form10q.htm
UNITED STATES
 
SECURITIES AND EXCHANGE COMMISSION
 
  WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark One)
 
  x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
 
ACT OF 1934
 
FOR THE QUARTERLY PERIOD ENDED August 31, 2011
 
COMMISSION FILE NUMBER 000-27688
 
SURGE COMPONENTS, INC.
 
(Exact name of registrant as specified in its charter)
 
Nevada
11-2602030
(State or other jurisdiction of  incorporation or organization)
(I.R.S. Employer Identification No.)
   
95 East Jefryn Blvd., Deer Park, New York
11729
(Address of principal executive offices)
(Zip code)
 
Issuer's telephone number: (631) 595-1818
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files. Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 Large accelerated filer o
Accelerated filer o
  
 
Non-accelerated filer   o
Smaller reporting company   x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes   o No x
 
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
 
DURING THE PRECEDING FIVE YEARS
 
Indicate by check mark whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes o No o
 
APPLICABLE ONLY TO CORPORATE ISSUERS
 
State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date:  As of October 4, 2011 there were 9,035,012 outstanding shares of the Registrant's Common Stock, $.001 par value.

 
 
 
1

 


 
 
 


SURGE COMPONENTS, INC
 
TABLE OF CONTENTS
 
Page
 
PART I - FINANCIAL INFORMATION
   
     
Item 1. Financial Statements
 
3
 
       
Consolidated Balance Sheets as of August 31, 2011 (unaudited) and November 30, 2010 
 
3
 
       
Consolidated Statements of Income for the nine and  three months ended August 31, 2011 and 2010 (unaudited)
 
5
 
       
Consolidated Statements of Cash Flows for the nine months ended August 31, 2011 and 2010 (unaudited)
 
6
 
       
Notes to Consolidated Financial Statements (unaudited) 
 
8
 
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
22
 
       
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
28
 
       
Item 4. Controls and Procedures 
 
28
 
       
 PART II - OTHER INFORMATION
     
       
 Item 1. Legal Proceedings
 
29
 
       
Item 1A. Risk Factors
 
29
 
       
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
29
 
       
Item 3. Defaults Upon Senior Securities
 
29
 
       
Item 4. (Removed and Reserved)
 
29
 
       
Item 5. Other Information
 
29
 
       
Item 6. Exhibits
 
29
 
       
SIGNATURES
 
30
 
 

 
2

 



PART I Financial Information


ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS AND NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.


SURGE COMPONENTS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets


ASSETS   August 31,     November 30,  
Current assets:
 
2011
   
2010
 
Cash
  $ 1,663,742     $ 883,331  
Restricted cash
    --       245,883  
Accounts receivable - net of allowance for doubtful accounts of $20,968 and $19,513
    4,399,609       4,117,049  
Inventory, net
    3,391,004       2,791,326  
Prepaid expenses and income taxes
    83,387       64,841  
                 
Total current assets
    9,537,742       8,102,430  
                 
Fixed assets – net of accumulated depreciation and amortization of $2,046,738 and $2,163,816
    135,828       187,553  
                 
Other assets
    6,701       1,643  
                 
Total assets
  $ 9,680,271     $ 8,291,626  

See notes to financial statements
 
 
 
3

 
 
 
SURGE COMPONENTS, INC. AND SUBSIDIARIES
 
Consolidated Balance Sheets
 

   
August 31,
   
November 30,
 
   
2011
   
2010
 
LIABILITIES AND SHAREHOLDERS' EQUITY
           
Current liabilities:
           
Loan payable
  $ -     $ -  
Accounts payable
    2,609,875       2,632,996  
Accrued expenses and taxes
    642,033       717,953  
Accrued salaries
    394,489       508,713  
                 
Total current liabilities
    3,646,397       3,859,662  
                 
Deferred rent
    13,563       2,466  
                 
Total liabilities
    3,659,960       3,862,128  
                 
Commitments and contingencies
               
                 
Shareholders' equity
               
Preferred stock - $.001 par value stock, 5,000,000 shares authorized:
               
Series A – 260,000 shares authorized, none outstanding.
               
Series B – 200,000 shares authorized,
               
none outstanding, non-voting, convertible, redeemable.
               
Series C – 100,000 shares authorized,
               
23,700 and 32,700 shares issued and outstanding,
               
redeemable, convertible, and a
               
liquidation preference of $5 per share
    24       33  
Common stock - $.001 par value stock,
               
75,000,000 shares authorized,
               
9,035,012 and 8,922,512 shares issued and
               
outstanding
    9,035       8,922  
Additional paid-in capital
    22,989,573       22,911,827  
Accumulated deficit
    (16,978,321 )     (18,491,284 )
                 
Total shareholders' equity
    6,020,311       4,429,498  
                 
Total liabilities and shareholders' equity
  $ 9,680,271     $ 8,291,626  

See notes to financial statements.
 
 
 
4

 
 
 
SURGE COMPONENTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
                         
   
Nine Months Ended
   
Three Months Ended
 
   
August 31,
    August 31,  
   
2011
   
2010
   
2011
   
2010
 
Net sales
  $ 17,336,082     $ 15,620,352     $ 6,318,925     $ 6,067,148  
                                 
Cost of goods sold
    11,989,346       10,958,792       4,361,529       4,252,684  
                                 
Gross profit
    5,346,736       4,661,560       1,957,396       1,814,464  
                                 
Operating expenses:
                               
Selling and shipping expenses
    1,327,022       1,248,187       485,044       450,531  
General and administrative expenses
    2,306,862       1,836,010       763,596       634,279  
Depreciation and amortization
    66,877       105,180       22,404       37,410  
                                 
Total operating expenses
    3,700,761       3,189,377       1,271,044       1,122,220  
                                 
Income before other income (expense)
                             
and income taxes
    1,645,975       1,472,183       686,352       692,244  
                                 
Other income (expense):
                             
Interest expense
    (46,340 )     (90,270 )     (830 )     (30,120 )
Investment income
    1,693       3,522       392       1,076  
                                 
Other income (expense)
    (44,647 )     (86,748 )     (438 )     (29,044 )
                                 
Income before income taxes
    1,601,328       1,385,435       685,914       663,200  
                                 
Income taxes
    74,265       9,137       5,818       (731 )
                                 
Net Income
    1,527,063       1,376,298       680,096       663,931  
Dividends on preferred stock
    14,100       16,350       5,925       8,175  
                                 
Net income available to common shareholders
  $ 1,512,963     $ 1,359,948     $ 674,171     $ 655,756  
                                 
Net income per share available to common shareholders:
                               
                                 
Basic
  $ .17     $ .15     $ .07     $ .07  
Diluted
  $ .16     $ .15     $ .07     $ .07  
                                 
Weighted Shares Outstanding:
                               
Basic
    8,992,311       8,895,008       9,035,012       8,922,512  
Diluted
    9,536,004       9,222,008       9,578,705       9,249,512  

See notes to financial statements.
 

 
5

 
 
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows
 
                                        
    Nine Months Ended  
    August 31,  
    2011     2010  
CASH FLOWS FROM OPERATING ACTIVITIES:
           
             
Net income   $ 1,527,063     $ 1,376,298  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    66,877       105,180  
Stock compensation expense
    77,850       23,740  
                 
CHANGES IN OPERATING ASSETS AND LIABILITIES:
               
Accounts receivable
    (282,560 )     (1,419,287 )
Inventory
    (599,678 )     (758,871 )
Prepaid expenses and taxes
    (18,546 )     (8,673 )
Other Assets
    239,336       (72 )
Accounts payable
    173,223       1,132,832  
Deferred Rent
    11,097       (20,714 )
Accrued expenses
    (400,588 )     69,926  
                 
                 
NET CASH FLOWS FROM OPERATING ACTIVITIES
    794,074       500,359  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Acquisition of fixed assets
    (13,663 )     (10,177 )
                 
NET CASH FLOWS FROM INVESTING ACTIVITIES
    (13,663 )     (10,177 )
 
See notes to financial statements.


 
6

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

Consolidated Statements Of Cash Flows
(CONTINUED)


 
   
Nine Months ended
 
    August 31,  
   
2011
    2010  
 
           
             
CASH FLOWS FROM FINANCING ACTIVITIES:
           
Net borrowings from loan payable
    -       (766,468 )
Net borrowings from note payable
     -       (1,304 )
 
               
NET CASH FLOWS FROM FINANCING ACTIVITIES
    -       (767,772 )
 
               
NET CHANGE IN CASH
    780,411       (277,590 )
                 
CASH AT BEGINNING OF YEAR
    883,331       1,140,338  
 
               
CASH AT END OF YEAR
  $ 1,663,742     $ 862,748  
 
               
                 
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
               
                 
                 
Income taxes paid
  $ 74,265     $ 9,137  
 
               
Interest paid
  $ 46,340     $ 90,270  
 
               
                 
NONCASH INVESTING AND FINANCING ACTIVITIES:
               
Accrued dividends on preferred stock
  $ 14,100     $ 16,350  
 
See notes to financial statements.
 
 
7

 
 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
 
NOTE A – ORGANIZATION, DESCRIPTION OF COMPANY'S BUSINESS AND BASIS OF PRESENTATION
 
Surge Components, Inc. (“Surge”) was incorporated in the State of New York and commenced operations on November 24, 1981 as an importer of electronic products, primarily capacitors and discrete semi-conductors selling to customers located principally throughout North America. On June 24, 1988, Surge formed Challenge/Surge Inc., (“Challenge”) a wholly-owned subsidiary to engage in the sale of electronic component products and sounding devices from established brand manufacturers to customers located principally throughout North America.
 
In May 2002, Surge and an officer of Surge founded and became sole owners of Surge Components, Limited (“Surge Limited”), a Hong Kong corporation. Under current Hong Kong law, Surge Limited is required to have at least two shareholders. Surge owns 999 shares of the outstanding common stock and the officer of Surge owns 1 share of the outstanding common stock. The officer of Surge has assigned his rights regarding his 1 share to Surge. Surge Limited started doing business in July 2002. Surge Limited operations have been consolidated with the Company.  Surge Limited is responsible for the sale of Surge’s products to the customers located in Asia.

On August 31, 2010, the Company changed its corporate domicile by merging into a newly-formed corporation, Surge Components, Inc. (Nevada), which was formed in the State of Nevada for that purpose.  Surge Components Inc. is the surviving entity. The number of common stock shares authorized for issuance was increased to 75,000,000 shares.
 
NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
[1] Principles of Consolidation:
 
The consolidated financial statements include the accounts of Surge, Challenge, and Surge Limited (collectively the “Company”).  All material intercompany balances and transactions have been eliminated in consolidation.
 
 
 
8

 

 
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 
NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
(1) Principles of Consolidation (Continued):
 
The accompanying interim consolidated financial statements have been prepared, without audit, in accordance with the instructions to Form 10-Q for interim financial reporting pursuant to the rules and regulations of the Securities and Exchange Commission.

The results and trends on these interim consolidated financial statements for the nine and three months ended August 31, 2011 and 2010 may not be representative of those for the full fiscal year or any future periods.

(2) Accounts Receivable:

Trade accounts receivable are recorded at the net invoice value and are not interest bearing. The Company considers receivables past due based on the payment terms. The Company reviews its exposure to amounts receivable and reserves specific amounts if collectability is no longer reasonably assured. The Company also reserves a percentage of its trade receivable balance based on collection history and current economic trends that might impact the level of future credit losses. The Company re-evaluates such reserves on a regular basis and adjusts its reserves as needed. Based on the Company’s operating history and customer base, bad debts to date have not been material.
 
(3) Revenue Recognition:
 
Revenue is recognized for products sold by the Company when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed and determinable, collectability is reasonably assured and title and risk of loss have been transferred to the customer. This occurs when product is shipped from the Company's warehouse. 

 For direct shipments, revenue is recognized when product is shipped from the Company’s supplier. The Company has no written arrangements with its suppliers. The Company purchases the merchandise from the supplier and has the supplier directly ship to the customer through a freight forwarder.  Title passes to customer upon the merchandise being received by a freight forwarder. Direct shipments were approximately $2,885,000 and $2,858,000 for the nine months ended August 31, 2011 and 2010 respectively.

The Company also acts as a sales agent to certain customers in North America for one of its suppliers. The Company reports these commissions as revenues in the period earned. Commission revenue totaled $257,482 and $144,560 for the nine months ended August 31, 2011 and 2010, respectively.

The Company performs ongoing credit evaluations of its customers and maintains reserves for potential credit losses.

The Company and its subsidiaries currently have agreements with several distributors.    Some of these agreements allow for the return of up to 10% of certain product sales for the previous 6 month period.  The Company does not recognize this portion of the revenues, or the related costs of the sale, until the right of return has expired.    There are no provisions for the granting of price concessions in any of the agreements.  Revenues under these distribution agreements were approximately $3,435,000 and $2,974,000 for the nine months ended August 31, 2011 and 2010, respectively.


 
9

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 
NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
(4) Inventories:
 
Inventories, which consist solely of products held for resale, are stated at the lower of cost (first-in, first-out method) or market.  Products are included in inventory when the Company obtains title and risk of loss on the products, primarily when shipped from the supplier. Inventory in transit principally from foreign suppliers at August 31 2011 approximated $1,056,000. The Company, at August 31, 2011, has a reserve against slow moving and obsolete inventory of $887,953. From time to time the Company’s products are subject to legislation from various authorities on environmental matters. Legislation was enacted, effective July 2006, eliminating lead in certain of the Company’s products. The Company has provided a reserve for these products which is reflected as slow moving. The Company is able to currently obtain products which comply with this law.
 
(5) Depreciation and Amortization:

Fixed assets are recorded at cost.  Depreciation is generally on a straight line method and amortization of leasehold improvements is provided for on the straight-line method over the estimated useful lives of the various assets as follows:

Furniture, fixtures and equipment
5 - 7 years
Computer equipment
5 years
Leasehold Improvements
Estimated useful
 
life or lease
 
term, whichever is
 
shorter

Maintenance and repairs are expensed as incurred while renewals and betterments are capitalized.


 
10

 
 
 
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(6) Concentration of Credit Risk:

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of accounts receivable.  The Company maintains substantially all of its cash balances in two financial institutions.  The balances are each insured by the Federal Deposit Insurance Corporation up to $250,000 through December 31, 2013. At August 31, 2011 and November 30, 2010, the Company's uninsured cash balances totaled approximately $878,000 and $690,000, respectively.
 
(7) Income Taxes:

The Company's deferred income taxes arise primarily from the differences in the recording of net operating losses, allowances for bad debts, inventory reserves and depreciation expense for financial reporting and income tax purposes.  A valuation allowance is provided when it has been determined to be more likely than not that the likelihood of the realization of deferred tax assets will not be realized.

The Company follows the provisions of the Accounting Standards Codification topic, ASC 740, “Income Taxes” (ASC 740).There have been no unrecognized tax benefits and, accordingly, there has been no effect on the Company’s financial condition or results of operations as a result of ASC 740.

The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company is no longer subject to U.S. federal tax examinations for years before fiscal years ending November 30, 2007, and state tax examinations for years before fiscal years ending November 30, 2006. Management does not believe there will be any material changes in our unrecognized tax positions over the next twelve months.

The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of ASC 740, there was no accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the nine month periods ended August 31, 2011 and 2010.

 
 
11

 
 
 
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
(8) Cash Equivalents:
 

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
 
(9) Use of Estimates:
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.

(10) Marketing and promotional costs:
 
Marketing and promotional costs are expensed as incurred and have not been material to date. The Company has contractual arrangements with several of its distributors which provide for cooperative advertising rights to the distributor as a percentage of sales . Cooperative advertising is reflected as a reduction in revenues and has not been material to date.
 
(11) Fair Value of Financial Instruments:
 
Cash balances and the carrying amount of the accrued expenses approximate their fair value based on the nature of those items. Estimated fair values of financial instruments are determined using available market information and appropriate valuation methodologies.  Considerable judgment is required to interpret the market data used to develop the estimates of fair value, and accordingly, the estimates are not necessarily indicative of the amounts that could be realized in a current market exchange.
 
 
 
12

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
(12) Shipping Costs

The Company classifies shipping costs as a component of selling expenses.  Shipping costs totaled $9,778 and $12,293 for the nine months ended August 31, 2011 and 2010, respectively.

(13) Earnings Per Share

Basic earnings per share includes no dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. The difference between reported basic and diluted weighted-average common shares results from the assumption that all dilutive stock options and convertible preferred stock exercised into common stock. Total potentially dilutive shares excluded from diluted weighted shares outstanding at August 31, 2011 and 2010 totaled 378,307 and 600,000, respectively.

(14) Stock Based Compensation to Employees

The Company accounts for its stock-based compensation for employees in accordance with Accounting Standards Codification (“ASC”) 718.   The Company recognizes in the statement of operations the grant-date fair value of stock options and other equity-based compensation issued to employees and non-employees over the related vesting period.

Stock Based Compensation to Other than Employees

The Company accounts for equity instruments issued in exchange for the receipt of goods or services from other than employees in accordance with ASC 718. Costs are measured at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably determinable. The value of equity instruments issued for consideration other than employee services is determined on the earlier of a performance commitment or completion of performance by the provider of goods or services. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.

(15) Recent Accounting Standards:

Comprehensive Income — In June 2011, the Financial Accounting Standards Board (“FASB”) issued new guidance on the presentation of comprehensive income. Specifically, the new guidance allows an entity to present components of net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income, or in two separate, but consecutive statements. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. While the new guidance changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive income under current accounting guidance. This new guidance is effective for fiscal years and interim periods beginning after December 15, 2011. We do not believe our adoption of the new guidance in the first quarter of fiscal 2013 will have an impact on our consolidated financial position, results of operations or cash flows.
 
Fair Value Measurement — In April 2011, the FASB issued new guidance to achieve common fair value measurement and disclosure requirements between GAAP and International Financial Reporting Standards. This new guidance amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. This new guidance is effective for fiscal years and interim periods beginning after December 15, 2011. We do not believe our adoption of the new guidance in the first quarter of fiscal 2013 will have an impact on our consolidated financial position, results of operations or cash flows.
 

 
13

 


SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
NOTE C - FIXED ASSETS

Fixed assets consist of the following:
 
   
August 31,
   
November 30,
 
   
2011
   
2010
 
             
Furniture and Fixtures
  $ 350,563     $ 349,930  
Leasehold Improvements
    906,449       898,942  
Computer Equipment
    925,554       1,102,497  
Less-Accumulated Depreciation
    (2,046,738 )     (2,163,816 )
Net Fixed Assets
  $ 135,828     $ 187,553  

Depreciation and amortization expense for the nine months ended August 31, 2011 and 2010 was $66,877 and $105,180, respectively.

NOTE D -  ACCRUED EXPENSES

Accrued expenses consist of the following:

   
August 31,
   
November 30,
 
   
2 0 11
   
2010
 
             
             
Commissions
  $ 234,428     $ 259,714  
Preferred Stock Dividends
    165,007       150,907  
Interest
    102,399       102,399  
Other accrued expenses
    140,199       204,933  
                 
    $ 642,033     $ 717,953  
                 
In March 2000, the Company completed a $7,000,000 private placement.  The entire note balance was converted into common stock in July 2001 pursuant to the automatic conversion provisions of the notes.  The interest accrued on the notes required approval by the holder in order to convert to common stock.  The accrued interest in the Company’s disclosures relate to the portion of the interest which was not converted.  No additional interest accrues on these amounts and none of this interest was repaid during any of the periods presented.
 
NOTE E – RETIREMENT PLAN

In June 1997, the Company adopted a qualified 401(k) plan for all full-time employees who are twenty-one years of age and have completed twelve months of service.  The Plan allows total employee contributions of up to fifteen percent (15%) of the eligible employee’s salary through salary reduction. The Company makes a matching contribution of twenty percent (20%) of each employee’s contribution for each dollar of employee deferral up to five percent (5%) of the employee’s salary.  Net assets for the plan, as estimated by Union Central, Inc., which maintains the plan’s records, were approximately $752,000 at November 30, 2010. Pension expense for the nine months ended August 31, 2011 and 2010 was $4,033 and $5,420, respectively.
 
 
 
14

 

 
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
 
NOTE F – SHAREHOLDERS’ EQUITY
 
[1] Preferred Stock:

In February 1996, the Company amended its Certificate of Incorporation to authorize the issuance of 1,000,000 shares of preferred stock in one or more series. In August 2010, the number of preferred shares authorized for issuance was increased to 5,000,000 shares.
 
In January 2000, the Company authorized 260,000 shares of preferred stock as Non-Voting Redeemable Convertible Series A Preferred Stock (“Series A Preferred”). None of the Series A preferred stock is outstanding as of August 31, 2011.

In November 2000, the Company authorized 200,000 shares of preferred stock as Voting Redeemable Convertible Series B Preferred Stock (“Series B Preferred”). No shares of Series B Preferred Stock are currently issued or outstanding.

In November 2000, the Company authorized 100,000 shares of preferred stock as Non-Voting Redeemable Convertible Series C Preferred Stock (“Series C Preferred”). Each share of Series C Preferred is automatically convertible into 10 shares of the Company’s Common Stock upon shareholder approval.  If the Series C Preferred were converted into common stock on or before April 15, 2001, these shares were entitled to cumulative dividends at the rate of $.50 per share per annum commencing April 15, 2001 payable on June 30 and December 31 of each year.  In November 2000, 70,000 shares of the Series C Preferred were issued in payment of financial consulting services to its investment banker and a shareholder of the Company.  In April 2001, 8,000 shares of the Series C Preferred were repurchased and cancelled.  Dividends aggregating $165,007 have not been declared or paid for the semiannual periods ended December 31, 2001 through the semiannual payment due June 30, 2011.  The Company has accrued these dividends.  

In April 2002, in connection with a Mutual Release, Settlement, Standstill and Non-Disparagement Agreement and among other provisions, certain investors transferred back to the Company 252,000 shares of common stock, 19,300 shares of Series C preferred stock, and certain warrants, in exchange for $225,000. These repurchased shares were cancelled.

In February 2006, the Company settled with a shareholder to repurchase 10,000 shares of Series C preferred stock plus accrued dividends for $50,000.

Pursuant to exchange agreements dated as of March 14, 2011, 9,000 shares of Series C Preferred Stock were returned to the Company for cancellation in exchange for 112,500 shares of common stock.

At August 31, 2011 there are 23,700 shares of Series C Preferred stock issued and outstanding.
 
[2] 1995 Employee Stock Option Plan:

In January 1996, the Company adopted, and in February 1996 the shareholders ratified, the 1995 Employee Stock Option Plan (“Option Plan”).  The plan provides for the grant of options to qualified employees of the Company, independent contractors, consultants and other individuals to purchase an aggregate of 350,000 common shares.  In March 1998, the Option Plan was amended to increase the number of aggregate Common Shares available under the plan to 850,000.

The Employee Stock Option Plan has expired. The remaining 53,000 options outstanding expired in July 2010.
 
 
 
15

 
 
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

NOTE F – SHAREHOLDERS’ EQUITY (Continued)
 
[3] 2010 Incentive Stock Plan

In March 2010, the Company adopted, and in April 2010 the shareholders ratified, the 2010 Incentive Stock Plan (“Stock Plan”).  The plan provides for the grant of options to officers, employees or consultants to the Company to purchase an aggregate of 1,500,000 common shares.

Stock option incentive plan activity is summarized as follows:
 
         
Weighted Average
 
   
Shares
   
Exercise Price
 
             
Options issued in May 2010
   
600,000
   
$
0.25
 
Options issued in February 2011
   
85,000 
   
$
1.15
 
Options outstanding August 31, 2011
   
685,000
   
$
0.36
 
Options exercisable August 31, 2011
   
600,000
   
$
0.25
 
 
Stock Compensation

The fair values of stock options are estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions during 2010: expected volatility of 60% (based on stock volatility of public company industry peers); average risk-free interest rate of 2.31% (the five year treasury note rate on the date of the grant); initial expected life of 5 years (based on the term of the options); no expected dividend yield; and amortized over the vesting period for a year. The weighted average grant date fair value of the stock options granted during the nine months ended August 31, 2010 was $0.14.  During the nine months ended August 31, 2011, the Company recorded stock based compensation totaling $66,228 as a result of these stock option grants.
 
The intrinsic value of the exercisable options at August 31, 2011 totaled $336,000.  At August 31, 2011, the weighted average remaining life of the stock options is 4.46 years.  At August 31, 2011, there was $58,105 of total unrecognized compensation cost related to the stock options granted under the plan.  This cost is expected to be recognized over a weighted average period of 1.38 years.

On February 25, 2011, the Company granted stock options to employees to purchase 85,000 shares of the Company’s common stock at an exercise price of $1.15, the value of the common stock on the date of the grant.  These options vest over a three year period and expire in ten years.  The fair values of these stock options are estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: expected volatility of 60% (based on stock volatility of public company industry peers); average risk-free interest rate of 3.42 (the ten year treasury note rate on the date of the grant); initial expected life of 10 years (based on the term of the options); no expected dividend yield; and amortized over the vesting period. The weighted average grant date fair value of the stock options granted during the nine months ended August 31, 2011 was $0.82.  During the nine months ended August 31, 2011, the Company recorded stock based compensation totaling $11,622  as a result of these stock option grants.


 
16

 
 
 
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

NOTE F – SHAREHOLDERS’ EQUITY (Continued)
 
[4] Authorized Repurchase:
 
In November 2002, the Board of Directors authorized the repurchase of up to 1,000,000 Common Shares at a price between $.04 and $.045. The Company has not repurchased any shares to date pursuant to such authority.

[5] Compensation of Directors

In May 2010, the Company issued 12,000 shares of its common stock to each non-officer director as compensation for services on the Board of Directors. These shares were valued at $0.18 per share, closing price of the common stock on the pink sheets. In addition, the directors receive $200 each month for their services on the Board of Directors. In May 2010, options were granted to each non-officer director to purchase 25,000 shares of common stock at an exercise price of $0.25.  (See Note F[3] for disclosure on the valuation and terms of these options.).
 
NOTE G – INCOME TAXES
 
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes using the enacted tax rates in effect in the years in which the differences are expected to reverse.  Because of the questionable ability of the Company to utilize these deferred tax assets, the Company has established a 100% valuation allowance for these assets.

The Company’s deferred income taxes are comprised of the following:
 
   
August 31,
   
November 30,
 
   
2011
   
2010
 
Deferred Tax Assets
           
    Net operating income
  $ 5,436,471     $ 6,150,931  
    Allowance for bad debts
    8,375       7,793  
    Inventory
    419,946       498,220  
    Deferred Rent
    5,409       985  
    Depreciation
    198,436       183,646  
                 
    Total deferred tax assets
    6,068,637       6,841,575  
    Valuation allowance
    (6,068,637 )     (6,841,575 )
                 
        Deferred Tax Assets
  $ -     $ -  
 
 
 
17

 
 
 
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
 
NOTE G – INCOME TAXES(CONTINUED)
 
The valuation allowance decreased by approximately $773,000 and $682,000 during the nine months ended August 31, 2011 and the year ended November 30, 2010, respectively.

The Company's income tax expense consists of the following:
 
   
Nine Months ended
 
   
August 31,
 
   
2011
   
2010
 
             
Current:
           
Federal
 
$
38,790
   
$
--
 
States
   
35,475
     
9,137
 
                 
     
74,265
     
 9,137
 
Deferred:
               
Federal
   
--
     
--
 
States
   
--
     
--
 
                 
Provision for income taxes
 
$
74,265
   
$
9,137
 
 
The Company files a consolidated income tax return with its wholly-owned subsidiaries and has net operating loss carryforwards of approximately $13,612,000 for federal and state purposes, which expire through 2031. The utilization of this operating loss carryforward may be limited based upon changes in ownership as defined in the Internal Revenue Code.
 
A reconciliation of the difference between the expected income tax rate using the statutory federal tax rate and the Company's effective rate is as follows:
 
   
Nine Months Ended
   
August 31,
   
2011
   
2010
           
U.S. Federal income
         
  tax statutory rate
    34 %     34 %
Valuation allowance
    (34 )%     (35 )%
State income taxes
    5 %     2 %
Effective tax rate
    5 %     1 %
 
 
 
 
18

 
 
 
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
 
NOTE H– RENTAL COMMITMENTS
 
The Company leases its office and warehouse space through 2020 from a corporation that is controlled by officers/shareholders of the Company (“Related Company”).  Annual minimum rental payments to the Related Company approximated $156,000 for the Fiscal 2010, and increase at the rate of three per cent per annum throughout the lease term.

Pursuant to the lease, rent expense charged to operations differs from rent paid because of scheduled rent increases.  Accordingly, the Company has recorded deferred rent.  Rent expense is calculated by allocating to rental payments, including those attributable to scheduled rent increases, on a straight line basis, over the lease term.

In June 2010, the Company entered into a lease to rent office space in Hong Kong for two years. Annual minimum rental payments are approximately $20,000.

The future minimum rental commitments at November 30, 2010:
 
 
 
Year Ending
     
November 30,
     
2011
  $ 176,310  
2012
    169,436  
2013
    162,625  
2014
    165,878  
2015
    169,195  
2016 & thereafter
    866,457  
         
    $ 1,709,901  
         

Net rental expense for the nine months ended August 31, 2011 and 2010 were $184,763 and $151,969 respectively, of which $160,973 was paid to the Related Company.


 
19

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 
NOTE I – EMPLOYMENT AND OTHER AGREEMENTS
 
The Company has employment agreements, with terms through July 30, 2012 (renewable on each July 30th for an additional one year period) with two officers/stockholders of the Company, which provides each with a base salary of $225,000, subject to certain increases as defined, per annum, plus fringe benefits and bonuses.  The Compensation Committee of the Company’s Board of Directors determines the bonuses.  Bonuses have been accrued to the two officers for the nine months ended August 31, 2011 totaling $300,000.  This is based on an executive compensation plan put into place in 2011.  The agreement also contains provisions prohibiting the officers from engaging in activities, which are competitive with those of the Company during employment and for one year following termination.  The agreements further provide that in the event of a change of control, as defined, or a change in ownership of at least 25% of the issued and outstanding stock of the Company, and such issuance was not approved by either officer, or if they are not elected to the Board of Directors of the Company and/or are not elected as an officer of the Company, then the non-approving officer may elect to terminate his employment agreement. If he elects to terminate the agreement, he will receive 2.99 times his annual compensation (or such other amount then permitted under the Internal Revenue Code without an excess penalty), in addition to the remainder of his compensation under his existing employment contract.  In addition, if the Company makes or receives a “firm commitment” for a public offering of Common Shares, each officer will receive a warrant to purchase, at a nominal value, up to 9.5% of the Company’s common stock, provided they do not voluntarily terminate employment.
 
NOTE J– MAJOR CUSTOMERS
 
The Company had two customers who accounted for 10% and 12% of net sales for the nine months ended August 31, 2011 and two customers who accounted for 13% and 11% of net sales for the nine months ended August 31, 2010.  The Company had one customer who accounted for 18% and 22% of accounts receivable at August, 31, 2011 and November 30, 2010, respectively.

NOTE K- MAJOR SUPPLIERS

During the nine months ended August 31, 2011 and 2010 there was one foreign supplier accounting for 44% and 53% of total inventory purchased.

The Company purchases a significant portion of its products overseas.  For the nine months ended August 31, 2011, the Company purchased 47% from Taiwan, 18% from Hong Kong, 26% from elsewhere in Asia and 1% overseas outside of Asia.

NOTE L - EXPORT SALES

The Company’s export sales approximated:
 
   
Nine Months Ended August 31,
 
   
2011
   
2010
 
Canada
    2,240,202       1,132,706  
China
    3,160,164       1,749,886  
Other Asian Countries
    1,688,897       2,815,930  
Europe
    106,779       76,071  
Central America
    -       4,308  

Revenues are attributed to countries based on location of customer. 
 
 
 
 
20

 

 

SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements


NOTE M – LINE OF CREDIT

In July 2002, the Company obtained a financing commitment with an asset-based lender totaling $1,000,000 (the “Credit Line”). Borrowings under the Credit Line accrue interest at the greater of the prime rate plus two percent (2.0%) or 6.75%. The Company is required to make monthly interest only payments. The Company may repay all or a portion of the line of credit at any time. In addition, the Company is obligated to pay one-quarter of one percent (1/4 of 1%) annually as an unused line fee for the difference between $1,000,000 and the average daily balance of the Credit Line. The Credit Line is collateralized by substantially all the Company’s assets and contains various financial covenants pertaining to the maintenance of working capital and tangible net worth.

In December 2003, the Company entered into a Security Agreement with the lender establishing a restricted cash collateral account totaling $200,000. The balance on the account including interest accrued was $245,883 at November 30, 2010.

In June 2011, the Company replaced its existing credit line with a line of credit with a new bank totaling $1,000,000.  Borrowings under the line accrue interest at 2.56% over the LIBOR rate and is due in June 2012.  The line is collateralized by all the Company’s assets and includes working capital and tangible net worth covenants.  At August 31, 2011, the Company was in compliance with the financial covenants.


 

 
21

 

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
This filing contains forward-looking statements. All statements other than statements of historical facts contained in this filing, including statements regarding our future results of operations and financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

 In some cases, forward-looking statements can be identified by terms such as "may," "will," "should," "expects," "plans," "anticipates," "could," "intends," "target," "projects," "contemplates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of these terms or other similar words. These statements are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. We discuss many of the risks in greater detail under the heading "Risk Factors" in the Form 10-K for November 30, 2010. Also, these forward-looking statements represent our estimates and assumptions only as of the date of the filing of this registration statement. Except as required by law, we assume no obligation to update any forward-looking statements after the date of the filing of this report.

Overview

The Surge product division 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 products that we sell are typically utilized in the electronic circuitry of diverse products, including, but not limited to, automobiles, cellular telephones, computers, consumer electronics, garage door openers, household appliances, power supplies and security equipment. The products that we sell  are sold to both original equipment manufacturers, commonly referred to as OEMs, who incorporate them into their products, and to distributors of our product lines, who resell these products within their customer base.  The products that we sell  are manufactured predominantly in Asia by approximately sixteen independent manufacturers. We do not have any binding long-term supply agreements, with our suppliers. We act as the exclusive sales agent utilizing independent sales representative organizations in North America to sell and market the products for one such manufacturer pursuant to an oral agreement. When we act as a sales agent, the supplier who sold the product to the customer that we introduced to such supplier will pay us a commission. The amount of the commission is determined on a sale by sale basis depending on the profit margin of the sale.

Challenge engages in the electronic components business. In 1999, Challenge began a division to sell audible sounding components. We have been able to increase the types of products that we sell because some of our suppliers introduced new products, and we also sourced other products from new suppliers.  As a result we are continually trying to add to the types of products that we sell. In 2002 we started to import products similar to our parent company Surge, and sold these under the Challenge name. It started with a line of transducers then we added battery snaps, and coin cell holders. In the past nine years we have increased our imported private label product mix to include buzzers, speakers, microphones, resonators, filters, and discriminators. We now also customize many of our products for many customers through their own designs and those that we redesign for them at our factories. Five years ago, we hired a design engineer on our staff that had thirty years experience with these types of products. We continue to expand our product line, we now are selling alarms and chimes. We sell these products through independent representatives that make a 5-6% commission rate on the gross sale of our products. We also are working with local, regional, and National distributors to sell these products to customers throughout North America.
 
 
 
22

 

 
As a result of voluntarily registering our stock, we became obligated to file annual, quarterly and current reports with the SEC pursuant to the Securities Exchange Act of 1934, as amended.  In addition, the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) and the new rules subsequently implemented by the SEC and the Public Company Accounting Oversight Board have imposed various new requirements on public companies, including requiring changes in corporate governance practices. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities of our more time-consuming and costly. We expect to spend between $150,000 and $200,000 in legal and accounting expenses annually to comply with our reporting obligations and Sarbanes-Oxley. These costs could affect profitability and our results of operations.

In 2002, Surge opened a Hong Kong sales office and warehouse and hired direct sales people in order to effectively handle the transfer business from United States customers purchasing and manufacturing in Asia after they do the design in America. This office has strengthened its global presence and service to its customer base.

The electronic components industry is currently experiencing a period of strong demand.  In addition, management believes that manufacturers are not expanding production capacity because they are unsure of how long the period of strong demand will last.  Management believes that demand for the electronic components will be strong through the end of the current calendar year.

In order for us to grow, we will depend on, among other things, the continued growth of the electronics and semiconductor industries, our ability to withstand intense price competition, our ability to obtain new clients, our ability to retain sales and other personnel in order to expand our marketing capabilities, our ability to secure adequate sources of products, which are in demand on commercially reasonable terms, our success in managing growth, including monitoring an expanded level of operations and controlling costs, and the availability of adequate financing.
 
Critical Accounting Policies
 
Accounts Receivable:

The allowance for doubtful accounts is based on the Company’s assessment of the collectability of specific customer accounts and an assessment of international, political and economic risk as well as the aging of the accounts receivable. If there is a change in actual defaults from the Company’s historical experience, the Company’s estimates of recoverability of amounts due could be affected and the Company would adjust the allowance accordingly.

Revenue Recognition:

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed and determinable, collectability is reasonably assured and title and risk of loss have been transferred to the customer. This occurs when product is shipped from the Company's warehouse.  For direct shipments, revenue is recognized when product is shipped from the Company’s supplier. The Company acts as a sales agent for certain customers for one of its suppliers. The Company reports these commissions as revenues in the period earned.

The Company performs ongoing credit evaluations of its customers and maintains reserves for potential credit losses.

At August 31, 2011, the Company is party to several distribution agreements. Some of these agreements allow for the return of up to 10% of certain product sales for the previous six month period.  The Company does not recognize this portion of the revenues, or the related costs of the sale, until the right of return has expired. There are no provisions for the granting of price concessions in any of the agreements.  Revenues under these distribution agreements were approximately $3,435,000 and $2,974,000 for the nine months ended August 31, 2011 and 2010, respectively.
 
 
 
23

 

 
Inventory Valuation

Inventories are recorded at the lower of cost or market.  Write-downs of inventories to market value are based on stock rotation, historical sales requirements and obsolescence as well as changes in the backlog.  Reserves required for obsolescence were not material in any of the periods in the financial statements presented.  A significant portion  (approximately $500,000) of the total amount of the reserves relate to a product line for which demand dropped significantly as a result of a change in an environmental law several years ago.  If market conditions are less favorable than those projected by management, additional write-downs of inventories could be required.  For example, each additional 1% of obsolete inventory would reduce operating income by approximately $34,000.

The Company does not have price protection agreements with any of its vendors and assumes the risk of changes in the prices of its products.  The Company does not believe there to be a significant risk with regards to the lack of price protection agreements as many of its inventory items are purchased to fulfill purchase orders received.
 
Results of Operations

Comparison of nine and three months ended August 31, 2011 and 2010

Consolidated net sales for the nine months ended August 31, 2011 increased by $1,715,730 or 11%, to $17,336,082 as compared to net sales of $15,620,352 for the nine months ended August 31, 2010.  Consolidated net sales for the three months ended August 31, 2011 increased by $251,777 or 4%, to $6,318,925 as compared to net sales of $6,067,148 for the three months ended August 31, 2010.   We attribute the increase to expanded business relationships with existing customers, as well as the attainment of business with new customers. The electronic components industry is currently experiencing a high demand in products and the Company is benefiting from that with an increase in volume. The Company also attributes the increase in sales to growth with its franchised distributors.

Our gross profit for the nine months ended August 31, 2011 increased by $685,176, or 15%, as compared to nine months ended August 31, 2010.  Gross margin as a percentage of net sales increased to 30.8% for the nine months ended August 31, 2011 compared to 29.8% for nine months ended August 31, 2010. Our gross profit for the three months ended August 31, 2011 increased by $142,932 or 8%, as compared to the three months ended August 31, 2010.  Gross margin as a percentage of net sales increased to 31% for the three months ended August 31, 2011 compared to 29.9% for the three months ended August 31, 2010.  We attribute the increase to attaining business with new customers with higher profit margins and increasing direct shipments, which has lowered our freight in costs.

Selling and shipping expenses for the nine months ended August 31, 2011 was $1,327,022, an increase of $78,835, or 6%, as compared to $1,248,187 for the nine months ended August 31, 2010.  The increase is directly related to the commissions due on the increased sales for the Company. Selling and shipping expenses for the three months ended August 31, 2011 was $485,044, an increase of $34,513, or 8%, as compared to $450,531 for the three months ended August 31, 2010. Specifically the increase is due to additional sales commissions and freight out expense.

General and administrative expenses for the nine months ended August 31, 2011 was $2,306,862, an increase of $470,852, or 25.6%, as compared to $1,836,010 for the nine months ended August 31, 2010.  General and administrative expenses for the three months ended August 31, 2011 was $763,596, an increase of $129,317, or 20.4%, as compared to $634,279 for the three months ended August 31, 2010. The increase is due to increased professional fees associated with the Company becoming a reporting company with the SEC and additional compensation approved by the Board for the officers of the Company. The Company has accrued $300,000 towards officer bonus compensation during the nine months ended August 31, 2011, pursuant to an executive compensation plan, as compared to no accrual for the nine months ended August 31, 2010.  The bonus compensation for Fiscal 2010 was determined during the fourth quarter upon implementation of an executive compensation plan executed at the end of February 2011.
 
 
 
24

 

 
Investment income for the nine months ended August 31, 2011 was $1,693, compared to $3,522 for the nine months ended August 31, 2010. Investment income for the three months ended August 31, 2011 was $392, compared to $1,076 for the three months ended August 31, 2010.  We attribute the decrease of $1,829, or 52%, for the nine months ended August 31, 2011 and the decrease of $684, or 64% for the three months ended August 31, 2011 to lower interest rates in our money market accounts in 2011.

Interest expense for the nine months ended August 31, 2011 was $46,340, compared to $90,270 for the nine months ended August 31, 2010. Interest expense for the three months ended August 31, 2011 was $830, compared to $30,120 for the three months ended August 31, 2010.   The decrease of $43,930 or 49% for the nine months ended August 31, 2010 and the decrease of $29,290, or 97% for the three months ended August 31, 2011 is attributed to the decrease in borrowing from our lender. Fees relating to the line of credit are reflected as part of interest expense.

Income taxes for the nine months ended August 31, 2011 were $74,265, compared to $9,137 for the nine months ended August 31, 2010. Income taxes for the three months ended August 31, 2011 were $5,818, compared to $(731) for the three months ended August 31, 2010. The increase for each period is due to the federal taxes due as a result of the limitation of the Company’s net operating losses in the calculation of alternative minimum taxes.
 
As a result of the foregoing, net income for the nine months ended August 31, 2011 was $1,527,063, or $.17 per share, compared to the net income of $1,376,298 for the nine months ended August 31, 2010 or $.15 per share.  As a result of the foregoing, net income for the three months ended August 31, 2011 was $680,096, compared to the net income of $663,931 for the three months ended August 31, 2010.
 
 
 
 
25

 
 
 
Liquidity and Capital Resources

As of August 31, 2011 we had cash of $1,663,742, and working capital of $5,891,345. We believe that our working capital levels and available financing are adequate to meet our operating requirements during the next twelve months.

During the nine months ended August 31, 2011, we had net cash flow from operating activities of $794,074, as compared to net cash from operating activities of $500,359 for the nine months ended August 31, 2010. The increase in cash flow from operating activities resulted from increase in the 2011 profit, an increase in accounts payable and a decrease in other assets offset by increase in accounts receivable and inventory and a decrease in accrued expenses. The Company adjusts its inventory levels based upon the industry outlook and near term expectations of demand for the Company’s products.

We had net cash used in investing activities of $13,663 for the nine months ended August 31, 2011, as compared to net cash used in investing activities of $10,177 for the nine months ended August 31, 2010.  This increase was the result of the Company purchasing additional computer hardware in 2011.

We had net cash from financing activities of $0 for the nine months ended August 31, 2011, as compared to net cash used in financing activities of $767,772 for the nine months ended August 31, 2010.   The decrease in net cash used in financing activities was the result of the decrease in borrowings from our lender in 2011.

As a result of the foregoing, the Company had a net increase in cash of $780,411 for the nine months ended August 31, 2011, as compared to a net decrease in cash of $277,590 for the nine months ended August 31, 2010.

In July 2002, the Company obtained a financing commitment with an asset-based lender totaling $1,000,000 (the “Credit Line”). Borrowings under the Credit Line accrue interest at the greater of the prime rate plus two percent (2.0%) or 6.75%. The Company is required to make monthly interest only payments. The Company may repay all or a portion of the line of credit at any time. In addition, the Company is obligated to pay one-quarter of one percent (1/4 of 1%) annually as an unused line fee for the difference between $1,000,000 and the average daily balance of the Credit Line. The Credit Line is collateralized by substantially all the Company’s assets and contains various financial covenants pertaining to the maintenance of working capital and tangible net worth.

In June 2011, the Company replaced its existing credit line with a line of credit with a new bank totaling $1,000,000.  Borrowings under the line accrue interest at 2.56% over the LIBOR rate and is due in June 2012.  The line is collateralized by all the Company’s assets and includes working capital and tangible net worth covenants. At August 31, 2011, the Company was in compliance with the financial covenants. At August 31, 2011, the Company had no borrowings on the credit line.
 
Long-term debt, operating leases and other long-term obligations as of August 31, 2011 mature as follows:
Payments due
 
     
0 – 12
     
13 – 36
     
37 – 60
   
More than
 
Obligations
 
Total
   
Months
   
Months
   
60 Months
 
                               
Long-term debt
 
$
--
   
$
--
   
$
--
   
$
--
 
Operating leases
   
176,310
     
332,059
     
335,074
     
731,066
 
Employment agreements
   
412,500
     
--
     
--
     
--
 
                                 
Total obligations
 
$
588,810
   
$
332,059
   
$
335,074
   
$
731,066
 

 
 
 
26

 
 
 
Inflation

In the past two fiscal years, inflation has not had a significant impact on our business. However, any significant increase in inflation and interest rates could have a significant effect on the economy in general and, thereby, could affect our future operating results. In addition, the interest on the Company's line of credit is based upon the libor rate. Any significant increase in the libor rate could significantly impact our future operating results.

Off Balance Sheet Arrangements

We do not have any off balance sheet arrangements.



 
27

 

 
ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
Not Applicable.


ITEM 4.  CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934, as amended (“Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (“Commission”). Ira Levy, the Company’s Chief Executive Officer and principal financial officer has  evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of August 31, 2011 and has concluded that, as of such date, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported with the time periods specified in the Commission's rules and forms.

Changes in Internal Controls
 
During our fiscal quarter ended August 31, 2011, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 
 
 
28

 

 
PART II
 
OTHER INFORMATION
 
ITEM 1.  LEGAL PROCEEDINGS.
 
There are no legal proceedings to which the Company or any of its property is the subject.

ITEM 1A.  RISK FACTORS.
 
Not applicable.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

None.
 
ITEM 4. (REMOVED AND RESERVED).


ITEM 5.  OTHER INFORMATION.
 
None.
 
ITEM 6.  EXHIBTS.
 
Exhibit Number
 
Description
     
31.1
 
Certification by Chief Executive Officer and principal financial officer pursuant to Section 302 
     
32.1
 
Certification by Chief Executive Officer and principal financial officer pursuant to 18 U.S.C. Section 1350
 
101.INS   **
 
XBRL Instance Document
   
101.SCH **
 
XBRL Taxonomy Extension Schema Document
   
101.CAL **
 
XBRL Taxonomy Extension Calculation Linkbase Document
   
101.DEF **
 
XBRL Taxonomy Extension Definition Linkbase Document
   
101.LAB **
 
XBRL Taxonomy Extension Label Linkbase Document
   
101.PRE **
 
XBRL Taxonomy Extension Presentation Linkbase Document

 
** XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
 

 
29

 
 
 
 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
SURGE COMPONENTS, INC.
 
       
Date: October 14, 2011
By:
/s/ Ira Levy
 
   
Name: Ira Levy
 
   
Title: Chief Executive Officer  (Principal Executive Officer, Principal Financial Officer, and Principal Accounting Officer)
 
       
 
 
 
 
 
 
 
 
 
 
 
 
30