board of directors on an annual basis reviews audit and non-audit services performed by the independent registered public accounting firm. All audit and non-audit services are pre-approved by the board of directors, which considers, among other things, the possible effect of the performance of such services on the auditors' independence. The board of directors has considered the role of Seligson & Giannattasio, LLP in providing services to us for the fiscal year ended November 30, 2010 and has concluded that such services are compatible with Seligson & Giannattasio, LLP’s independence as the Company's independent registered public accounting firm..
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules.
The following documents are filed as a part of this report or incorporated herein by reference:
(1)
Our Consolidated Financial Statements are listed on page of this Annual Report.
(2)
Financial Statement Schedules:
None
(3)
Exhibits:
The following documents are included as exhibits to this Annual Report:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ Ira Levy
Ira Levy
February 28, 2011
Chief Executive Officer and Chief Financial Officer (Principal Executive Officer, Principal Financial Officer and Principal Accounting Officer)
/s/ Steven J. Lubman
Steven J. Lubman
February 28, 2011
Director
/s/ Alan Plafker
Alan Plafker
February 28, 2011
Director
David Siegel
February 28, 2011
Director
/s/ Lawrence Chariton
Lawrence Chariton
February 28, 2011
Director
Gary M. Jacobs
February 28, 2011
Director
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To The Board of Directors and Stockholders of
Surge Components, Inc.
We have audited the accompanying consolidated balance sheets of Surge Components, Inc. and subsidiaries as of November 30, 2010 and 2009 and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the years in the two year period ended November 30, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Surge Components, Inc. and subsidiaries as of November 30, 2010 and 2009 and the consolidated results of their operations and their consolidated cash flows for the years in the two year period ended in November 30, 2010 in conformity with accounting principles generally accepted in the United States of America.
/s/ Seligson & Giannattasio, LLP
Seligson & Giannattasio, LLP
White Plains, New York
February 25, 2011
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
See notes to financial statements.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
See notes to financial statements.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Consolidated Statements of Income
See notes to financial statements.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity
Years ended November 30, 2010 and 2009
See notes to financial statements.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
See notes to financial statements.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Consolidated Statements Of Cash Flows
(CONTINUED)
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 rectifiers, to customers located principally throughout the United States. On June 24, 1988, Surge formed Challenge/Surge Inc., (“Challenge”) a wholly-owned subsidiary to engage in the distribution of electronic component products from established brand manufacturers to customers located principally throughout the United States.
In May 2002, Surge and an officer of Surge 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.
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. The number of common stock shares authorized for issuance was increased to 75,000,000 shares.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
[1] Principles of Consolidation:
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.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
[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 contractual 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:
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.
For direct shipments, revenue is recognized when product is shipped from the Company’s supplier. The Company has no written arrangements with its suppliers. The Company purchases the merchandise from the supplier and has the supplier directly ship to the customer. Title passes to customer upon the merchandise being received by a freight forwarder. Direct shipments were approximately $2,889,000 and $1,355,000 for the years ended November 30, 2010 and 2009, respectively.
The Company also acts as a sales agent for North America for certain customers for one of its suppliers. The Company reports these commissions as revenues in the period earned. Commission revenue totaled $212,502 and $229,177 for the years ended November 30, 2010 and 2009, 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. Half of these agreements were entered into in October 2009. Some of these agreements allow for the return of up to 10% of certain product sales for the previous six month period. The Company does not recognize this portion of the revenues, or the related costs of the sale, until the right of return has expired. There are no provisions for the granting of price concessions in any of the
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
[3] Revenue Recognition (continued):
agreements. Revenues under these distribution agreements were approximately $4,104,629 and $1,433,000 for the years ended November 30, 2010 and 2009, 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 market. 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 November 30, 2010 approximated $884,000. The Company, at November 30, 2010, has a reserve against slow moving and obsolete inventory of $1,183,944. From time to time the Company’s products are subject to legislation from various authorities on environmental matters. Legislation was enacted, effective July 2006, eliminating lead in certain of the Company’s products. The Company has provided a reserve for these products which is reflected as slow moving. The Company is able to currently obtain products which comply with this law.
[5] Depreciation and Amortization:
Fixed assets are recorded at cost. Depreciation is generally 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
5 - 7 years
and equipment
Computer equipment
5 years
Leasehold
Estimated useful
Improvements
life or lease
term, whichever is shorter
Maintenance and repairs are expensed as incurred, while renewal 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 accounts receivable. The Company maintains substantially all of its cash balances in a limited number of financial institutions. The balances are each insured by the Federal Deposit Insurance Corporation up to $250,000 through December 31, 2013. At November 30, 2010 and 2009, the Company's uninsured cash balances totaled approximately $690,000 and $640,848, 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 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.
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, 2007, and state tax examinations for years before fiscal years ending November 30, 2006. 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 tax benefits, nor was any interest expense recognized during the twelve month periods ended November 30, 2010 and 2009.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
[8] Cash Equivalents:
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
[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 obligations. Cooperative advertising is reflected as a reduction in revenues and has not been material to date.
[11] Fair Value of Financial Instruments:
Cash balances and the carrying amount of the 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.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
[12] Shipping Costs
The Company classifies shipping costs as a component of selling expenses. Shipping costs totaled $13,808 and $6,902 for the years ended November 30, 2010 and 2009, respectively.
(13) Earnings Per Share
Basic earnings per share includes no dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. 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 November 30, 2010 and 2009 totaled 524,053 and 380,000, respectively.
(14) 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.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
[15] Recent Accounting Standards:
In October 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition (Topic 605) - Multiple Deliverable Revenue Arrangements.” ASU No. 2009-13 eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method and expands the disclosures related to multiple deliverable revenue arrangements. ASU No. 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier adoption permitted. The adoption of ASU No. 2009-13 is not expected to have a material impact on the Company’s results of operations or financial position.
In September 2009, the FASB also ratified authoritative accounting guidance requiring the sales of all tangible products containing both software and non-software components that function together to deliver the product’s essential functionality to be excluded from the scope of the software revenue guidance. The Company adopted the guidance on a prospective basis during the three months ended September 27, 2009 effective for all periods in 2009. Prior to the adoption of this guidance, the Company assessed all software items included in the Company’s product offerings to be incidental to the product itself and, therefore, excluded all sales from the scope of the related software revenue guidance. As a result, the adoption of this guidance had no impact on the Company’s consolidated financial statements.
NOTE C - FIXED ASSETS
Depreciation and amortization expense for the years ended November 30, 2010 and 2009 was $136,154 and $141,843, respectively.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE D - ACCRUED EXPENSES
Accrued expenses consist of the following:
NOTE E - RETIREMENT PLAN
In June 1997, the Company adopted a qualified 401(k) 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 $752,000 at November 30, 2010. Pension expense for the years ended November 30, 2010 and 2009 was $5,229 and $3,662, respectively.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE F - 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 January 2000, the Company authorized 260,000 shares of preferred stock as Non-Voting Redeemable Convertible Series A Preferred Stock. None of the Series A preferred stock is outstanding as of November 30, 2009.
In November 2000, the Company authorized 200,000 shares of preferred stock as Voting Redeemable Convertible Series B Preferred Stock (“Series B Preferred”). No shares of Series B Preferred Stock are currently issued or outstanding.
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 the Company’s 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. In April 2001, 8,000 shares of the Series C Preferred were repurchased and cancelled. Dividends aggregating $150,907 have not been declared or paid for the semiannual periods ended December 31, 2001 through the semiannual payment due June 30, 2010. The Company has accrued these dividends. The December 31, 2010 dividend of $8,175 has not been declared or paid.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE F- SHAREHOLDERS’ EQUITY (Continued)
[1] Preferred Stock (continued):
In April 2002, in connection with a Mutual Release, Settlement, Standstill and Non-Disparagement Agreement and among other provisions, certain investors transferred back to the Company 252,000 shares of common stock, 19,300 shares of Series C preferred stock, and certain warrants, in exchange for $225,000. These repurchased shares were cancelled.
In February 2006, the Company settled with a shareholder to repurchase 10,000 shares of Series C preferred stock plus accrued dividends for $50,000.
At November 30, 2010 there are 32,700 shares of Series C Preferred stock issued and outstanding.
[2] 1995 Employee Stock Option Plan:
In January 1996, the Company adopted, and in February 1996 the shareholders ratified, the 1995 Employee Stock Option Plan (“Option Plan”). The plan provides for the grant of options to qualified employees of the Company, independent contractors, consultants and other individuals to purchase an aggregate of 350,000 common shares. In March 1998, the Option Plan was amended to increase the number of aggregate Common Shares available under the plan to 850,000.
The Employee Stock Option Plan has expired. The remaining 53,000 options outstanding expired in July 2010.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
[3] 2010 Incentive Stock Plan
In March 2010, the Company adopted, and in April 2010 the shareholders ratified, the 2010 Incentive Stock Plan (“Stock Plan”). The plan provides for the grant of options to officers, employees or consultants to the Company to purchase an aggregate of 1,500,000 common shares.
Stock option incentive plan activity is summarized as follows:
Stock Compensation
The fair values of stock options are estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions during 2010: expected volatility of 6%; average risk-free interest rate of 3.58%; initial expected life of 5 years; no expected dividend yield; and amortized over the vesting period. During the year ended November 30, 2010, the Company recorded stock based compensation totaling $15,100 as a result of these stock option grants.
The intrinsic value of the exercisable options at November 30, 2010 totaled $0. At November 30, 2010, the weighted average remaining life of the stock options is 4.2 years. At November 30, 2010, there was $10,478 of total unrecognized compensation cost related to the stock options granted under the plan. This cost is expected to be recognized over a weighted average period of 0.35 years.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
[4] Authorized Repurchase:
In November 2002, the Board of Directors authorized the repurchase of up to 1,000,000 Common Shares at a price between $.04 and $.045. The Company has not repurchased any shares to date pursuant to such authority.
[5] Compensation of Directors
In May 2010, the Company issued 12,000 shares of its common stock to each non-officer director as compensation for services on the Board of Directors. These shares were valued at $0.18 per share, the price of the common stock on the date of the issuance. In addition, the directors receive $200 each per month for their service on the Board of Directors.
NOTE G - 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. Because of the questionable ability of the Company to utilize these deferred tax assets, the Company has established a 100% valuation allowance for these assets.
The Company’s deferred income taxes are comprised of the following:
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE G - INCOME TAXES(CONTINUED)
The valuation allowance changed by approximately $(682,000) and $(2,900) during the years ended November 30, 2010 and 2009, respectively.
The Company's income tax expense consists of the following:
The Company files a consolidated income tax return with its wholly-owned subsidiaries and has net operating loss carry forwards of approximately $15,400,000 for federal and state purposes, which expire through 2028. The utilization of this operating loss carry forward may be limited based upon changes in ownership as defined in the Internal Revenue Code.
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:
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE H- RENTAL COMMITMENTS
The Company leases its office and warehouse space through 2020 from a corporation that is controlled by officers/shareholders of the Company (“Related Company”). Annual minimum rental payments to the Related Company approximated $156,000 for the Fiscal 2010, 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 2010, the Company entered into a lease to rent office space in Hong Kong for two years. Annual minimum rental payments are approximately $20,000.
The future minimum rental commitments at November 30, 2010:
Net rental expense for Fiscal 2010 and 2009, were $209,465 and $201,972 respectively, of which $212,213 was paid to the Related Company. Commencing in May 2006, the Company had sublet certain of its space it occupies. The sublease, whose term is for five years, includes a base rent, which increases over the term, and provides for additional rent for a portion of the real estate taxes and certain operating expenses. The tenant has terminated the lease as of December 31, 2010.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE I - EMPLOYMENT AND OTHER AGREEMENTS
The Company has employment agreements, with terms through July 30, 2010 (renewable on each July 30th for an additional one year period) with two officers/stockholders of the Company, which provides each with a base salary of $225,000, subject to certain increases as defined, per annum, plus fringe benefits and bonuses. The Compensation Committee of the Company’s Board of Directors determines the bonuses. Bonuses authorized to the two officers totaled $424,022 and $38,000 for the year ended November 30, 2010 and 2009. The agreement also contains provisions prohibiting the officers from engaging in activities, which are competitive with those of the Company during employment and for one year following termination. The agreements further provide that in the event of a change of control, as defined, or a change in ownership of at least 25% of the issued and outstanding stock of the Company, and such issuance was not approved by either officer, or if they are not elected to the Board of Directors of the Company and/or are not elected as an officer of the Company, then the non-approving officer may elect to terminate his employment agreement. If he elects to terminate the agreement, he will receive 2.99 times his annual compensation (or such other amount then permitted under the Internal Revenue Code without an excess penalty), in addition to the remainder of his compensation under his existing employment contract. In addition, if the Company makes or receives a “firm commitment” for a public offering of Common Shares, each officer will receive a warrant to purchase, at a nominal value, up to 9.5% of the Company’s common stock, provided they do not voluntarily terminate employment.
NOTE J- MAJOR CUSTOMERS
The Company had two customers that accounted for 13% and 11% of net sales for the year ended November 30, 2010 and one customer who accounted for over 14% of net sales for the year ended November 30, 2009. The Company had one customer who accounted for 22% of accounts receivable at November 30, 2010 and 21% of accounts receivable at November 30, 2009.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE K- MAJOR SUPPLIERS
During Fiscal 2010 and Fiscal 2009 there was one foreign supplier accounting for 52% and 46% of total inventory purchased.
The Company purchases a significant portion of its products overseas. For Fiscal 2010, the Company purchased 55% from Taiwan, 12% from Hong Kong, 23 % from elsewhere in Asia and 1% overseas outside of Asia.
NOTE L - EXPORT SALES
The Company’s export sales approximated:
Revenues are attributed to countries based on location of customer.
NOTE M - LINE OF CREDIT
In July 2002, the Company obtained a financing commitment with an asset-based lender totaling $1,000,000 (the “Credit Line”). Borrowings under the Credit Line accrue interest at the greater of the prime rate plus two percent (2.0%) or 6.75%. The Company is required to make monthly interest only payments. The Company may repay all or a portion of the line of credit at any time. In addition, the Company is obligated to pay one-quarter of one percent (1/4 of 1%) annually as an unused line fee for the difference between $1,000,000 and the average daily balance of the Credit Line. The Credit Line is collateralized by substantially all the Company’s assets and contains various financial covenants pertaining to the maintenance of working capital and tangible net
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE N - LINE OF CREDIT(CONTINUED)
worth. At November 30, 2010, the Company was in compliance with the financial covenants.
In December 2003, the Company entered into a Security Agreement with the lender establishing a restricted cash collateral account totaling $200,000. The balance on the account including interest accrued is $245,883 and $244,020 at November 30, 2010 and November 30, 2009, respectively.
At November 30, 2010 the balance on the line of credit is $0.
NOTE O - NOTE PAYABLE
The Company leased equipment under a capitalized lease arrangement with Capital One Equipment Leasing. Pursuant to the leases, the lessor retained actual title to the leased property until the termination of the lease, at which time the equipment can be purchased for one dollar. The term of the lease was 36 months with monthly payments of $1,320. The assumed interest rate on the lease was 16%. The Company exercised its option to purchase the equipment in January 2010.
NOTE P - SUBSQUENT EVENTS
On February 25, 2011, the Company granted stock options to purchase 85,000 shares of the Company’s common stock at an exercise price of $1.15, the value of the common stock on the date of the grant. These options vest over a three year period and expire in ten years.