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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB/A
Amendment No. 1
ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended November 30, 1997
Commission file number 0-14188
SURGE COMPONENTS, INC.
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(Name of small business issuer in its charter)
New York 11-2602030
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1016 Grand Boulevard, Deer Park, New York 11729
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (516) 595-1818
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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. [X]
The issuer's net sales for its most recent fiscal year were $10,833,798.
The aggregate market value of the 4,291,910 shares of voting stock held
by non-affiliates of the Registrant, as of February 9, 1998 when the closing
sale price was $2.625 per share, was $11,266,263 (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 9, 1998, was 4,823,907.
Documents Incorporated by Reference: Not Applicable.
Exhibit Index is located on page 30
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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.
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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 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, 1996 ("Fiscal 1996") and November 30, 1997 ("Fiscal 1997"),
capacitors accounted for approximately 83% and 75%, respectively, of the
Company's sales while discrete components accounted for approximately 17% and
25%, 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:
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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 and adopted throughout the world
to ensure that the facility's manufacturing processes, equipment and associated
quality control systems will satisfy specific customer requirements. This
system is 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
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.
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
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miniaturization) and auto rectifiers. ISO 9002 and QS 9000 automotive
certification is giving Surge an open door to market its products in the
automotive segment.
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
ISO 9002 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 suppressers 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
may 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,
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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. The
Company is also marketing multilayer ceramic capacitors widely used in
computers and telecommunications applications for filtering.
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 has
begun to commence individual bar coding on 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 has
used the proceeds of its Public Offering to maintain its inventories. 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 1997 and 1996, the average per
component sales price of the products sold by the Company was approximately
$.07. As of November 30, 1997 and November 30, 1996, the Company maintained an
inventory of $1,228,941 and $1,332,644, 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 1997
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were manufactured in foreign countries, with the majority purchased in Taiwan
24.2%, China 18.7%, South Korea 3.6%, India 1.4% and Hong Kong 1.2%. 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. 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. The Company, however, may be severely impacted by the recent and
current economic conditions in Southeast Asia, based upon the amount of business
it transacts there. Potential concerns may include drastic devaluations of
currencies, loss of suppliers and increased competition within the region. 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, 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 1997 two suppliers each accounted for in excess of 10% of
the Company's net purchases. The two are Lifu Electronics, a Taiwanese company,
and Master Instrument New York Company, Inc., a New York corporation. Purchases
from these suppliers in Fiscal 1997 were $1,034,783 and $1,376,457,
respectively, or 13.6%, and 18.1%, respectively. In Fiscal 1996 purchases from
the foregoing two suppliers plus a third one, Pal Up Taiwan Company Ltd., a
Taiwanese company, were $1,085,932, $794,267, and $1,154,262, respectively, or
17%, 13% and 18%, 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.
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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.
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. Sales by the independent
organization Win-Cor Electronics Sales Corp. represented 19.1% of sales of the
Company for Fiscal 1997. 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 February 1997, the Company hired an Eastern Regional
Sales Manager and in December 1997 a Midwest Regional Sales Manager was hired.
The Company plans to hire a West Cost regional sales manager to oversee the
Company's sales representatives in that geographic area. The Company believes
that such regional sales managers will ensure that the Company's sales
activities function properly. The Company has initiated a formal national
distribution program to attract more distributors to promote Surge products.
Surge has appointed a National District Manager to develop and manage this
program. The Company expects this market segment to contribute significantly
to the Company's sales growth over time.
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
electronics community, the Company opened locations in California during 1996
and Massachusetts in 1997 and has put on hold plans to open locations in such
countries as Ireland, Taiwan, China and potentially Mexico, where there existed
strong electronic components markets, however, demand is currently weak.
Accordingly, there are no current plans to open additional locations.
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.
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Effective January 1, 1996, Challenge entered into an agreement to
supply audible transducers for computer keyboards to Intel Corporation. The
agreement was renewed in January 1998 and is continuing, although it is
terminable at will by Intel Corporation.
As of November 30, 1997, the Company had arrangements with 19 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.
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 trade shows
throughout the year. The Company's products were promoted at electronic
distribution shows in Las Vegas, Nevada in 1996 and 1997, 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 Fiscal 1997 or Fiscal
1996. For Fiscal 1997, two customers accounted for 16.8% and 13.1% of the
Company's net sales. For Fiscal 1996, a third customer accounted for 13.2% of
the Company's net sales. 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.
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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 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 has
commenced individual bar 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.
The Company believes that many of its suppliers and customers have year
2000 Issues ("Year 2000 Issue") which could affect the Company. Many older
computer software programs recognize only the last two digits of the year in any
date (e.g., "98" for "1998"). These programs were designed and developed without
considering the impact of the upcoming change in the century. If the software is
not reprogrammed or replaced, many computer applications could fail or create
erroneous results by or at the Year 2000. The Company will commence a program to
pursue compliance by those with whom it electronically interconnects. It is not
possible, however, at present, to quantify the overall cost of resolving this
issue for the Companys suppliers and customers. The Company has been advised by
its MIS consultants, Friendly Software, that their own software has been
designed and developed with a resolution to the Year 2000 Issue and as such the
Company presently believes that the cost of fixing the Year 2000 Issue will not
have a material effect on the Companys current financial position, liquidity or
results of operations.
CUSTOMER SERVICE
The Company maintains two 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.
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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.
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. See "Item 6. Managements Discussion Analysis or Plan of
Operation, Liquidity and Capital Resources."
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. 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
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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, 1997, the Company's backlog was approximately
$2,033,918, as compared with approximately $2,728,612 at November 30, 1996.
Substantially all backlog is shipped by the Company in 90 to 180 days. Year to
year comparisons of backlog are not necessarily indicative of future operating
results.
EMPLOYEES
As of November 30, 1997, the Company employed 18 persons, of whom two
are employed in executive capacities, four 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. Seventeen (17) 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 and $64,729 during 1997. 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 the year 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. The Company is
renovating the office facilities to allow for expansion of the sales department,
clerical, finance and purchasing departments. The Company believes the new
working environment will lead to greater productivity. 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.
12
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER 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 Common Shares and Warrants are
listed on the Boston Stock Exchange under the symbols "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, 1998 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 ENDED NOVEMBER 30, 1997
FIRST QUARTER
(December 1, 1996 - February 28, 1997) 5 3/8 3 1/2
SECOND QUARTER
(March 1, 1997 - May 31, 1997) 5 5/8 2
THIRD QUARTER
June 1, 1997 - August 31, 1997) 2 3/16 1/2
FOURTH QUARTER
(September 1, 1997 - November 30, 1997) 2 3/8 5/8
FISCAL YEAR ENDING NOVEMBER 30, 1998
FIRST QUARTER
(December 1, 1997 - January 31, 1998) 2 1/4 1 15/32
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 1/4 1 3/4
FISCAL YEAR ENDED NOVEMBER 30, 1997
FIRST QUARTER
(December 1, 1996 - February 28, 1997) 2 1/8 1/2
SECOND QUARTER
(March 1, 1997 - May 31, 1997) 13/16 7/32
THIRD QUARTER
(June 1, 1997 - August 31, 1997) 5/16 3/32
FOURTH QUARTER
(September 1, 1997 - November 30, 1997) 13/16 1/8
FISCAL YEAR ENDING NOVEMBER 30, 1998
FIRST QUARTER
(December 1, 1997 - January 31, 1998) 13/16 3/8
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 25, 1998, the closing trade price of a Common Share and a
Warrant were $2.37 and $1.00, respectively.
13
<PAGE>
On February 25, 1998, the Company had 178 and 22 recordholders of its
Common Stock and Warrants, respectively, and reasonably believed it had in
excess of 300 beneficial holders of its Common Stock.
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, 1997 as Compared to Fiscal Year Ended
November 30, 1996.
Net sales for Surge Components, Inc. and Subsidiary (the "Company")
for the fiscal year ended November 30, 1997 ("Fiscal 1997") increased by
$2,363,900, or 28%, to $10,833,798, as compared to net sales of $8,469,898 for
the fiscal year ended November 30, 1996 ("Fiscal 1996"). This increase was
attributable primarily to increased sales volumes of newly introduced
products, as well as existing Surge products. The Company introduced various
new product lines in the fourth quarter of Fiscal 1996 which increased sales
during Fiscal 1997.
The Company's gross profit for Fiscal 1997 increased by $283,382, or
12%, as compared to Fiscal 1996. This increase was due primarily to increased
sales volume. Gross margin as a percentage of net sales, however, decreased from
27.5% in Fiscal 1996 to 24.1% in Fiscal 1997. The lower margins were primarily a
result of increased competition in the electronics industry. Part of the
increased competition is derived from customers requiring global marketing and
customer support. Suppliers are being asked to promote their products to
customers in each country where they do business. Rather than committing
significant resources, however, the Company is contracting with independent
sales representatives throughout the world in a similar approach used in the
United States. The Company is expected to make its operations more efficient and
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 used inventory warehousing and shipping services from a
California firm prior to July 1997.
General and administrative expenses for Fiscal 1997 increased by
$364,364, or 23%, as compared to Fiscal 1996. General and administrative
expenses, as a percentage of net sales, remained relatively unchanged. The
absolute increase is partially due to the hiring of an engineer, regional sales
manager, public relations firm, investment banking consulting fees and the
general costs incurred by a public reporting 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 in
1998 or later. These expenditures were all part of the Company's business
strategy when it effected its August 1996 Public Offering. The foundation of the
Company strategy is to increase sales volumes (and corresponding profit margins)
for its core business to offer customers a "one-stop shop" for their needs.
Selling and shipping expenses for Fiscal 1997 increased by $189,297,
or 36%, compared to Fiscal 1996. Selling and shipping expenses, as a
percentage of net sales, remained relatively
14
<PAGE>
unchanged. The absolute increase is primarily due to the Company's commitment to
sales promotion and literature. The Company began to more actively promote
itself and its products through attendance at various trade shows and through
increased activity with a marketing/public relations firm. The increase in
selling and shipping expenses is also due to the increased internal commissions
resulting from the increase in sales volume and increased participation of
independent sales representatives which received commissions typically at a rate
of 5% of net sales. The Company is committed to continuing to increase sales
through authorized distributors, sales representatives, an Internet website,
literature, participation in trade shows, the opening of new offices in
strategic locations and utilization of a marketing/public relations firm.
Significant resources, including personal, have been allocated to assist the
Company with the development of the distribution market.
Interest expense for Fiscal 1997 increased by $14,577, or 35%, as
compared to Fiscal 1996. This increase is primarily due to the Company's
increased buying of purchases through letters of credit and bankers
acceptances. The Company intends to continue utilizing letters of credit and
bankers acceptances on an as needed basis based on its cash needs.
Interest income for Fiscal 1997 increased by $171,022, or 181%, as
compared to Fiscal 1996. This increase is primarily due to the income
generated by the Company's invested funds. These funds result from proceeds
from the public offering which have not yet been utilized.
As result of the foregoing, the Company had net loss from operations
and net income of $(176,068) and $75,350 for Fiscal 1997, as compared to
income from operations and net income of $134,288 and $139,138 for Fiscal
1996.
Liquidity and Capital Resources
At November 30, 1997 Compared to November 30, 1996
Working capital increased by $158,322 for Fiscal 1997 from $6,138,095
at November 30, 1996 to $6,296,417 at November 30, 1997. This increase resulted
primarily from the increase in accounts receivable reduced by additional
spending related to the Company's expansion plans. The Company's Current Ratio
(current assets to current liabilities) decreased to 4.6:1 at November 30, 1997,
as compared to 5.3:1 at November 30, 1996, as a result of funds used for
operations and increased borrowings. The average number of days to collect
receivables remained relatively the same, decreasing from 42 days to 41 days.
Inventory turned more frequently in Fiscal 1997 as a result of the Company's
increased sales. Working capital levels as expected to be adequate to meet the
Company's current operating requirements.
15
<PAGE>
On August 8, 1996, the Company completed its Public Offering for
which it grossed $5,520,000 and netted $4,807,027 of proceeds. 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 ("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 in 1994 by one of the Underwriters of
the Public Offering were exercised to purchase 1,000,000 shares of the Company's
Common Stock for which the Company received $120,000.
In May 1996, the Company entered into a 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 acceptances (drafts 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
required the Company to be in compliance with certain financial ratios
including a debt to equity ratio and a minimum amount of tangible net worth.
In July 1997, the Company renewed the letter of credit agreement with
the bank through May 31, 1998. Pursuant to the agreement all terms and
conditions remain the same except for the following: (1) the interest rate on
direct borrowings has been reduced to the prime rate, (2) the requirement of
officer guarantees has been removed, and (3) the amount of minimum tangible net
worth was increased and the debt to equity ratio decreased to more accurately
reflect the Company's financial position. The Company was in compliance with
the required financial ratios as of November 30, 1997. As of November 30, 1997
and 1996, there was no outstanding direct borrowings, although outstanding
banker's acceptances and letters of credit totaled approximately $578,000 and
$306,000, respectively. Borrowings are collateralized by the assets of the
Company.
The Company intends to expand its existing facilities in order to
achieve and maintain growth, primarily through the increased penetration of the
OEM and distribution market, the introduction of new products and the upgrade of
existing product lines. In order to effect this expansion, the Company has
allocated approximately $200,000 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.
As of November 30, 1997 the Company did not expend any funds for expansion. The
Company is renovating the office facilities to allow for expansion of the sales
department, clerical, finance and purchasing departments. The Company believes
the new working environment will lead to greater productivity. Additionally, the
renovation plans contain provisions for additional space for test labs, which
will allow the Company to provide customers with prompt information regarding
the specifications of its products and additional sales staff expected to manage
the Company's sales growth.
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, marketing and facilities
related charges, as well as professional fees associated with being a public
company. 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.
16
<PAGE>
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 with a one year renewal option; however, it is
terminable at will by Intel Corporation. Intel Corporation renewed the agreement
in January 1998.
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 which include resistors, inductors,
thermistors and high reliability electrolytics. As of November 30, 1997, the
Company had purchased new computer equipment, including scanning equipment,
updated its accounting software and networked all of its computers, in addition,
new testing equipment has been acquired for the Company's test laboratory. The
Company increased personnel in its warehouse and seeks to hire additional sales
personnel. The Company obtained Apple Computer Quality Certification ISO-9000-2
which the Company expects will reduce employee workloads and improve efficiency.
The Company has initiated a public relations program to promote these products
through various trade journals. In 1997, the Company established a Website,
giving the engineering community exposure and access to any and all of the
Company's products which they would consider to include in their design. 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 has began to commence individual bar coding
on products in order to manage lot traceability.
The Company believes that many of its suppliers and customers have
year 2000 Issues ("Year 2000 Issue") which could affect the Company. Many
older computer software programs recognize only the last two digits of the
year in any date (e.g., "98" for "1998"). These programs were designed and
developed without considering the impact of the upcoming change in the
century. If the software is not reprogrammed or replaced, many computer
applications could fail or create erroneous results by or at the Year 2000.
The Company will commence a program to pursue compliance by those with whom it
electronically interconnects. It is not possible, however, at present, to
quantify the overall cost of resolving this issue for the Companys suppliers
and customers. The Company has been advised that their own software has been
designed and developed with a resolution to the Year 2000 Issue and as such
the Company presently believes that the cost of fixing the Year 2000 Issue
will not have a material effect on the Company's current financial position,
liquidity or results of operations.
Approximately 49% of the total goods purchased by the Company in 1997
and 1996 were manufactured in foreign countries and substantially all of
Surge's purchases are made from manufacturers in Asia. Substantially all of
Challenge's products are purchased domestically. In
17
<PAGE>
addition, approximately 5% and 3% of 1997 and 1996 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.
The Company, however, may be severely impacted by the recent and current
economic conditions in Southeast Asia, based upon the amount of business it
transacts there. Potential concerns may include drastic devaluations of
currencies, loss of suppliers and increased competition within the region. The
Company can not estimate at the current time any potential impact of these
conditions to its financial position, liquidity or results of operations.
During Fiscal 1997, the Company had net cash used by operating
activities of $533,610, as compared to $237,378 used by operating activities in
Fiscal 1996. The increase in cash used by operating activities resulted from an
increase in accounts receivable, bad debt and prepaid expenses and taxes, as
partially offset by decreased inventory and accounts payable. 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 its revenue for
bad debts.
The Company had net cash used by investing activities of $143,318 for
Fiscal 1997, as compared to $2,132,445 for Fiscal 1996. During Fiscal 1996,
the Company invested the unused proceeds from the Public Offering in
marketable securities and reinvested the dividends on these securities in
Fiscal 1997.
The Company had net cash provided by financing activities of $331,263
for Fiscal 1997, as compared to $4,931,188 for Fiscal 1996. This decrease in
the cash provided by financing activities was the result of the proceeds from
the issuance of stock in 1996 in the Public Offering and private placement and
net borrowings under the letter-of credit-agreement during 1997. As a result
of the foregoing, the Company had a net decrease in cash of $345,665 during
Fiscal 1997, as compared to a net increase of $2,561,365 for Fiscal 1996.
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.
18
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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(1) 72 Chairman of the Board
Ira Levy 41 President and Director
Steven J. Lubman 42 Vice President, Principal Financial
Officer, Secretary and Director
Mark Siegel(1) 43 Director
(1) Member of the Audit Committee and the Compensation Committee
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 Electronice Corp., an electronics parts distributor. Mark Siegel is the
son of David Siegel.
19
<PAGE>
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, 1997.
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, 1997 ("Fiscal 1997"), the fiscal year ended November 30, 1996
("Fiscal 1996") and the fiscal year ended November 30, 1995 ("Fiscal 1995") by
those persons who served as Chief Executive Officer and any Named Executive
Officer who received compensation in excess of $100,000 during such years.
<TABLE>
<CAPTION>
Long-Term
Annual Compensation Compensation
------------------------------------------------------------ ------------------
Awards
Other Annual ------
Salary Bonus Compensation Shares Underlying
Name and Principal Position Year ($) ($) ($)(1) Options(#)
- --------------------------- ---- -------- -------- ------------ ------------------
<S> <C> <C> <C> <C> <C>
Ira Levy 1997 $197,500 $ 52,325 0 75,000
President and CEO 1996 $137,116 $107,500(1) 0 0
1995 $143,500 $103,600(1) 0 0
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
Long-Term
Annual Compensation Compensation
------------------------------------------------------------ ------------------
Awards
Other Annual ------
Salary Bonus Compensation Shares Underlying
Name and Principal Position Year ($) ($) ($)(1) Options(#)
- --------------------------- ---- -------- -------- ------------ ------------------
<S> <C> <C> <C> <C> <C>
Steven J. Lubman 1997 $199,000 $ 53,565 0 75,000
Vice President 1996 $128,742 $107,500(1) 0 0
1995 $162,845 $103,600(1) 0 0
</TABLE>
- ----------
(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 $50,000 or 10% of such
person's annual salary and bonus.
21
<PAGE>
Option Grants in Last Fiscal Year
The table below includes the number of stock options granted to the
executive officers named in the Summary Compensation Table during Fiscal 1997
and exercise information.
<TABLE>
<CAPTION>
Individual Grants
----------------------------------
Number of Percent of
Securities Total Options
Underlying Granted to
Options Employees in Exercise Expiration
Name Granted(#) Fiscal Year Price($/sh) Date
- ---- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Ira Levy 25,000 9.1% $1.25 6/29/02
50,000 18.1% $1.53 10/27/02
Steven J. Lubman 25,000 9.1% $1.25 6/29/02
50,000 18.1% $1.53 10/27/02
David Siegel 10,000 3.6% $1.25 1/7/02
Mark Siegel 10,000 3.6% $1.25 1/7/02
</TABLE>
Aggregated Option Exercises in Last Fiscal Year and FY End Option Values
The table below includes information regarding the value realized on
option exercises and the market value of unexercised options held by the
executive officers named in the Summary Compensation Table during Fiscal 1997.
<TABLE>
<CAPTION>
Value of
Number of Unexercised
Unexercised In-The-Money
Shares Options Options
Acquired at FY-End(#) at FY-End($)
on Exer- Value Exercisable/ Exercisable/
Name cise (#) Realized($) Unexercisable Unexercisable
- ---- -------- ----------- ------------- -------------
<S> <C> <C> <C> <C>
Ira Levy 0 0 75,000/0 $56,313/0(1)
Steven J. Lubman 0 0 75,000/0 $56,313/0(1)
</TABLE>
- ----------
(1) Based on the closing price per share of the Company's Common Stock on
November 28, 1997, of $2.1875.
22
<PAGE>
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. On June 30, 1997,
these options were re-granted with an exercise price of $1.25.
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.
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.
23
<PAGE>
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
were 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. On
June 30, 1997, the Company re-granted these options at an exercise price of
$1.25 per share, with the same vesting terms and a termination date of June
30, 2002. 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, the Quality
Assurance Director of Marketing, and the then National Sales Manager,
respectively, each 20,000 options, or an aggregate of 40,000 options subject to
the vesting schedule specified in the agreements, at an exercise price of $3.50
per share. These options were re-granted on June 30, 1997 at an exercise price
of $1.25 per share and the same vesting schedule. 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. These options were
re-granted on June 30, 1997 at an exercise price of $1.25 per share. On June 30,
1997, Ira Levy and Steven J. Lubman, officers and directors, were each granted
25,000 options at an exercise price of $1.25, and on October 28, 1997 each were
granted 50,000 options at an exercise price of $1.53.
24
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of February 25, 1998,
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 330,000(3) 6.7%
Steven J. Lubman 330,000(4) 6.7%
David Siegel 10,000(5) (6)
Mark Siegel 31,998(5) (6)
All directors and executive
officers as a group (4 persons) 701,998(5) 14.3%
- ---------------
(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 4,823,907 shares issued and outstanding as of February 9, 1998.
(3) Includes 75,000 shares issuable upon exercise of currently exercisable
stock options. Includes 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) Includes 75,000 shares issuable upon exercise of currently exercisable
stock options. Includes 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) Represents less than one percent ownership.
25
<PAGE>
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 was $4,598 and $5,078 during 1996, and 1997,
respectively increasing at 5% per annum during the term of the lease which
expires on December 31, 1998. See Item 2. "Description of Property."
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. These options were re-granted on June 30, 1997 at an
exercise price of $1.25 per share. On June 30, 1997, Ira Levy and Steven J.
Lubman, officers and directors, were each granted options to purchase 25,000
shares of common stock at an exercise price of $1.25, and on October 28, 1997
each were granted 50,000 options at an exercise price of $1.53.
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.
26
<PAGE>
ITEM 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
3.1 Certificate of Incorporation of the Company, as amended. (1)
3.2 By-Laws of the Company. (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, 1998. (1)
11. Computation of Earnings Per Share
21.1 Subsidiaries of the Company. (1)
27. Financial Data Schedule.
</TABLE>
- ---------------
27
<PAGE>
* 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.
28
<PAGE>
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/ Steven J. Lubman By: /s/ Ira Levy
- --------------------------- ----------------
Steven J. Lubman Ira Levy,
Principal Financial Officer and President
Principal Accounting Officer
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 December 2, 1998
/s/ Ira Levy
- -----------------------
Ira Levy President, CEO (Principal December 2, 1998
Executive Officer and Director)
/s/ Steven J. Lubman
- -----------------------
Steven J. Lubman Secretary and Director December 2, 1998
(Principal Financial Officer)
/s/ Mark Siegel
- -----------------------
Mark Siegel Director December 2, 1998
<PAGE>
<TABLE>
EXHIBIT INDEX
<CAPTION>
Exhibit No. Name
- ----------- ----
<S> <C>
11 Computation of Earnings Per Common Share
27 Financial Data Schedule
</TABLE>
30
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
Index to Financial Statements
for the Year Ended November 30, 1997
Independent Auditors' Report F-2
Consolidated Balance Sheet F-3-4
Consolidated Statements of Income F-5
Consolidated Statements of Stockholders' Equity F-6
Consolidated Statements of Cash Flows F-7-8
Notes to Consolidated Financial Statements F-9-22
F - 1
<PAGE>
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, 1997 and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the two years ended November 30, 1997. 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, 1997 and the results of their operations and
their cash flows for the two years ended November 30, 1997 in conformity with
generally accepted accounting principles.
Seligson & Giannattasio, LLP
N. White Plains, New York
January 26, 1998
F - 2
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
November 30, 1997
ASSETS (Note 4)
Current assets:
Cash (Note 2) $ 2,895,695
Marketable securities (Note 2) 2,217,370
Accounts receivable (net of allowance for
doubtful accounts of $15,724) 1,544,536
Inventory 1,228,941
Prepaid expenses and taxes 130,844
Cash surrender value 29,789
-----------
Total current assets $8,047,175
Fixed assets - net of accumulated depreciation
of $160,858 (Note 3) 123,942
Other assets:
Security deposits 2,985
----------
Total assets $8,174,102
==========
See accompanying notes to consolidated financial statements.
F - 3
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
November 30, 1997
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Loan payable - bank (Note 4) $ 495,495
Accounts payable 960,073
Accrued expenses 294,734
Corporation taxes payable 456
-----------
Total current liabilities $1,750,758
Long term debt:
Deferred income tax (Note 7) 1,396
----------
Total liabilities 1,752,154
Commitments and contingencies (Notes 4 through 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) 75,980
Retained earnings 5,282
----------
Total stockholders' equity 6,421,948
----------
Total liabilities and stockholders' equity $8,174,102
==========
See accompanying notes to consolidated financial statements.
F - 4
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
November 30,
1 9 9 7 1 9 9 6
------- -------
Sales $ 10,887,608 $ 8,501,318
Less returns and allowances 53,810 31,420
------------ ------------
Net sales 10,833,798 8,469,898
Cost of goods sold 8,224,670 6,144,152
------------ ------------
Gross profit 2,609,128 2,325,746
------------ ------------
Operating expenses:
General and administrative
expenses 1,955,306 1,590,942
Selling and shipping expenses 719,185 529,888
Depreciation 54,693 29,193
------------ ------------
Total operating expenses 2,729,184 2,150,023
------------ ------------
Income (loss) from operations (120,056) 175,723
Other income and (expense)
Investment income 265,307 94,285
Interest expense (56,012) (41,435)
------------ ------------
Income before income taxes 89,239 228,573
Income taxes (Note 9) 13,889 89,435
------------ ------------
Net income $ 75,350 $ 139,138
============ ============
Weighted average shares outstanding 4,964,983 3,650,662
Earnings per share $ .02 $ .04
See accompanying notes to consolidated financial statements.
F - 5
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED NOVEMBER 30, 1997 AND 1996
<TABLE>
<CAPTION>
Additional Unrealized Retained Total
Preferred Stock Common Stock Paid-In Holding Earnings Stockholders'
Shares Amount Shares Amount Capital Gain (Deficit) Equity
--------- --------- ---------- ---------- ---------- ---------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance - December 1, 1995 -- $ -- 1,748,958 $ 1,749 $1,529,829 $ -- $ (209,206) $1,322,372
Net unrealized gain in
marketable securities -- -- -- -- -- 35,751 -- 35,751
Proceeds from issuance of
private offering -- -- 350,000 350 286,533 -- -- 286,883
Proceeds from exercise of
warrants -- -- 1,000,000 1,000 119,000 -- -- 120,000
Proceeds from issuance of
public offering -- -- 1,725,000 1,725 4,400,500 -- -- 4,402,225
Net income for the period -- -- -- -- -- -- 139,138 139,138
--------- --------- ---------- ---------- ---------- ---------- ---------- ----------
Balance - November 30, 1996 -- -- 4,823,958 4,824 6,335,862 35,751 (70,068) 6,306,369
Proceeds from issuance
of stock -- -- -- -- -- -- -- --
Net unrealized gain in
marketable securities -- -- -- -- -- 40,229 -- 40,229
Net income for the period -- -- -- -- -- -- 75,350 75,350
--------- --------- ---------- ---------- ---------- ---------- ---------- ----------
Balance - November 30, 1997 -- $ -- 4,823,958 $ 4,824 $6,335,862 $ 75,980 $ 5,282 $6,421,948
========= ========= ========== ========== ========== ========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
F - 6
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended
November 30,
1 9 9 7 1 9 9 6
------- -------
OPERATING ACTIVITIES:
Net income $ 75,350 $ 139,138
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation 54,693 29,193
Deferred income taxes (3,092) 200
Provision for losses on
accounts receivable 6,518 2,188
CHANGES IN OPERATING ASSETS AND LIABILITIES:
Accounts receivable (651,203) 125,378
Inventory 103,703 (596,288)
Prepaid expenses and taxes (109,017) (14,216)
Deposit on merchandise -- 1,150
Cash surrender value (13,317) (9,558)
Accounts payable (9,881) 233,983
Accrued expenses and taxes 12,636 (123,709)
Customer deposit -- (24,837)
----------- -----------
NET CASH USED BY OPERATING ACTIVITIES (533,610) (237,378)
----------- -----------
INVESTING ACTIVITIES
Purchase of marketable securities (134,460) (2,006,930)
Acquisition of fixed assets (8,858) (125,515)
----------- -----------
NET CASH USED BY INVESTING ACTIVITIES (143,318) (2,132,445)
----------- -----------
See accompanying notes to consolidated financial statements
F - 7
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended
November 30,
1 9 9 7 1 9 9 6
------- -------
FINANCING ACTIVITIES
Deferred offering costs $ -- $(1,068,201)
Net borrowings under
letter-of-credit agreement 331,263 34,389
Proceeds from public offering -- 5,520,000
Proceeds from private offering -- 325,000
Proceeds from exercise of warrant -- 120,000
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 331,263 4,931,188
----------- -----------
NET CHANGE IN CASH (345,665) 2,561,365
CASH AT BEGINNING OF PERIOD 3,241,360 679,995
----------- -----------
CASH AT END OF PERIOD $ 2,895,695 $ 3,241,360
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Income taxes paid $ 150,908 $ 26,749
=========== ===========
Interest paid $ 56,012 $ 41,435
=========== ===========
Payment of legal services through issuance
of stock (Note 8) $ -- $ 25,000
=========== ===========
See accompanying notes to consolidated financial statements.
F - 8
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
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, 1997 is as follows:
Aggregate cost $2,141,390
Gross unrealized gain 75,980
Gross unrealized loss --
----------
$2,217,370
==========
Cost of the securities used in the computation of realized gains and losses is
determined using the specific identification method. During 1997 and 1996,
there were no sales of these securities.
F - 9
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
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. No material
adjustments were made to adjust to the physical count for the years ended
November 30, 1997 and 1996.
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 equipment 5 - 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.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash and accounts receivable. The Company
maintains substantially all its cash balances in two financial institutions. The
balances are insured by the Federal Deposit Insurance Corporation up to
$100,000. At November 30, 1997 and 1996, the Company's uninsured cash balances
totaled $1,190,696 and $3,114,300, respectively. The Company performs periodic
reviews of the relative credit rating of its bank to lower its risk. The Company
believes that concentration with regards to accounts receivable is limited due
to its large customer base.
F - 10
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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.
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) were 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 - 11
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
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 carrying value of cash, receivables and accounts payable
approximates fair value due to the short maturity of these instruments. The
carrying value of short-term debt approximates fair value based on discounting
the projected cash flows using market rates available for similar maturities.
The Company estimates that the fair value of all financial instruments at
November 30, 1997, 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, 1997 and 1996 were computed
by dividing net income by the weighted average number of common and common
equivalent shares outstanding and is adjusted for the assumed conversion of
shares issuable upon the exercise of options and warrants.
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128 -
"Earnings Per Share", which changes the method for calculating earnings per
share. SFAS No. 128 requires presentation of "basic" and "diluted" earnings per
share, as opposed to "primary" and "fully diluted" earnings per share and is
effective for periods ending after December 15, 1997. Early adoption is not
permitted. Management does not believe that earnings per share reported in
accordance with SFAS No. 128 will materially differ from earnings per share as
currently reported.
F - 12
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
NOTE 3 - FIXED ASSETS
Fixed assets consist of the following at November 30, 1997:
Furniture and fixtures $ 35,967
Leasehold improvements 53,258
Computer equipment 195,575
--------
284,800
Less - accumulated depreciation 160,858
--------
Total fixed assets $123,942
Depreciation expense for the years ended November 30, 1997 and 1996 was $54,693
and $29,193, respectively.
NOTE 4 - LETTERS OF CREDIT TO BANK
In May 1996, the Company entered into a 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 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 borrowings are collateralized by the Company's
assets. The agreement also contains provisions for the creation of banker's
acceptances and covenants requiring the Company to maintain specified levels of
tangible net worth. The direct borrowings incur interest at a rate of prime plus
one percent per annum.
In July 1997, the Company renewed its letter of credit agreement. The terms and
conditions pursuant to this agreement remain unchanged except direct borrowings
incur interest at the prime rate. On November 30, 1997 and 1996, the bankers
acceptances totaled $495,495 and $164,232 and the outstanding letters of credit
totaled $82,390 and $141,350, respectively. At November 30, 1997 and 1996, there
were no direct borrowings outstanding.
F - 13
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
NOTE 5 - RETIREMENT PLAN
In June 1997, the Company adopted a qualified 401(k) plan for all full-time
employees who are twenty-one years of age and have completed twelve months of
service. The Plan allows total employee contributions of up to fifteen percent
(15%) of the eligible employee's salary through a salary reduction mechanism.
The Company will make a matching contribution of twenty percent (20%) of each
employee's contribution for each dollar of employee deferral up to five percent
(5%) of the employee's salary. Net assets in the plan as of November 30, 1997
totaled $33,983. Pension expense for the year ended November 30, 1997 was
$2,931.
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,
1997, 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 a
financial advisory and investment banking agreement. In exchange for $1,200, the
investment banker received 1,000,000 warrants exercisable for 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 - 14
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
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 1995, 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 - 15
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
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.
Stock option incentive plan activity is summarized as follows:
Option Price
Shares Per Share
------ ---------
Options outstanding December 1, 1995 -- --
Granted 146,000 $ 3.20
Exercised -- --
--------
Options outstanding November 30, 1996 146,000 $3.20
Granted 336,000 $1.25 - $3.50
Canceled (178,000) $3.20 - $3.50
Exercised -- --
--------
Options outstanding November 30, 1997 304,000 $1.25 - $3.20
========
Options exercisable November 30, 1997 203,250
========
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 years ended November 30, 1997
and 1996 would have been $(94,091) and $(.02) and $17,049 and $.01, respectively
had the new method been applied.
F - 16
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
NOTE 6 - STOCKHOLDERS' EQUITY (Continued)
1995 Employee Stock Option Plan (Continued)
Compensation for nonemployees is accounted for based on the fair value of the
consideration received or the fair value of the equity instruments issued,
whichever is more reliably measurable.
The fair value of each option grant was estimated on the date of the grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions: expected volatility of 154%, 118% and 37% for 1997 and 32% for
1996; risk free interest rate of 6.75%; and expected lives of 4 to 5 years.
The effects of applying SFAS 123 in the above pro forma disclosures are not
indicative of future amounts as they do not include the effects of awards
granted prior to 1996. Additionally, future amounts are likely to be affected by
the number of grants awarded since additional awards are generally expected to
be made at varying amounts.
Consulting Agreement
The Company retained the services of the underwriter for the Public Offering
pursuant to a consulting agreement. Under the agreement, the underwriter
performed certain financial advisory and investment banking services for the
Company in exchange for fees totaling $92,000, which were paid over a one-year
period.
Proposed Stock Repurchase
In June 1997, the Company offered to repurchase up to $500,000 worth of the
Company's issued and outstanding common shares and warrants on the open market
subject to the rules and regulations of the Securities and Exchange Commission.
As of the date of this report, no such purchases have been made.
Shareholder Protection Rights Plan
The Company has adopted a Shareholder Protection Rights Plan (the "Rights Plan")
whereby each shareholder of record on June 30, 1997 receives two rights to
purchase common shares at $.01 a share for a five year period. The Rights Plan
provides that if a person acquires more than twenty percent (20%) of the issued
and outstanding common shares of the Company, all shareholders of record, except
someone who becomes a 20% shareholder, shall be entitled to exercise the rights.
F - 17
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
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, 1997:
Deferred tax liability:
Fixed assets $1,396
The Company's income tax expense consists of the following:
Year Ended
November 30,
1 9 9 7 1 9 9 6
------- -------
Current:
Federal $13,186 $77,847
States 3,795 11,388
------- --------
$16,981 $89,235
======= =======
Deferred:
Federal $ (1,715) $ 140
States (1,377) 60
--------- ---------
$ (3092) $ 200
========= =========
Provision for income taxes $13,889 $89,435
======= =======
F - 18
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
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 7 1 9 9 6
------- -------
U.S. Federal income tax statutory rate 34% 34%
State income tax, net of Federal income tax benefit 6 6
Nontaxable dividends (18) (1)
Benefit from lower tax brackets (15) (1)
Nondeductible expenses 9 1
--- --
Effective tax rate 16% 39%
=== ==
F - 19
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
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, 1997:
Year Ending November 30,
1998 $ 60,595
1999 5,070
--------
$ 65,665
========
Rental expense for the years ended November 30, 1997 and 1996, was $64,729 and
$58,821, 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.
F - 20
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
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
Revenues to single customers in excess of 10% of the Company's total sales
consists of the following:
Year Ended
November 30,
1 9 9 7 1 9 9 6
------- -------
Customer A $ -- $1,114,488
Customer B 1,818,659 --
Customer C 1,419,976 --
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 7 1 9 9 6
------- -------
Supplier A $ -- $1,154,262
Supplier B 1,034,783 1,085,932
Supplier C 1,376,457 794,267
F - 21
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1997
NOTE 12 - EXPORT SALES
Export sales consist of the following:
Year Ended
November 30,
1 9 9 7 1 9 9 6
------- -------
Surge Components Inc.
Canada $ 18,835 $ 12,524
Europe 16,284 --
Asia 27,298 15,775
Challenge/Surge Inc.
Canada $ 73,232 $ 59,417
Europe 54,346 28,709
Asia 310,736 128,575
F - 22
<PAGE>
SURGE COMPONENTS, INC. AND SUBSIDIARY
EXHIBIT 11
COMPUTATION OF EARNINGS PER COMMON SHARE
1 9 9 7 1 9 9 6
------- -------
Net income $ 75,350 $ 139,138
---------- ----------
Shares:
Weighted common shares outstanding 4,823,958 3,623,890
Stock options 141,025 26,772
---------- ----------
Total weighted shares outstanding 4,964,983 3,650,662
---------- ----------
Earnings per share $ .02 $ .04
========== ==========
31
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND STATEMENTS OF INCOME FILED AS PART OF THE REPORT
ON FORM 10KSB FOR THE YEAR ENDED NOVEMBER 30, 1997 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH REPORT ON FORM 10KSB.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> NOV-30-1997
<PERIOD-END> NOV-30-1997
<CASH> 2,895,695
<SECURITIES> 2,217,370
<RECEIVABLES> 1,560,260
<ALLOWANCES> 15,724
<INVENTORY> 1,228,941
<CURRENT-ASSETS> 8,047,175
<PP&E> 284,800
<DEPRECIATION> 160,858
<TOTAL-ASSETS> 8,174,102
<CURRENT-LIABILITIES> 1,750,758
<BONDS> 1,396
0
0
<COMMON> 4,824
<OTHER-SE> 6,417,124
<TOTAL-LIABILITY-AND-EQUITY> 8,174,102
<SALES> 10,833,798
<TOTAL-REVENUES> 11,099,105
<CGS> 8,224,670
<TOTAL-COSTS> 2,729,184
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 56,012
<INCOME-PRETAX> 89,239
<INCOME-TAX> 13,899
<INCOME-CONTINUING> 75,350
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 75,350
<EPS-PRIMARY> .02
<EPS-DILUTED> .02
</TABLE>
