SURGE COMPONENTS, INC.
1016 Grand Boulevard
Deer Park, New York 11729
February 27, 1997
VIA EDGAR
Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549
Re: Surge Components, Inc. (File No. 0-14188)--
Annual Report on Form 10-KSB for the fiscal year
ended November 30, 1996
Ladies and Gentlemen:
On behalf of Surge Components, Inc.(the "Company"),
transmitted herewith for filing pursuant to the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), is the Company's
Annual Report on Form 10-KSB for the fiscal year ended November 30,
1996 (the "Form 10-KSB"), including all exhibits thereto.
The financial statements in the Form 10-KSB do not reflect a
change from the preceding year in any accounting principles or
practices or in the methods of application of those principles or
practices.
Very truly yours,
/s/Ira Levy
Ira Levy,
President
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended November 30, 1996
Commission file number 0-14188
SURGE COMPONENTS, INC.
(Name of small business issuer in its charter)
New York 11-2602030
(State or other jurisdiction of (I.R.S.Employer Identification No.)
incorporation or organization)
1016 Grand Boulevard, Deer Park, New York 11729
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (516) 595-1818
Securities registered under Section 12(b) of the Exchange
Act:Common Shares, $.001 par value
Class A Common Share Purchase Warrants
Securities registered under Section 12(g) of the Exchange Act:
Common Shares, $.001 par value
Class A Common Share Purchase Warrants
Check whether the issuer (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past
12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
Check if there is no disclosure of delinquent filers in
response to Item 405 of Regulation S-B contained herein, and no
disclosure will be contained, to the best of the registrant's
knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.
The issuer's revenues for its most recent fiscal year were
$8,469,898.
The aggregate market value of the 4,052,292 shares of voting
stock held by non-affiliates of the Registrant, as of February
24, 1997 when the closing sale price was $5 3/8 per share, was
$21,781,070 (assuming solely for purposes of this calculation
that all directors, officers and greater than 5% stockholders of
the Registrant are "affiliates").
The number of shares outstanding of the issuer's common stock,
par value $.001 per share, as of February 20, 1997, was
4,823,958.
Documents Incorporated by Reference: Not Applicable.
Exhibit Index is located on page 23
PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
The Company is 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
Company's products 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 smoke
detectors. The Company's products are sold to both original
equipment manufacturers ("OEMs"), who incorporate them into their
products, and to distributors of Surge's product lines.
Surge's products are manufactured predominantly in Asia by
approximately 20 independent manufacturers. The Company does not
have any written long-term supply, distribution or franchise
agreements with its distributors. The Company acts as the
exclusive sales agent through independent sales representative
organizations in North America for many of its manufacturers
pursuant to oral agreements. Through the Company's wholly-owned
subsidiary, Challenge, the Company also engages in the broker
distribution business. In such business, Challenge purchases name
brand electronic components and products, typically from domestic
manufacturers and authorized distributors, to fill specific
customer orders. Challenge purchases such components and products
in the open market on the best available terms and generally does
not keep inventories, although it expects to maintain inventories
if it is able to obtain product rights to certain brand name
product lines. Challenge operates as a separate entity and has
certain sales representatives of its own, but generally shares
management and facilities with the Company.
The statements discussed in this Report include forward
looking statements that involve a number of risks and
uncertainties. These include the Company's lack of profitability,
need to manage its growth, general economic downturns, intense
price cutting in the electronics industry, seasonality of quarterly
results, and other risks detailed from time to time in the
Company's filings with the Securities and Exchange Commission.
The Company was incorporated under the laws of the State of
New York on November 24, 1981. The Company completed an initial
public offering of its securities in 1984 and a second offering
(the "Public Offering") in August 1996 in which it received net
proceeds of approximately $4,807,000. The Company's principal
executive offices are located at 1016 Grand Boulevard, Deer Park,
New York 11729; and its telephone number is (516) 595-1818.
1
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 resistors), and electromechanical, interconnect
and computer products. The Company focuses its efforts on the
distribution of capacitors and discrete components, a small subset
of the electronic component market. The United States market for
all surface mount discrete components was in excess of $4 billion
in 1995 according to Sierra Marketing Group, a California-based
consulting/research firm, and for all capacitors was approximately
$3.2 billion in 1995, according to Electronic Outlook, a
California-based research company.
The electronics industry has been characterized by intense
price cutting which could materially adversely affect the
Company's 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 Company's products, as well as all 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 Company's
products. Accordingly, any downturn in the electronics industry
in general, could adversely affect the Company's business and
results of operations.
PRODUCTS
The Company supplies a wide variety of electronic components
bearing the Company's private "Surge" label which can be broadly
divided into two categories -- capacitors and discrete components.
For the fiscal years ended November 30, 1995 ("Fiscal 1995") and
November 30, 1996 ("Fiscal 1996"), capacitors accounted for
approximately 80% and 83%, respectively, of the Company's sales
while discrete components accounted for approximately 20% and 17%,
respectively. Capacitors and discrete components can be
categorized based on various factors, including function,
construction, fabrication and capacity. The principal products
sold by the Company under the Surge name or brokered by Challenge
are as follows.
CAPACITORS
A capacitor is an electrical energy storage device used in
the electronics industry for varied applications, principally as
elements of resonant circuits, in coupling and bypass application,
blockage of DC current, as frequency determining and timing
elements, as filters and delay-line components, and in voltage
transient suppression (circuit protection devices). The Company's
product line of capacitors includes:
2
Aluminum Electrolytic Capacitors. These capacitors, which
are the Company'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.
The Company's supplier in Taiwan has one of the largest
facilities for these products in Taiwan. This facility is fully
certified for the International Quality Standard ISO 9002, which
means that it meets certain stringent requirements established in
Europe but adopted throughout the world to ensure that the
facilities manufacturing processes, equipment and associated
quality control systems will satisfy specific customer
requirements. This system is designed to ensure clear and
thorough record keeping of all quality control and testing
information. Further, it is designed to ensure clear
communication from one department to another about the
information (i.e., quality control, production or engineering).
This permits the Company to monitor its quality
control/manufacturing process information and to respond to any
customer questions.
Ceramic Disc Capacitors. These capacitors are the least
expensive and most 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
consumer products including 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. The Company's supplier
in Taiwan has a facility fully certified for the International
Quality Standard ISO 9002.
Tantalum Capacitors. These capacitors are miniature in size
and are used predominately in timing circuits and applications
which are critical in response time, such as in smoke detectors
and security equipment.
Multilayer Chip Ceramic Capacitors. These capacitors are used
to filter noise and static in semiconductors. They are very popular
and market uses vary heavily.
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 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. The Company almost exclusively distributes
discrete, low power semiconductor components rather than
integrated circuits.
Rectifiers. Low power semiconductor rectifiers are devices
that convert alternating current into one directional current by
permitting current in one direction only. They tend to be found
in most electrical apparatuses, especially those drawing power
from an AC wall outlet. The Company sells a wide variety of
rectifiers, including Schottky barrier rectifiers (a high speed
rectifier which utilizes a metal to silicon barrier), 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
(utilize silicon rectifying cells designed to withstand large
currents and high voltages), soft recovery/fast switching
rectifiers, high voltage rectifiers, bridge rectifiers (connect
multiple circuits in parallel), flat pack surface mount
rectifiers (chip style used in miniaturization), self package
surface mount rectifiers (chip style without leads and used in
miniaturization) and auto rectifiers.
3
Transistors. Transistors 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.
The Company sells many types of transistors, including small
signal transistors (designed for lower levels of current), power
transistors (designed for large currents to safely dissipate large
amounts of power), lead mounted transistors and surface mounted
transistors.
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. Diodes sold by the Company
include zener diodes (a silicon diode used as a voltage
regulator), high speed switching diodes and rectifiers, the most
popular type of diode.
OTHER PRODUCTS AVAILABLE
Optoelectronic Devices. These devices are solid state
products which provide light displays, optical links, and
fiber-optic signal coupling. Applications vary from digital
displays on consumer video equipment, to fiber optic transmission
of computer signals, to pattern sensing for regulation, such as is
found in automobile cruise controls. Optoelectronic devices sold
by the Company include a wide variety of light emitting diode
products and numeric display products.
Circuit Protection Devices. The Company's 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.
Audible Signaling Components. These include audible
transducers and Piezo buzzers which produce an audible sound for,
and are used in back-up power supplies for, computers, alarms,
smoke detectors, automobiles, telephones and other products which
produce sounds. These products have been used much more
frequently in place of conventional speaker types. The Company
will attempt to obtain certain product rights for audible
components.
New Products. The Company is in the process of developing
new discrete semiconductor components and capacitors which are
intended to complement the Company's existing product lines. In
particular, there are several products currently being sold by
other suppliers for which patent protection has recently expired
and for which the Company believes existing demand is significant.
The Company is currently marketing surface mount rectifiers which
are used in miniature or compact products such as cellular
telephones and pagers. The products for which patent protection
has recently expired are primarily product units which are used in
high heat or thermal stress applications, such as power supplies
and lighting ballasts. The Company began to market its own
competitive versions of these products in late 1996 with the
introduction of a new item known as a superdiode. This product
was sold only by General Instruments which had patent protection
until 1995. The Company is offering shorter lead times and more
competitive pricing than General Instruments.
4
INVENTORY
The Company's products are largely stable in price and not very
susceptible to obsolescence as are many other electronic components.
In order to obtain the best available price from its suppliers, the
Company will typically waive the right to obtain refunds if prices are
subsequently lowered prior to the Company's sale of the products, as
well as the right to return inventory to manufacturers. The Company
will generally pass these savings on to its customers. The Company
intends to implement a bar code system to improve the efficiency of its
inventory control. A bar code system will enable the Company to
automatically record all inventory received, reduce the open order
status with the supplier by such amounts of inventory received and
create customer invoices based on shipments made to them. The Company
will also commence individual date coding in 1996 on most products in
order to manage lot traceability.
In order to adequately service its customers' needs, the Company
believes that it is necessary to maintain large inventories. The
Company is using proceeds of its Public Offering to increase its
inventories to meet expected growth. At any given time, the Company
attempts to maintain a three to four month inventory on certain
products in high demand for distributors and at least one month for
other products. The Company's inventory currently contains more than
25,000,000 component units consisting of more than 2,700 different part
numbers. Although the number of components and products will continue
to increase as the Company uses proceeds of the Public Offering to
increase its inventories, it will still generally maintain a three to
four month inventory. The Company's products range in sales price from
less than one cent for a commercial diode to more than $2.00 for high
power capacitors and semiconductors. In 1996 and 1995, the average per
component sales price of the products sold by the Company was
approximately $.07. As of November 30, 1996 and November 30, 1995,
the Company maintained an inventory of $1,332,644 and $736,356,
respectively.
Challenge is in the broker distribution business and purchases
products for specific customer orders. Challenges' electronic
components include virtually any product which a customer requires.
Challenge currently maintains small inventories. Challenge is seeking
to obtain product rights to certain brand name product lines and
establish direct relationships with those manufacturers.
MANUFACTURERS
Surge obtains substantially all of its products from manufacturers
in Asia while Challenge historically purchased its products
domestically although it recently has entered into certain foreign
purchase agreements. Approximately 49% of the total goods purchased by
the Company in 1996 were manufactured in foreign countries, with the
majority purchased in Taiwan (35%), South Korea (7%), Hong Kong (2%),
India (4%) and Malaysia (1%). The Company purchases its products from
approximately 20 different global manufacturers, for many of which the
Company acts as exclusive sales agent in North America. While these
manufacturers are often the leading suppliers for OEMs, especially in
the consumer market which is extremely price sensitive, they are
typically not the largest manufacturers for these products.
5
Management believes, however, that these manufacturers usually
offer lower prices and quicker response times than some of the
largest manufacturers. Most of the facilities which manufacture
products for the Company have obtained or have applied for the
International Quality Standard ISO 9002 certification. The
Company predominantly purchases its products in United States
currency in order to minimize the risk of currency fluctuations.
See "Foreign Trade Regulation." In most cases, the Company
utilizes two or more alternative sources of supply for each of its
products with one primary and one complementary supplier for each
product. The products are manufactured to the Company's order
with the "Surge" logo and label. The Company is continually
building relationships with suppliers and from time to time adds
new suppliers when needed. The Company's relationships with many
of its suppliers date back to the commencement of the Company's
import operations in 1983.
The Company has never had a written agreement with any of its
suppliers. Based upon the experience of the Company's Management
and the Company's excellent working relationship with its current
manufacturers, the Company does not believe that written agreements are,
or shall in the foreseeable future, become necessary to continue to obtain
its products. The Company has established payment terms with its
manufacturers including letters of credit and 60 day open account terms.
For Fiscal 1996 three suppliers each accounted for in excess
of 10% of the Company's net purchases. Two are Taiwanese
suppliers, Pal Up Taiwan Company Ltd. and Lifu Electronics and
the third one is Master Instrument New York Company, Inc., a New
York corporation. Purchases from these suppliers in Fiscal 1996
were $1,154,262, $1,085,032 and 794,267, respectively, or 18%, 17%
and 13%, respectively, of total purchases. Purchases from Pal Up
Taiwan Company Ltd., Lifu Electronics and Master Instrument in
Fiscal 1995 were $1,228,332, $842,964 and $324,193, or 19%, 13%
and 5%, respectively, of total purchases. However, the Company
does not regard any one supplier as essential to its operations,
since equivalent replacements for most of the products the Company
markets are either available from one or more of the Company's
other suppliers or are available from various other sources at
competitive prices. Nevertheless, the loss of, or a significant
disruption in, the relationship with one or both of the Company's
two major suppliers would most likely have a material adverse
effect on its business and results of operations until a suitable
replacement could be obtained.
MARKETING AND SALES
The Company's sales efforts are directed towards OEM
customers in numerous industries where the Company's products have
wide application. The Company currently employs nine sales and
marketing personnel, including two of its executive officers, who
are responsible for certain key customer relationships. The
Company's executive officers also devote a significant amount of
time to developing and maintaining continuing relations with the
Company's key customers.
6
The Company uses independent sales representative organizations,
which often specialize in specific products and areas and, therefore,
have specific knowledge of and contacts in particular markets. These
organizations normally employ between one and twelve sales
representatives. The individual sales representatives employed by
the sales organizations generally possess the expertise which
enhances the scope of the Company's marketing and sales efforts.
This permits the Company to avoid the significant costs associated
with creating a direct marketing network. The Company has maintained
relationships with certain of its sales organizations since 1988 and
continues to engage new sales organizations as needed. The Company
believes that additional sales organizations and representatives are
available, if required.
The Company engages independent sales representative
organizations in various regions throughout the United States for
marketing to OEM customers and distributors. In October 1996, the
Company hired a National Sales Manager and before that a Southeast
Regional Sales Manager. The Company plans to hire up to two other
regional sales managers to oversee the Company's sales
representatives in each respective geographic area. The Company
believes that such regional sales managers will ensure that the
Company's sales activities function properly.
Many OEMs require their suppliers to have a local presence and
the Company's network of independent sales representatives are
responsive to these needs. In that regard, in order to service the
growing importance of the global electronics community, the Company
opened locations in Rhode Island and California during 1996 and
expects to open locations in such countries as Ireland, Taiwan,
Singapore, China and potentially Mexico, in which countries
Management is aware of strong electronic components markets.
Challenge will purchase any electronic products which a customer
requires. It, therefore, directly markets its services to the entire
electronics industry. However, Challenge's success has resulted
primarily from its servicing and purchasing capabilities and its
reputation of being able to obtain "hard to find" parts. Challenge's
customers include several companies in telecommunications, computers
and power supply. Two of Surge's sales representative organizations
also represent Challenge.
Effective January 1, 1996, Challenge entered into an agreement
to supply audible transducers for computer keyboards to Intel
Corporation. The agreement was for one year and is continuing,
although it is terminable at will by Intel Corporation.
As of December 31, 1996, the Company had arrangements with 15
sales representative organizations. Sales 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 agreements
with independent sales representatives, such representatives are
permitted to represent other electronics manufacturers, but are
generally prohibited from carrying a line of products competitive
with the Company's products. They develop a territory by selling to
both distributors and OEMs. These agreements are terminable on
written notice by either party or if breached by either party.
7
The Company utilizes the services of the Progressive
Marketing Corp., Melville, New York, an unaffiliated
marketing/public relations organization, which publicizes the
Company's achievements and helps the Company develop greater name
recognition in the electronics industry. On an ongoing basis, this
organization publishes announcements in trade journals concerning
new product introductions, the hiring of key personnel and/or of
new sales organizations or representatives by the Company. There
is no written agreement with Progressive Marketing whom the
Company pays $800 per month.
Other marketing efforts include generation and distribution
of the Company's product catalogs and brochures and attendance at
trade shows. The Company has produced an exhibit for display at
electronics shows throughout the year. The Company's products
were promoted at electronic distribution shows in Las Vegas,
Nevada in 1996, from which the Company identified and contracted
with eight distributors for its products. The Company advertises
in various trade publications, and intends to produce sales
literature to advertise the Company's products and to participate
in additional trade shows.
CUSTOMERS
The Company's products are sold to distributors and OEMs in
such diverse industries as the automotive, computer,
communications, cellular telephones, consumer electronics, garage
door openers, smoke detectors, and household appliances
industries. The Company requires its distributors to provide
point of sales reporting enabling the Company to gain knowledge of
the breakdown of industries into which its products are sold.
However, based on its sales to OEMs, the Company believes that no
one industry accounted for a majority of the applications of the
products it sold in 1996 or 1995. For 1996, one customer
accounted for 13.2% of the Company's net sales. This customer
accounted for 8.1% of the Company's net sales during Fiscal 1995
and no one customer accounted for 10% or more of the Company's net
sales in Fiscal 1995. The Company's discrete components are often
sold to the same clients as its capacitors. These OEM customers
typically accept samples for evaluation and, if approved, the
Company works towards procuring the next orders for these items.
The Company does not maintain contracts with its customers
and generally sells products pursuant to customer purchase orders.
The loss of certain customers could have a materially adverse
effect on the Company. The Company's sales to OEMs are typically
at higher prices than to distributors resulting in somewhat better
profit margins. However, industry trends are toward selling
through distributors. Because of the Company's contracts and good
working relationships with its distributors, the Company offers
the OEMs when purchasing through distributors, extended payment
terms, just-in-time deliveries and one-stop shopping for many
types of electronic products.
COMPETITION
The markets for the Company's products are highly
competitive. The Company competes with numerous well-established
foreign and domestic importers, and numerous local, regional and
national distributors. The Company's principal competitors in the
sale of capacitors include Nichicon, Panasonic, Illinois
Capacitor, and United Chemicon. Its principal competitors in the
sale of discrete components include General Instrument Corp.,
Motorola, Inc., Liteon Corporation, and Microsemi Corp. Many of
the Company's competitors are well established, with substantial
expertise, and possess substantially greater financial, marketing,
personnel and other resources than the Company. The Company
believes it competes effectively with such companies by providing
equal or higher quality products at lower prices, and with an
8
additional emphasis on marketing and customer service. The
Company's motto is "never say no," as the Company offers same day
fulfillment without minimum purchase order requirements or other
limitations and generally maintains flexibility to ensure complete
customer satisfaction. Management believes that Challenge is able
to compete effectively, in large part, because of its sourcing and
purchasing capabilities and its knowledge of where "hard to find"
parts are available. Generally, the Company believes that larger
semiconductor manufacturers and distributors do not currently
focus their selling efforts on small to medium size OEMs and
distributors, which constitute the majority of the Company's
customers.
MANAGEMENT INFORMATION SYSTEMS
The Company has made an investment in computer hardware and
software. The Company's management information systems ("MIS")
consultants are responsible for software and hardware upgrades,
maintenance of current software and related databases, and
designing custom systems. The Company believes that its MIS
personnel are important to the Company's success and believes in
continually upgrading its hardware and software. As part of its
MIS program, the Company intends to commence individual date
coding on most products and intends to implement a bar code system
to improve the efficiency of its inventory control system. All
sales personnel of the Company are equipped with computer
terminals to assist in providing up-to-date reliable information
to customers. The Company's purchasing department manages the
Company's inventory on a real time computer system offering the
sales and accounting departments complete knowledge regarding
inventory availability, income and expense levels, sales and
product line information. Management also analyzes various
reports, including product, profit, and sales trends using the
Company's computer system. The Company intends to continually
evaluate and upgrade its IBM compatible computer system.
CUSTOMER SERVICE
The Company maintains one full-time customer service employee
whose time is dedicated largely to respond to inquiries such as
price quote requests, delivery status of new or existing purchase
orders, changes of existing order dates, quantities, dates, etc.
The Company intends to use a portion of the net proceeds of the
Public Offering to increase its customer service capabilities.
PROPRIETARY INFORMATION
The Company holds no patents and has no trademarks or
copyrights registered in the United States Patent and Trademark
Office or in any state. While such protection is not currently
considered essential to the success of its business, it may become
important to the Company in the future.
The Company relies on proprietary know-how and will employ
various methods to protect its processes, concepts, ideas and
documentation associated with its proprietary products. However,
such methods may not afford complete protection, and there can be
no assurance that others will not independently develop such
processes, concepts, ideas and documentation.
9
FOREIGN TRADE REGULATION
Most products supplied by the Company are manufactured in
Asia, including such countries as Taiwan, South Korea, Hong Kong,
India and Malaysia. 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, imposition of tariffs and import and
export controls, and changes in governmental policies, any of
which could have a material adverse effect on the Company's
business and results of operations.
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. The Company 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
its business, financial condition or results of operations.
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 the
Company's business. The Company's 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 the Company does not believe that
any of these factors adversely impact its business at present,
there can be no assurance that these factors will not materially
adversely effect the Company in the future. Any significant
disruption in the delivery of merchandise from the Company's
suppliers, substantially all of whom are foreign, could have a
material adverse impact on the Company's 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 the Company. The Company believes it is in
substantial compliance with all material federal, state and local
laws and regulations regarding safe working conditions. The
Company believes that the cost of compliance with such
governmental regulations is not material.
BACKLOG
As of November 30, 1996, the Company's backlog was
approximately $2,728,612, while backlog as of the year earlier is
unavailable. Substantially all backlog is shipped by the Company
in 60 to 90 days. Year to year comparisons of backlog are not
necessarily indicative of future operating results.
10
EMPLOYEES
As of November 30, 1996, the Company employed 21 persons, of
whom two are employed in executive capacities, seven are engaged
in sales, one in engineering, one in purchasing, four are engaged
in administrative capacities, one is in customer service, two are
in bookkeeping and three are in warehousing. Twenty (20)
employees are employed full-time and one is employed part-time by
the Company. None of the Company's employees is covered by a
collective bargaining agreement. The Company considers its
relationship with its employees to be good.
ITEM 2. DESCRIPTION OF PROPERTY
The Company leases its executive offices and warehouse
facility, located at 1016 Grand Boulevard, Deer Park, New York,
11729, at an annual rental of $58,821 during 1996. The lessor is
Great American Realty of Deer Park Co., an entity owned equally by
the Company's President, Vice President and Mark Siegel, a
Director. Rent is scheduled to increase by 5% in each successive
year of the lease ending on December 31, 1998. The facility
consists of approximately 2,000 square feet of office space and
approximately 3,000 square feet of warehouse space. The Company
intends to expand and/or renovate the facility, including an enclosed
climate controlled test lab space, with a portion of the proceeds of
the Public Offering. Any leasehold improvements will be and will
remain the property of the lessor.
ITEM 3: LEGAL PROCEEDINGS
The Company is not currently subject to any legal
proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None.
11
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDE
MATTERS
The Common Stock and Class A Warrants are respectively traded
in the over-the counter market and are quoted on the National
Association of Securities Dealers Automated Quotation System, Inc.
SmallCap Market ("Nasdaq") under the symbols "SRGE" and "SRGEW".
From August 1, 1996 until September 3, 1996, the Units of the
Company each consisting of one Common Share and one Class A
Warrant were quoted on Nasdaq under the symbol "SRGEU." In
addition, the Units, Common Shares and Warrants are listed on the
Boston Stock Exchange under the symbols "SRGU," "SRG" and "SRGW,"
respectively.
The following table sets forth for the periods indicated, the
high and low trade prices of the Company's Common Shares from
August 1, 1996, through January 31, 1997 as reported by Nasdaq.
Security Trading Period High Low
Common Shares FISCAL YEAR ENDED NOVEMBER 30, 1996
THIRD QUARTER
(August 1, 1996 - August 31, 1996) 7 4 1/4
FOURTH QUARTER
(September 1, 1996 - November 30, 1996) 5 7/8 4
FISCAL YEAR ENDING NOVEMBER 30, 1997
FIRST QUARTER
(December 1, 1996 - January 31, 1997) 5 1/8 3 1/2
Warrants FISCAL YEAR ENDED NOVEMBER 30, 1996
THIRD QUARTER
(August 1, 1996 - August 31, 1996) 2 3/4 1/4
FOURTH QUARTER
(September 1, 1996 - November 30, 1996) 3 3/4 1 3/4
FISCAL YEAR ENDING NOVEMBER 30, 1997
FIRST QUARTER
(December 31, 1996 - January 31, 1997) 2 1/8 1/2
Units FISCAL YEAR ENDED NOVEMBER 30, 1996
THIRD QUARTER
(August 1, 1996 - August 31, 1996) 8 1/8 4
FOURTH QUARTER
(September 1, 1996 - September 3, 1996) 7 9/32 7 9/32
On February 24, 1997, the closing trade price of a Common
Share and a Warrant were $5 3/8 and $1 1/8, respectively.
12
On February 20, 1997, the Company had 174 and 5
recordholders of its Common Stock and Warrants, respectively, and
reasonably believed it had in excess of 300 beneficial holders of
its Common Shares.
The Company has not paid any cash dividends on its Common
Stock during the last two years and does not anticipate paying any
in the foreseeable future. The Board of Directors intends to
retain any earnings to support the growth of the Company's
business.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATION
Fiscal Year Ended November 30, 1996 as Compared to Fiscal
Year Ended November 30, 1995.
Net sales for Surge Components, Inc. and Subsidiary (the
"Company") for the fiscal year ended November 30, 1996 ("Fiscal
1996") decreased by $295,067, or 3%, to $8,469,898, as compared to
net sales of $8,764,965 for the fiscal year ended November 30,
1995 ("Fiscal 1995"). This decrease was primarily attributable to
the economic effect of conditions within the broker distributor
market in which the Company's subsidiary, Challenge/Surge Inc.
("Challenge"), operates. This market has had an over abundance of
electronic components causing Challenge's customers and potential
customers to purchase more of their component needs from
authorized distributors. This condition may continue through the
middle of 1997. The Company's net sales without Challenge's
sales increased by 14% for Fiscal 1996. This increase was
attributable primarily to increased sales volumes with existing
and new customers who purchased items from new product lines, as
well as items previously sold by the Company.
The Company's gross profit for Fiscal 1996 increased by
$254,257, or 12% as compared to Fiscal 1995. This increase was
due primarily to lower purchasing costs. The Company's increased
inventory, related to its expansion plans, is expected to make
operations more efficient and further reduce inventory acquisition
costs, including air shipment costs, by purchasing inventory in
larger quantities, at more opportune times and at more favorable
prices. The Company has used third party inventory and shipping
services from a firm located in California. The Company plans to
open additional warehousing facilities during 1997.
General and administrative expenses for Fiscal 1996 increased
by $138,540, or 10%, as compared to Fiscal 1995. The increase is
partially due to the hiring of an engineer, national sales
manager, public relations firm, investment banking consulting fees
and the cost of being a public company. In addition, the
Company's investment in personnel is expected to significantly
increase costs prior to the generation of increased sales
attributable from such additional employees during the fiscal year
ending November 30, 1997 or later.
Selling and shipping expenses for Fiscal 1996 increased by
$55,705, or 12%, as compared to Fiscal 1995. This increase is
primarily due to the Company's commitment to sales promotion
through literature, attendance at trade shows and association with
a marketing/public relations firm.
Interest expense remained relatively unchanged for Fiscal
1996, as compared to Fiscal 1995. The Company intends to continue
utilizing letters of credit and bankers acceptances on an as
needed basis based on its cash needs.
13
As result of the foregoing, the Company had net income of
$139,138 for Fiscal 1996, as compared to a net income of $50,441
for Fiscal 1995.
Liquidity and Capital Resources
At November 30, 1996 Compared to November 30, 1995
Working capital increased by $4,975,566 for Fiscal 1996 from
$1,162,529 at November 30, 1995 to $6,138,095 at November 30,
1996. This increase resulted primarily from the receipt of the
proceeds received from the completion of the Private Placement
Memorandum and August 1996 Public Offering. In addition,
inventory increased due to the Company's inventory purchasing
policies related to its expansion plans. The Company's Current
Ratio (current assets to current liabilities) improved to 5.3:1 at
November 30, 1996, as compared to 1.9:1 at November 30, 1995. The
average number of days to collect receivables increased from 38
days to 42 days. Inventory turned less in Fiscal 1996 as a result
of the Company's commitment to increase stock inventory levels.
Working capital levels as expected to be adequate to meet the
current operating requirements of the Company.
On August 8, 1996, the Company completed the Public Offering
for which it grossed $5,520,000 and netted $4,807,027. The
offering consisted of 1,725,000 units, at a selling price of $3.20
per unit. Each unit consisted of one Common Share and one
redeemable Class A Common Share Purchase Warrant. Each Warrant
entitles the holder to purchase one Common Share for a period of
five years commencing two years after the effective date of the
offering at a price of $5.00.
In June 1996 warrants purchased by the Harriman Group, Inc.
in 1994 were exercised into 1,000,000 shares of the Company's
Common Stock for which the Company received $120,000.
In May 1996, the Company renewed the letter of credit
agreement with a bank allowing the Company to obtain up to
$800,000 in outstanding letters of credit and $200,000 in direct
borrowings. The direct borrowings incur interest at a prime rate
plus one percent per annum. The agreement also provides for the
creation of banker's acceptance (a draft drawn on and accepted by
a bank). Direct borrowings are limited to advances based on 80%
of eligible receivables and 25% of eligible inventory capped at
$100,000. The Company is charged one-half percent (1/2%) upon
opening of the letter of credit, one-half percent (1/2%) on
negotiation and two percent (2%) per annum over the banker's
acceptance rate over the borrowed term. The agreement requires
the Company to be in compliance with certain financial ratios
including a debt to equity ratio and a minimum amount of tangible
net worth. The Company was in compliance with the required
financial ratios as of November 30, 1996. As of November 30, 1996
and 1995, there was no outstanding direct borrowings, although
outstanding banker's acceptances and letters of credit totaled
approximately $306,000 and $261,000, respectively. Borrowings are
collateralized by the assets of the Company and guaranteed by
officers of the Company.
14
The Company intends to expand its facilities over the next
several years in order to achieve and maintain the growth expected
primarily through the increased utilization of its distribution
network, the introduction of new products and the upgrade of
existing product lines. In order to effect this expansion, the
Company has allocated a portion of the net proceeds of the Public
Offering toward the significant up-front expenditures associated
with the expansion of office and warehouse space at its current
facilities in addition to potentially establishing additional
sales/stocking facilities in other strategic locations. This
additional warehouse space would allow the Company to maintain the
inventory levels it deems necessary to achieve the expected
growth. Additionally, the new warehouse facilities would include
space for test labs, which will allow the Company to provide
customers with prompt information regarding the specifications of
its product. The Company intends to open such additional
warehouse facilities to service customers and will not otherwise
open such additional facilities.
In addition to the costs associated with the expansion of the
Company's facilities, the Company expects to continue to incur
significant operating costs. These costs consist principally of
payroll and facilities related charges, as well as professional
fees associated with being a public company. Upon the updating of
its current facilities and the potential opening of new
facilities, facilities related charges are expected to rise
dramatically. Staffing requirements for any new facilities may
substantially increase payroll related costs. The future
profitability of the Company will therefore depend on increased
future sales levels. In that regard the Company does not plan on
opening new facilities unless demand warrants such opening.
In December 1995, the Company completed a private offering of
the Company's securities. The offering consisted of 16.5 units at
a price of $50,000 per unit, plus an additional 50,000 Class A
Warrants. Each unit, as amended, consisted of 50,000 Common
Shares and 50,000 Class A Warrants, which warrants are identical
to the Warrants. The Company received net proceeds of $683,500
from the 1995 Private Placement. The net proceeds were applied to
purchase inventory and for other general working capital purposes,
including certain costs connected with the Public Offering.
Effective January 1, 1996, Challenge entered into an
agreement to supply audible transducers for computer keyboards to
Intel Corporation. The agreement is for one year with a one year
renewal option; however, it is terminable at will by Intel
Corporation.
The Company is in the process of updating its equipment,
procedures and personnel which it hopes will better enable itself
to attract new customers as well as increase the sales volume with
its existing customers, expand sales to its existing customer base
by offering a broad range of complementary products and newly
introduced product lines. The Company has initiated a public
relations program to promote these products through various trade
journals. The Company has hired a national sales manager to
assist in achieving these goals.
The Company introduced various new product lines in the
fourth quarter Fiscal 1996. On one of these product lines, the
patent on a competitor's product expired and the Company
negotiated with a new Asian manufacturer to market this new line
which protects the product from high intensity heat found in
ballast lighting fixtures and automobiles.
15
Approximately 49% and 47% of the total goods purchased by the
Company in 1996 and 1995, respectively, were manufactured in
foreign countries with substantially all of Surge's purchases made
from manufacturers in Asia. Substantially all of Challenge's
products are purchased domestically. In addition, approximately
3% and 5% of 1996 and 1995 sales, respectively, are exported to
various countries. The Company has minimized the risk of currency
fluctuations by purchasing and selling its products in United
States currency.
During Fiscal 1996, the Company had net cash used in
operating activities of $237,378, as compared to $187,003 used in
operating activities in Fiscal 1995. The increase in cash used in
operating activities resulted from an increase in inventory and
decrease in accrued expenses and taxes, as partially offset by net
income and increased accounts payable and reductions in accounts
receivable.
The Company had net cash provided by financing activities of
$4,931,188 for Fiscal 1996, as compared to $339,103 for Fiscal
1995. This increase resulted primarily from the net receipt of
proceeds from the Public Offering and private placement and the
exercise of warrants. The Company has used these proceeds to
invest in additional staff, marketable securities, testing
equipment, computer software and computer equipment. As a result
of the foregoing, the Company had a net increase in cash of
$2,561,365 during Fiscal 1996, as compared to a net increase of
$106,435 for Fiscal 1995.
The Company expects that its cash flow from operations, the
proceeds from the Public Offering and the Company's line of credit
agreement will be sufficient to meets its current financial
requirements over at least the next twelve months.
INFLATION
The effects of inflation have lessened in recent years as
indicated by the average consumer price index, which has been
below 3% in each of the past two years. The Company has generally
been able to offset the impact of rising costs through purchase
price reductions. As a result, inflation has not had, nor is it
expected to have, a significant impact on the Company's business.
However, inflation and changing interest rates have had a
significant effect on the economy in general and, therefore, could
affect the Company's future operating results.
ITEM 7. FINANCIAL STATEMENTS
The financial statements to be provided pursuant to this Item
7 begin on page F-1 of this Report, following Part III hereof.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
16
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE
ACT
The Directors and executive officers of the Company are as
follows:
Name Age Positions
David Siegel 71 Chairman of the Board
Ira Levy 40 President and Director
Steven J. Lubman 41 Vice President, Principal Financial
Officer, Secretary and Director
Mark Siegel 42 Director
DIRECTORS AND EXECUTIVE OFFICERS
David Siegel has served as Chairman of the Board of Directors
of the Company since 1983. Mr. Siegel also serves on the Boards
of Directors of Nu-Horizons Electronics Corp., Kent Electronics
Corp. and Micronetics Corp., each of which is a publicly owned
company. David Siegel is the father-in-law of Ira Levy and the
father of Mark Siegel.
Ira Levy has served as President of the Company and a
Director since its inception on November 24, 1981. From 1976 to
1981, Mr. Levy was employed by Capar Components Corp. ("Capar"),
an importer and supplier of capacitor and resistor products.
Steven J. Lubman has served as Vice President, Principal
Financial Officer, Secretary and a Director of the Company since
its inception on November 24, 1981. From 1975 to 1981, Mr. Lubman
was employed by Capar.
Mark Siegel was appointed to the Board of Directors in
October 1996. Since 1985, Mr. Siegel has been the President of
Mark Siegel Inc. d/b/a Great American Electronics Corp., an
electronics parts distributor. Mark Siegel is the son of David
Siegel.
All directors hold office until the next annual meeting of
shareholders and the election and qualification of their
successors. The Company's Managing Underwriter, Maidstone
Financial, Inc. ("Maidstone") has the right during the three-year
period ending July 31, 1999, in its sole discretion, to designate
one person for election as a director, or alternatively to
designate an individual to serve as a non-voting advisor to the
Company's Board of Directors. David Siegel and Mark Siegel
comprise the Company's Audit and Compensation Committees with
David Siegel serving as Chairman. Officers are elected annually by
the Board of Directors and serve at the discretion of the Board.
Compliance with Section 16(a) of the Exchange Act
Pursuant to Section 16 of the Exchange Act, the Company's
Directors and executive officers and beneficial owners of more
than 10% of the Company's common stock, par value $.001 ("Common
Stock"), are required to file certain reports, within specified
time periods, indicating their holdings of and transactions in the
Common Stock and derivative securities. Based solely on a review
of such reports provided to the Company and written
representations from such persons regarding the necessity to file
such reports, the Company is not aware of any failures to file
reports or report transactions in a timely manner during the
Company's fiscal year ended November 30, 1996.
17
ITEM 10. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth all compensation awarded to,
earned by, or paid for all services rendered to the Company during
the fiscal year ended November 30, 1996 ("Fiscal 1996"), the
fiscal year ended November 30, 1995 ("Fiscal 1995") and the fiscal
year ended November 30, 1994 ("Fiscal 1994") by those persons who
served as Chief Executive Officer and any Named Executive Officers
who received compensation in excess of $100,000 during such years.
Long-Term
Annual Compensation Compensation
Other Annual Shares
Name and Salary Bonus Compensation Underlying
Principal Year ($) ($) ($)(1) Options(#)
Position
Ira Levy 1996 $137,116 $107,500(1) 0 0
President 1995 $143,500 $103,600(1) 0 0
and CEO 1994 $131,715 $ 30,000(1) 0 0
Steven J.Lubman 1996 $128,742 $107,500(1) 0 0
Vice President 1995 $162,845 $103,600(1) 0 0
1994 $122,430 $ 30,000(1) 0 0
(1) The above compensation figures do not include the cost to the
Company of the use of automobiles leased by the Company, the cost
to the Company of benefits, including premiums for life insurance
and any other perquisites provided by the Company to such persons
in connection with the Company's business all of which does not
exceed the lesser of $50,000 or 10% of such person's annual salary
and bonus.
The Company did not grant any options in the last two fiscal
years to any of its executive officers. The Company does not have
any long-term incentive plans for compensating its executive
officers.
Option Grants in Last Fiscal Year
The table below includes the number of stock options granted
to the executive officers named in the Summary Compensation Table
during the year ended November 30, 1996 and exercise information.
Individual Grants
Number of Percent of
Securities Total Options
Underlying Granted to
Options Employees in Exercise Expiration
Name Granted(#) Fiscal Year Price($/sh) Date
None
18
Aggregated Option Exercises in Last Fiscal Year and FY End
Option Values
The table below includes information regarding the value
realized on option exercises and the market value of unexercised
options held by the executive officers named in the Summary
Compensation Table during the year ended November 30, 1996.
Value of
Number of Unexercised
Unexercised In-The-Money
Shares Options Options
Acquired at FY-End(#) at FY-End($)
on Exer- Value Exercisable/ Exercisable/
Name cise (#) Realized($) Unexercisable Unexercisable
None
Director Fees
Officer-directors currently receive no compensation for
serving on the Board of Directors other than reimbursement of
reasonable expenses incurred in attending meetings. David
Siegel currently receives $750 per month in recognition for his
service to the Board of Directors as a member and President of
the Audit and Compensation Committees. Mark Siegel currently
receives $500 per month for serving on the Audit and
Compensation Committees. Each outside director also receives
reimbursement of expenses, as well as options from time to time,
at the discretion of the Board of Directors. On January 8,
1997, Mark Siegel and David Siegel were each granted 10,000
shares of Common Stock exercisable at $3.50 per share in
recognition of their service on the Board of Directors, all of
which vested immediately.
Employment Agreements
The Company entered into Employment Agreements dated as of
February 1, 1996 with Ira Levy, President, and Steven J. Lubman,
Vice President. The Agreements provide that Messrs. Levy and
Lubman shall devote all of their business time to the Company,
each in consideration of an annual salary of $200,000 for the
five-year period commencing on July 31, 1996. Bonuses to
Messrs. Levy and Lubman are to be based upon the performance of
the Company and determined at the discretion of the Board of
Directors. Their salaries may be increased annually during the
term of the employment agreements at the discretion of the Board
of Directors (or a Compensation Committee). Their agreements
provide that during the term of employment with the Company and
for a period of one year following termination of employment,
Messrs. Levy and Lubman are prohibited from engaging in
activities which are competitive with those of the Company. The
agreements further provide that in the event of a change of
control, where Ira Levy or Steven J. Lubman is 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 of at least 25% of the issued and outstanding stock of
the Company, and such issuance was not approved by either Ira
Levy or Steven J. Lubman, then the non-approving person(s) may
elect to terminate his employment contract and 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.
19
The Company has agreements with independent representatives
who receive commissions of 5% on the net amount of invoices
rendered by the representative after all trade discounts,
freight, transportation allowances, sales taxes, insurance and
the like have been deducted. The representatives agree to not
represent any person or entity manufacturing or selling products
which are competitive with products and services sold by the
Company throughout the term of the agreement. The agreements
continue unless terminated by written notice by either party or
the agreement is breached by either party.
Stock Bonus Plan
In January 1996 the Company adopted and the shareholders
ratified in February 1996, the 1995 Employee Stock Option Plan
(the "Option Plan"). The Option Plan provides for the grant of
options to qualified employees (including officers and
directors) of the Company, employees of the Company's
subsidiary, independent contractors, consultants and other
individuals to purchase an aggregate of 350,000 Common Shares.
The exercise power of all options must be at least 85% of fair
market value of the Common Shares on the date of grant.
Stock Options
On February 19, 1996, the Company granted five-year
incentive stock options under the Option Plan to ten (10)
employees to purchase an aggregate of 86,000 Common Shares. The
options become effective on July 31, 1996 and are exercisable at
$3.20 per Common Share and vest in either 25% increments at the
end of each of the first four years from July 31, 1996 or in 50%
increments at the end of each of the first two years from July
31, 1996. The Company also granted five-year non-qualified
stock options under the Option Plan to seven (7) persons with
whom the Company has a business relationship, to purchase an
aggregate of 60,000 Common Shares. These options become
effective on July 31, 1996 and are exercisable at $3.20 per
Common Share and vest in 25% increments at the end of each of
the first four years from July 31, 1996.
On January 8, 1997, the Company granted Tsung-Ming Chen and
Gerald Schimmel, the Quality Assurance Director of Marketing and
the National Sales Manager, respectively, each 20,000 options,
subject to the vesting schedule specified in the agreements, at
an exercise price of $3.50 per share. On January 8, 1997, Mark
Siegel and David Siegel, non-officer directors, were each
granted 10,000 shares of Common Stock exercisable at $3.50 per
share in recognition of their service on the Board of
Directors, all of which vested immediately.
20
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth information as of February
19, 1997, based on information obtained from the persons named
below, with respect to the beneficial ownership of Common Shares
by (i) each person known by the Company to be the beneficial
owner of more than 5% of the outstanding Common Shares, (ii)
each Director (iii) each person named in the Summary
Compensation Table and (iv) all executive officers and Directors
as a group.
Name and Address Amount and Nature of Percentage of
of Beneficial Owner Beneficial Ownership (1) Common Stock Owned(2)
Ira Levy 355,000(3) 7.4%
Steven J. Lubman 355,000(4) 7.4%
David Siegel 71,666(5)(6) 1.5%
Mark Siegel 37,498(5) 0.8%
All directors and executive
officers as a group
(4 persons) 819,164(5)(6) 16.9%
(1) Unless otherwise noted, the Company believes that all
persons named in the table have sole voting and investment power
with respect to all Common Shares beneficially owned by them. A
person is deemed to be the beneficial owner of securities that
can be acquired by such person within 60 days from the date
hereof upon the exercise of warrants or options. Each
beneficial owner's percentage ownership is determined by
assuming that options or warrants that are held by such person
(but not those held by any other person) and which are
exercisable within 60 days from the date hereof have been
exercised.
(2) Based on 4,823,958 shares issued and outstanding.
(3) Excludes Common Shares held by Mr. Lubman which are subject
to certain voting and transfer restrictions pursuant to a Stock
Purchase Agreement made by and between Mr. Levy and Mr. Lubman.
See "Certain Relationships and Related Transactions"
(4) Excludes Common Shares held by Mr. Levy which are subject
to certain voting and transfer restrictions pursuant to a Stock
Purchase Agreement made by and between Mr. Lubman and Mr. Levy.
See "Certain Relationships and Related Transactions."
(5) Includes 10,000 shares issuable upon exercise of currently
exercisable options.
(6) Includes 61,666 shares held in an irrevocable trust for the
benefit of Mr. Siegel's children, of which trust Mr. Siegel is a
Trustee.
21
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company has entered into five-year employment agreements
with Ira Levy, President, and Steven J. Lubman, Vice President,
effective July 31, 1996 at an annual salary of $200,000. These
agreements contain non-competition provisions and the payment of
"golden parachutes" in the event of a change in control of the
Company, as defined. See Item 10. "Executive Compensation-Employment
Agreements."
The Company's executive offices and warehouse facility are
leased from Great American Realty of Deer Park Co., a company whose
stock is owned 33 1/3 % each by Ira Levy and Steven J. Lubman,
officers of the Company and Mark Siegel, a Director. The monthly
rental is $4,598 during 1996, increasing at 5% per annum during the
term of the lease which expires on December 31, 1998. See Item 2.
"Description of Property."
Pursuant to a warrant agreement dated April 5, 1994, the Company
issued to HGI, Incorporated, an underwriter of the Company's Public
Offering for an aggregate purchase price of $1,200, warrants (the
"HGI Warrants") to purchase up to an aggregate of 1,000,000 shares of
the Company's Common Shares, each warrant entitling the holder
thereof to purchase one Common Share at $.12 per share. In June
1996, HGI exercised the HGI Warrants and sold the 1,000,000 Common
Shares for an aggregate of $3,200,000, or $3.20 per Common Share, in
a private transaction to Joel M. Pashcow, a client of HGI, who was an
existing non-affiliated shareholder of the Company. The Company has
been advised by Mr. Paschow that he no longer owns the aforementioned
1,000,000 Common Shares and therefore a voting proxy held by Ira Levy
over Mr. Pashcow's shares is no longer in effect.
Ira Levy and Steven J. Lubman, officers of the Company, borrowed
funds totaling $39,425 during the two- year period ended November 30,
1995. All of these loans were repaid in 1995. The loans were
payable upon demand and bore interest at a rate of eight percent (8%)
per annum.
Messrs. Levy and Lubman have personally guaranteed the Company's
letter of credit agreement and direct borrowings with the Company's
lender for an aggregate of approximately $1,000,000.
Ira Levy and Steven J. Lubman entered into a Stock Purchase
Agreement in March 1992 which relates to their respective share
ownership in the Company. Pursuant to the agreement, Messrs. Levy
and Lubman each agreed to vote their shares, for as long as the other
party continues to own voting shares of the Company, in such manner
to elect each of them as a director of the Company. Furthermore, in
the event of the death of either Messrs. Levy or Lubman, the survivor
shall buy the decedent's shares of the Company. The purchase shall
be funded through the use of life insurance policies held by Messrs.
Levy and Lubman which name the other party as beneficiary. In
addition, the agreement grants Messrs. Levy and Lubman a right of
first refusal to purchase each other's shares in the event of
disability, retirement or sales to third parties at an agreed upon
price.
On January 8, 1997, Mark Siegel and David Siegel , non-officer
directors, were each granted 10,000 shares of Common Stock
exercisable at $3.50 per share in recognition of their service on the
Board of Directors, all of which vested immediately.
The Company believes that the terms of each of the foregoing
transactions were no less favorable to the Company than could have
been obtained from non-affiliated third parties, although no
independent appraisals were obtained. Future transactions with
affiliates of the Company, if any, will be on terms believed by the
Management to be no less favorable than are available from
unaffiliated third parties and will be approved by a majority of
disinterested directors.
22
ITEM 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description
3.1 Certificate of Incorporation of the Company, as amended. (1)
3.2 By-Laws of the Company. (1)
3.3 Certificate of Incorporation of Challenge/Surge, Inc. (1)
3.4 By-laws of Challenge/Surge, Inc. (1)
4.1 Form of Underwriter's Warrants. (1)
4.2 Form of Public Warrant Agreement. (1)
4.3 Specimen Common Share Certificate. (1)
4.4 Specimen Class A Warrant Certificate. (1)
4.5 Form of Registration Rights Agreement included in Private
Placement Subscription Agreement. (1)
4.6 Form of Lock-Up Agreement. (1)
4.7 [Intentionally Omitted]
4.8 Irrevocable Voting Proxy dated June 28, 1996 from Joel
Pashcow to Ira Levy. (1)
4.9 Registration Rights Agreement dated June 28, 1996 between
Joel Pashcow and the Company. (1)
4.10 Lock-Up Agreements between Joel Pashcow and
Maidstone Financial Inc. and The Nasdaq Stock Market (1)
4.11 Stock Purchase Agreement dated June 26, 1996 between
Joel Pashcow and The Harriman Group, Inc. (1)
10.1 Financial Consulting Agreement between the Underwriter
and the Company. (1)
10.2 The Company's 1995 Employee Stock Option Plan. (1)
10.3 Employment Agreement between the Company and Ira Levy.
(1)
10.4 Employment Agreement between the Company and Steven J.
Lubman.(1)
10.5 Revolving Credit Line Agreement between European American
Bank and the Company. (1)
10.6 Lease Agreement with Great American Realty of Deer Park
dated January 1, 1994. (1)
10.7 Financial Advisory and Investment Banking Agreement dated
April 5, 1994, as amended, between the Company and The Harriman
Group, Inc. (1)
10.8 Warrant Agreement dated April 5, 1994 between the Company
and The Harriman Group, Inc. (1)
10.9 Qualified Independent Underwriters' report of Chatfield
Dean & Co., Inc. (1)
10.10 Stock Purchase Agreement dated March 1992 by and
between Ira H. Levy and Steven J. Lubman. (1)
10.11 Form of sales representative agreement. (1)
*10.12 Intel Corporation Purchase Agreement dated January 1, 1996. (1)
11. Computation of earnings per share.
21.1 Subsidiaries of the Company. (1)
27. Financial Data Schedule.
* Confidential Treatment for a portion of the contract has been
granted by the Securities and Exchange Commission.
(1) Incorporated by reference from the Company's Registration
Statement on Form SB-2 (No. 333-630 NY) declared effective by
the Securities and Exchange Commission on July 31, 1996.
23
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,
hereunto duly authorized.
SURGE COMPONENTS, INC.
By: /s/ Ira Levy
Ira Levy,
President
In accordance with the requirements of the Securities Act of
1933, this Registration Statement has been signed by the
following persons in the capacities and on the dates stated:
Signature Title Date
/s/ David Siegel
David Siegel Chairman of the Board February 21 , 1997
/s/ Ira Levy
Ira Levy President, CEO (Principal February 25 , 1997
Executive Officer and Director)
/s/ Steven J. Lubman
Steven J. Lubman Secretary and Director February 25 , 1997
(Principal Financial Officer)
/s/ Mark Siegel
Mark Siegel Director February 21, 1997
SURGE COMPONENTS, INC. AND SUBSIDIARY
Index to Financial Statements
for the Year Ended November 30, 1996
Independent Auditors Report F - 2
Consolidated Balance Sheet F - 3 - 4
Consolidated Statements of Income F - 5
Consolidated Statements of Stockholders' Equity F - 6 - 7
Consolidated Statements of Cash Flows F - 8 - 9
Notes to Consolidated Financial Statements F - 10 - 23
F - 1
INDEPENDENT AUDITORS' REPORT
To The Board of Directors
Surge Components, Inc. and Subsidiary
We have audited the accompanying consolidated balance sheet of
Surge Components, Inc. and Subsidiary as of November 30, 1996 and
the related consolidated statements of income, changes in
stockholders' equity and cash flows for each of the two years ended
November 30, 1996. 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 generally accepted
auditing standards. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Surge
Components, Inc. and Subsidiary as of November 30, 1996 and the
results of their operations and their cash flows for the two years
ended November 30, 1996 in conformity with generally accepted
accounting principles.
Seligson & Giannattasio, LLP
N. White Plains, New York
January 17, 1997
F - 2
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
November 30, 1996
ASSETS (Note 5)
Current assets:
Cash (Note 3) $ 3,241,360
Marketable securities (Note 2) 2,042,681
Accounts receivable (net of allowance for
doubtful accounts of $9,206) 899,851
Inventory 1,332,644
Prepaid expenses and taxes 21,827
Cash surrender value 16,472
Total current assets $7,554,835
Fixed assets - net of accumulated depreciation
of $107,114 (Note 4) 169,777
Other assets:
Security deposits 2,985
Total assets $7,727,597
See accompanying notes to consolidated financial statements.
F - 3
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
November 30, 1996
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Loan payable - bank (Note 5) $ 164,232
Accounts payable 969,954
Accrued expenses 220,792
Corporation taxes payable 61,762
Total current liabilities $1,416,740
Long term debt:
Deferred income tax (Note 7) 4,488
Total liabilities 1,421,228
Commitments and contingencies (Notes 3, 5, 6, 7, 8, 9, 10, 11 and
12)
Stockholders' equity (Note 6):
Preferred stock - $.001 par value stock,
1,000,000 shares authorized, none issued
and outstanding --
Common stock - $.001 par value stock,
25,000,000 shares authorized, 4,823,958
shares issued and outstanding 4,824
Additional paid-in capital 6,335,862
Unrealized holding gain (Note 2) 35,751
Retained deficit (70,068)
Total stockholders' equity 6,306,369
Total liabilities and stockholders' equity $7,727,597
See accompanying notes to consolidated financial statements.
F - 4
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
November 30,
1 9 9 6 1 9 9 5
Sales $8,501,318 $8,847,603
Less returns and allowances 31,420 82,638
Net sales 8,469,898 8,764,965
Cost of goods sold 6,144,152 6,693,476
Gross profit 2,325,746 2,071,489
Operating expenses:
General and administrative
expenses 1,590,942 1,452,402
Selling and shipping expenses 529,888 474,183
Interest expense 41,435 40,539
Depreciation 29,193 20,162
Total operating expenses 2,191,458 1,987,286
Income from operations 134,288 84,203
Interest income 94,285 12,963
Income before income taxes 228,573 97,166
Income taxes (Note 7) 89,435 46,725
Net income $ 139,138 $ 50,441
Weighted average shares outstanding 3,650,662 2,211,458
Earnings per share $ .04 $ .02
See accompanying notes to consolidated financial statements.
F - 5
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED NOVEMBER 1996 AND 1995
Preferred Stock Common Stock
Shares Amount Shares Amount
Balance - December 1, 1994 -- $ -- 1,248,958 $1,249
Receipt of subscription
receivable -- -- -- --
Proceeds from issuance of
stock (Note 6) -- -- 500,000 500
Net income for the perio -- -- -- --
Balance - November 30, 1995 -- -- 1,748,958 1,749
Proceeds from issuance
of stock -- -- 3,075,000 3,075
Net unrealized gain in
marketable securities -- -- -- --
Net income for the period -- -- -- --
Balance - November 30, 1996 -- $ -- 4,823,958 $4,824
See accompanying notes to consolidated financial statements.
F - 6
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED NOVEMBER 1996 AND 1995
Unrealized
Additional Subscriptions Holding Retained
Paid-In Capital Receivable Gain (Deficit)
Balance - December 1, 1994 $1,127,447 $(1,200) -- $(259,647)
Receipt of subscription
receivable -- 1,200 -- --
Proceeds from issuance of
stock (Note 6) 402,382 -- -- --
Net income for the period -- -- -- 50,441
Balance - November 30, 1995 1,529,829 -- -- (209,206)
Proceeds from issuance
of stock 4,806,033 -- -- --
Net unrealized gain in
marketable securities -- -- 35,751 --
Net income for the period -- -- -- 139,138
Balance - November 30, 1996 $6,335,862 $ -- $35,751 $ (70,068)
See accompanying notes to consolidated financial statements.
F - 7
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended
November 30,
1 9 9 6 1 9 9 5
OPERATING ACTIVITIES:
Net income $ 139,138 $ 50,441
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation 29,193 20,162
Deferred income taxes 200 (157)
Provision for losses on
accounts receivable 2,188 (268)
CHANGES IN OPERATING ASSETS AND LIABILITIES:
Accounts receivable 125,378 (219,809)
Inventory (596,288) (196,069)
Prepaid expenses and taxes (14,216) 3,151
Deposit on merchandise 1,150 --
Cash surrender value (9,558) (6,914)
Accounts payable 233,983 (128,143)
Accrued expenses and taxes (123,709) 265,766
Customer deposit (24,837) 24,837
NET CASH USED BY OPERATING ACTIVITIES (237,378) (187,003)
INVESTING ACTIVITIES
Purchase of marketable securities (2,006,930) --
Acquisition of fixed assets (125,515) (45,665)
NET CASH USED BY INVESTING ACTIVITIES (2,132,445) (45,665)
See accompanying notes to consolidated financial statements
F - 8
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended
November 30,
1 9 9 6 1 9 9 5
FINANCING ACTIVITIES
Deferred offering costs $(1,068,201) $(184,809)
Net borrowings under
letter-of-credit agreement 34,389 (17,383)
Receipt of subscription -- 1,200
Advances to employees -- 2,901
Advances to officers -- 37,194
Proceeds from public offering 5,520,000 500,000
Proceeds from private offering 325,000 --
Proceeds from exercise of warrant 120,000 --
NET CASH PROVIDED BY FINANCING ACTIVITIES 4,931,188 339,103
NET CHANGE IN CASH 2,561,365 106,435
CASH AT BEGINNING OF PERIOD 679,995 573,560
CASH AT END OF PERIOD $3,241,360 $679,995
SUPPLEMENTAL CASH FLOW INFORMATION:
Income taxes paid $ 26,749 $ 63,577
Interest paid $ 41,435 $ 40,539
Payment of legal services through issuance
of stock (Note 6) $ 25,000 $ --
See accompanying notes to consolidated financial statements.
F - 9
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 1 - ORGANIZATION AND DESCRIPTION OF COMPANY'S BUSINESS
Surge Components, Inc. 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
1, 1988 the Company formed Challenge/Surge Inc., 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.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary. All material intercompany
balances and transactions have been eliminated in consolidation.
Marketable Securities
Effective November 1, 1993, the Company adopted Financial
Accounting Standards Board (FASB) Statement of Financial Accounting
Standards (SFAS) Number 115 "Accounting for Certain Investments in
Debt, and Equity Securities". Under this standard, certain
investments in debt and equity securities will be reported at fair
value. The Company's marketable securities, which consist primarily
of mutual funds, are being reported as securities held for sale.
The market value of these securities at November 30, 1996 is as
follows:
Aggregate cost $2,006,930
Gross unrealized gain 35,751
Gross unrealized loss --
$2,042,681
Cost of the securities used in the computation of realized gains
and losses is determined using the specific identification method.
During 1996, there were no sales of these securities.
F - 10
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Inventories
Inventories, which consist solely of goods held for resale, are
stated at the lower of cost (first-in, first-out method) or market.
The Company measures inventory and cost of goods sold for interim
financial statements by use of a historically developed gross
profit percentage. Annually, the Company adjusts the inventory to
reflect the results of a physical count.
Depreciation and Amortization
Fixed assets are recorded at cost. Depreciation is generally
provided on an accelerated method (double-declining balance) for
personal property and on the straight-line method for real property
over the estimated useful lives of the various assets as follows:
Furniture, fixtures and equipment5 - 7 years
Transportation equipment 3 - 5 years
Leasehold Improvements 10 - 39 years
Maintenance and repairs are expensed as incurred while renewals and
betterments are capitalized.
Reserve for Bad Debts
The Company, due to its customer base has experienced an
insignificant amount of bad debts. As a result, the Company has
not provided for a material change in the reserve for bad debts.
Accrued Vacation Pay
Employees are required to take vacation in the year of entitlement.
Accrued unpaid vacation entitlement has not been significant and,
as a result, no accrual has been provided for.
F - 11
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Deferred Offering Costs
Costs and fees incurred in conjunction with the private placement
(Note 6) were deferred and have been charged against gross proceeds
of the securities on a prorata basis. Costs and fees incurred in
conjunction with the public offering (Note 6) have been deferred
and charged against the gross proceeds of the securities.
Income Taxes
The Company's deferred income taxes arise primarily from the
differences in the recording of the depreciation expense for
financial reporting and income tax purposes. Income taxes are
reported based upon the Company's adoption of the Statement of
Financial Accounting Standards (SFAS) number 109 "Accounting for
Income Taxes".
Cash Equivalents
The Company considers all highly liquid investments with an
original maturity of three months or less to be cash equivalents.
Estimates
The preparation of financial statements in conformity with
generally accepted accounting principles 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 revenues and expenses during the reporting
period. Actual results could differ from those estimates.
F - 12
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Fair Value
The Company has a number of financial instruments, none of which
are held for trading purposes. The Company estimates that the fair
value of all financial instruments at November 30, 1996, does not
differ materially from the aggregate carrying values of its
financial instruments recorded in the accompanying balance sheets.
The estimated fair value amounts have been determined by the
Company using available market information and appropriate
valuation methodologies. Considerable judgment is necessarily
required in interpreting market data to develop the estimates of
fair value, and accordingly, the estimates are not necessarily
indicative of the amounts that the Company could realize in a
current market exchange.
Earnings Per Share
Earnings per share for the years ended November 30, 1996 and 1995
were computed by dividing net income by the weighted average number
of common and common equivalent shares outstanding.
Reclassifications
Certain prior year information has been reclassified to conform to
the current year's reporting presentation.
F - 13
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 3 - UNINSURED CASH BALANCES
The Company maintains its cash balances in several financial
institutions. Accounts at each financial institution are secured
by the FDIC up to $100,000. Uninsured balances at November 30,
1996 were approximately $3,114,300.
NOTE 4 - FIXED ASSETS
Fixed assets consist of the following at November 30, 1996:
Furniture and fixtures $ 36,915
Leasehold improvements 48,259
Computer equipment 191,717
276,891
Less - accumulated depreciation 107,114
Total fixed assets $169,777
F - 14
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 5 - LETTERS OF CREDIT TO BANK
In May 1994, the Company entered into a letter of credit agreement
with a bank allowing the Company to obtain up to $600,000 in
outstanding letters of credit. The fees on the letters of credit
are one half percent (1/2%) upon opening the letter of credit, one
half percent (1/2%) on negotiation and two percent (2%) per annum
over the banker's acceptance rate over the borrowed term. These
letters of credit are collateralized by the Company's assets and
are guaranteed by officers of the Company. The agreement also
contains provisions for the creation of bankers acceptances and
covenants requiring the Company to maintain specified levels of
tangible net worth.
In May 1995, the Company renewed the letter of credit agreement
with the following changes in terms. The agreement allows the
Company to obtain up to $800,000 in outstanding letters of credit
and $200,000 in direct borrowings. The direct borrowings incur
interest at a rate of prime plus one percent per annum. On
November 30, 1996 and 1995, the bankers acceptances totaled
$164,232 and $129,843 and the outstanding letters of credit totaled
$141,350 and $130,872. At November 30, 1996 and 1995, there were
no direct borrowings outstanding.
In May 1996, the Company renewed the letter of credit agreement
with a bank allowing the Company to obtain up to $800,000 in
outstanding letters of credit and $200,000 in direct borrowings.
The direct borrowings incur interest at a rate of prime plus one
percent per annum. All other terms and conditions are identical to
the prior agreement.
F - 15
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 6 - STOCKHOLDERS' EQUITY
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, with each series to have
such designations, rights and preferences as may be determined from
time to time by the Board of Directors. At November 30, 1996, none
of the shares has been designated.
Warrant Agreement
In April 1994, the Company entered into a warrant agreement with
The Harriman Group, Inc., a broker-dealer registered with the
United States Securities and Exchange Commission, in consideration
for the services rendered under the above-described financial
advisory and investment banking agreement. In exchange for $1,200,
the investment banker received 1,000,000 warrants which may be
exercised into 1,000,000 shares of the Company's common stock at
$.12 per share for a one year period commencing on the date the
Company's common stock has been listed on any stock exchange, or
sooner, upon mutual agreement of the Company and The Harriman
Group, Inc. In June 1996, the warrants were exercised.
F - 16
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 6 - STOCKHOLDERS' EQUITY (Continued)
Private Placement
Pursuant to a Private Placement Memorandum dated October 3, 1995
the Company completed a private offering of securities pursuant to
Regulation D of the Securities Act of 1933, as amended. This
exempt offering consisted of a minimum of $500,000 (consisting of
10 units, totaling 500,000 shares, at $50,000 per unit) and a
maximum of $1,000,000 (20 units, totaling 1,000,000 shares, at
$50,000 per unit). Each unit, as amended, consisted of one share
of the Company's common stock and one Class A Warrant plus an
additional Class A Warrant, which warrants are identical to those
issued in the public offering. In November 1995, the Company
grossed $500,000 and netted $397,500 from the issuance of the
units. In December, the Company completed the offering raising
aggregate net proceeds totaling $683,500 for the Company consisting
of the sale of 16-1/2 units.
Additional Shares Issued
In January 1996, the Company issued 25,000 shares and 50,000 Class A
warrants to a partnership whose partners are members of a law firm
retained by the Company, in exchange for legal services rendered.
The shares and Class A warrants are identical in all respects to
those issued in the private placement.
Public Offering
On August 8, 1996, the Company grossed $5,520,000 and netted
approximately $4,807,000 from the completion of a public offering
(the "Public Offering") under the Securities Act of 1933 as
amended. The offering consisted of 1,725,000 units, at a selling
price of $3.20 per unit. Each unit consisted of one Common Share
(the "Common Shares") and one redeemable Class A Common Share
Purchase Warrant (the "Warrants"). Each Warrant entitles the
holder to purchase one Common Share for a period of five years
commencing two years after the July 31, 1996 effective date of the
Public Offering at a price of $5.00.
Stock Split
In February 1996, the Company effected a one-for-twelve reverse
stock split. The effect of the split is being presented
retroactively for all periods presented.
F - 17
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 6 - STOCKHOLDERS' EQUITY (Continued)
1995 Employee Stock Option Plan
In January 1996, the Company adopted, and shareholders ratified in
February 1996, the 1995 Employee Stock Option Plan ("Option Plan").
The plan provides for the grant of options to qualified employees
of the Company and its subsidiary, independent contractors,
consultants and other individuals to purchase an aggregate of
350,000 common shares.
On February 19, 1996, the Company granted five year incentive stock
options under the Option Plan to ten employees to purchase an
aggregate of 86,000 common shares. The options became effective on
the effective date of the Public Offering, are exercisable at $3.20
per common share and vest ratably over either a two or four year
period. The Company also granted five year nonqualified stock
options under the Option Plan to purchase an aggregate of 60,000
common shares to seven persons with whom the Company has a business
relationship. These options became effective on the effective date
of the Public Offering and are exercisable at $3.20 per common
share and vest ratably over a four year period.
In October 1995, the FASB issued SFAS No. 123, "Accounting for
Stock-Based Compensation". The Company currently accounts for its
stock-based compensation plans using the accounting prescribed by
Accounting Principles Board Opinion No. 25 "Accounting for Stock
Issued to Employees". Since the Company is not required to adopt
the fair value based recognition provisions prescribed under SFAS
No. 123, it has elected only to comply with the disclosure
requirements set forth in the statement which includes disclosing
pro forma net income and earnings per share as if the fair value
based method of accounting had been applied. The pro forma net
income and earnings per share for the year ended November 30, 1996
would have been $17,049 and $.01 had the new method been applied.
Consulting Agreement
The Company retained the underwriter for the Public Offering to a
consulting agreement. Pursuant to the agreement, the underwriter
is performing certain financial advisory and investment banking
services for the Company in exchange for fees totaling $92,000,
payable monthly over a one-year period.
F - 18
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 7 - 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. Deferred income tax
liabilities are comprised as follows at November 30, 1996:
Deferred tax liability:
Fixed assets $4,488
The Company's income tax expense consists of the following:
Year Ended
November 30,
1 9 9 6 1 9 9 5
Current:
Federal $77,847 $33,164
States 11,388 13,718
$89,235 $46,882
Deferred:
Federal $ 140 $ (85)
States 60 (72)
$ 200 $ (157)
Provision for income taxes $89,435 $46,725
F - 19
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 7 - INCOME TAXES (Continued)
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:
Year Ended
November 30,
1 9 9 6 1 9 9 5
U.S. Federal income tax statutory rate 34% 34%
State income tax, net of Federal income tax benefit 6 6
Other - including tax free income (1) 8
Effective tax rate 39% 48%
F - 20
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 8 - RELATED PARTY TRANSACTIONS
Lease
The Company leases office and warehouse space through December 31,
1998 from a corporation which is controlled by officers of the
Company. In December 1994, the Company received a five year
extension on the lease. The following is a schedule of future
minimum rental payments required at November 30, 1996:
Year Ending November 30,
1997 $ 57,709
1998 60,595
1999 5,070
$123,374
Net rental expense for the years ended November 30, 1996 and 1995,
was $58,821 and $56,589, respectively.
Employment Agreements
Effective February 1, 1996, the Company entered into employment
agreements with two officers of the Company. Among other
provisions, the agreement allows for a base salary of $200,000 plus
bonuses based on performance over a five year period commencing on
the effective date of the Public Offering. 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, the
current officers 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 of at least 25% of the
issued and outstanding stock of the Company, and such issuance was
not approved by either officer, then the non-approving officer may
elect to terminate his employment contract and 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. If these agreements were in place as of December 1, 1994,
the proforma results of operations for the year ended November
30, 1995 would have resulted in a net loss of $30,604 and loss per
share of $.01.
F - 21
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 9 - INDEPENDENT REPRESENTATIVES
The Company has agreements with independent representatives who
receive commissions of 5% on the net amount of invoices rendered by
the representative after all trade discounts, freight,
transportation allowances, sales taxes, insurance and the like have
been deducted. The representatives agree to not represent any
person or entity manufacturing or selling products which are
competitive with products and services sold by the Company
throughout the term of the agreement. The agreements continue
unless terminated by written notice by either party or the
agreement is breached by either party.
NOTE 10 - MAJOR CUSTOMERS
For the year ended November 30, 1995, no single customer accounted
for more than 10% of the Company's total revenues. For the year
ended November 30, 1996, revenues from one customer were in excess
of 10% of the Company's total revenues and aggregated $1,114,488.
NOTE 11 - MAJOR SUPPLIERS
Inventory purchased from one supplier in excess of 10% of the
Company's total purchases consists of the following:
Year Ended
November 30,
1 9 9 6 1 9 9 5
Supplier A $1,154,262 $1,228,332
Supplier B 1,085,932 842,964
Supplier C 794,267 --
F - 22
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1996
NOTE 12 - EXPORT SALES
Export sales consist of the following:
Year Ended
November 30,
1 9 9 6 1 9 9 5
Surge Components Inc.
Canada $12,524 $ 37,232
Europe -- 40,756
Asia 15,775 --
Challenge/Surge Inc.
Canada $59,417 $300,162
Europe 28,709 52,784
Asia 128,575 --
NOTE 13 - SUBSEQUENT EVENTS
Stock Option Agreement
In January 1997, the Company granted five year incentive stock
options under the option plan to two employees to purchase 20,000
common shares each. The options became effective on January 8,
1997, are exercisable at $3.50 per common share and vest ratably
over a four year period. The Company also granted a nonqualified
stock option under the option plan to purchase 10,000 common shares
each to two members of the Board of Directors. The options become
effective on January 8, 1997 and are exercisable at $3.50 per
common share at any time on or after January 8, 1997.
F - 23
SURGE COMPONENTS, INC. AND SUBSIDIARY
EXHIBIT II
COMPUTATION OF EARNINGS PER COMMON SHARE
1 9 9 6 1 9 9 5
Net income $ 139,138 $ 50,441
Shares:
Weighted common shares outstanding 3,623,890 1,248,958
Employees stock options 26,772 ---
Options to The Harriman Group -- 962,500
A warrants -- --
Underwriter warrants -- --
Total weighted shares outstanding 3,650,662 2,211,458
Earnings per share $ .04 $ .02
_______________________________
1
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted
from the Balance Sheet and Statements of Income filed as part
of the report on Form 10KSB and is qualified in its entirety
by reference to such report on Form 10KSB.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> NOV-30-1996
<PERIOD-END> NOV-30-1996
<CASH> 3,241,360
<SECURITIES> 2,042,681
<RECEIVABLES> 909,057
<ALLOWANCES> 9,206
<INVENTORY> 1,332,644
<CURRENT-ASSETS> 7,554,835
<PP&E> 276,891
<DEPRECIATION> 107,114
<TOTAL-ASSETS> 7,727,597
<CURRENT-LIABILITIES> 1,416,740
<BONDS> 0
0
0
<COMMON> 4,824
<OTHER-SE> 6,301,545
<TOTAL-LIABILITY-AND-EQUITY> 7,727,597
<SALES> 8,469,898
<TOTAL-REVENUES> 8,564,183
<CGS> 6,144,152
<TOTAL-COSTS> 2,150,023
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 41,435
<INCOME-PRETAX> 228,573
<INCOME-TAX> 89,435
<INCOME-CONTINUING> 139,138
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 139,138
<EPS-PRIMARY> .04
<EPS-DILUTED> .04
</TABLE>
