UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(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, 2002
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[ ] Transition report pursuant to Section 13 or 15(d) of the Exchange Act
For the transition period from to
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Commission file number 0 - 14188
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Surge Components, Inc.
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(Exact name of small business issuer as specified in its charter)
New York 11-2602030
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
95 Jefryn Boulevard, Deer Park, NY 11729
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(Address of principal executive offices)
(631) 595-1818
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(Issuer's telephone number)
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(Former name, former address and former fiscal year,
if changed since last report)
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 15 , 2002: 8,752,926 shares of common stock,
par value $.001 per share.
Transitional Small Business Disclosure Format (check one):
Yes [ ] No [X]
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Index to Form 10-QSB
for the Period Ended August 31, 2002
Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets 3 - 4
Consolidated Statements of Operations and Comprehensive Loss 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7 - 9
Item 2. Management's Discussion and Analysis or Plan of Operation. 10- 16
Item 3. Controls and Procedures 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. 18
Item 6. Exhibits and Reports on Form 8-K. 18
Signatures 19
Certifications 20
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
SURGE COMPONENTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
August 31, November 30,
2002 2001
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ASSETS
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Current assets:
Cash and equivalents $1,528,940 $1,030,181
Marketable securities - available for sale 268,215 1,176,534
Accounts receivable (net of allowance for
doubtful accounts of $40,335) 1,674,208 1,610,032
Due under repurchase agreement 217,125 1,054,602
Inventory, net 1,977,984 2,311,412
Prepaid expenses and income taxes 162,303 142,454
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Total current assets 5,828,775 7,325,215
Fixed assets - net of accumulated depreciation
of $728,790 and $475,706 1,249,317 1,478,886
Other assets 5,179 7,985
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Total assets $7,083,271 $8,812,086
========== ==========
See accompanying notes to consolidated financial statements.
3
SURGE COMPONENTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
August 31, November 30,
2002 2001
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LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Loan payable $ 282,605 $ --
Accounts payable 1,989,467 2,315,760
Accrued expenses and taxes 859,559 1,113,479
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Total current liabilities 3,131,631 3,429,239
Deferred rent 44,130 28,910
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Total liabilities 3,175,761 3,458,149
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Minority interest 33,191 --
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Commitments and contingencies
Shareholders' equity
Preferred stock - $.001 par value stock,
1,000,000 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, 42,700 and 62,000
shares issued and outstanding, redeemable,
convertible, liquidation preference
of $5 per share 43 62
Common stock - $.001 par value stock,
25,000,000 shares authorized, 8,752,926 and
9,022,448 shares issued and outstanding 8,754 9,023
Additional paid-in capital 22,990,945 23,080,835
Stock subscription receivable (5,200) (9,200)
Accumulated other comprehensive loss-
unrealized loss on marketable securities-
available for sale (16,490) (61,912)
Accumulated deficit (19,103,733) (17,664,871)
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Total shareholders' equity 3,874,319 5,353,937
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Total liabilities and shareholders' equity $ 7,083,271 $ 8,812,086
============ =============
See accompanying notes to consolidated financial statements.
4
SURGE COMPONENTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(UNAUDITED)
Nine Months Ended Three Months Ended
August 31, August 31,
2 0 0 2 2 0 0 1 2 0 0 2 2 0 0 1
------- ------- ------- -------
Net sales $ 8,362,575 $12,897,707 $3,000,176 $2,943,668
Cost of goods sold 6,149,170 9,137,403 2,267,264 1,719,909
----------- ----------- ---------- ----------
Gross profit 2,213,405 3,760,304 732,912 1,223,759
----------- ----------- ---------- ----------
Operating expenses:
General and administrative expenses 2,556,379 5,032,290 732,874 1,387,132
Selling and shipping expenses 745,894 982,658 261,589 292,262
Financial consulting fees 268,850 2,170,838 -- --
Provision for bad debts 8,413 172,922 8,413 --
Recovery on Global settlement -- (46,000) -- --
Loss on investment on MailEncrypt -- 607,188 -- --
----------- ----------- ---------- ----------
Total operating expenses 3,579,536 8,919,896 1,002,876 1,679,394
----------- ----------- ---------- ----------
Loss from operations (1,366,131) (5,159,592) (269,964) (455,635)
----------- ----------- ---------- ----------
Other income and (expense):
Other income -- 1,000,000 -- --
Investment income 43,238 206,713 7,862 46,117
Interest expense (23,592) (338,351) (13,991) (223,942)
Loss on sale of marketable securities (81,282) (43,372) -- (3,520)
----------- ----------- ---------- ----------
Total other income and (expense) (61,636) 824,990 (6,129) (181,345)
----------- ----------- ---------- ----------
(1,427,767) (4,334,602) (276,093) (636,980)
Minority interest (544) -- (544) --
----------- ----------- ---------- ----------
Loss before income taxes (1,427,223) (4,334,602) (275,549) (636,980)
Income taxes 11,639 23,821 3,103 8,121
----------- ----------- ---------- ----------
Net loss (1,438,862) (4,358,423) (278,652) (645,101)
Dividends on preferred stock 26,175 -- 10,675 --
----------- ----------- ---------- ----------
Net loss available to
common shareholders $ (1,465,037) $(4,358,423) $ (289,327) $ (645,101)
============ =========== =========== ==========
Other comprehensive loss:
Net loss $ (1,438,862) $(4,358,423) $ (278,652) $ (645,101)
Unrealized holding (loss) gain
on securities arising during
the period (45,422) 22,644 3,860 17,522
Reclassification adjustment-loss
on sale of securities 81,282 43,372 -- 3,520
------------ ----------- ----------- ---------
Total comprehensive loss $ (1,403,002) $(4,292,407) $ (274,792) $ (624,059)
============ =========== =========== ==========
Weighted average shares outstanding
Basic 8,881,298 7,020,385 8,752,926 7,654,845
Diluted 8,881,298 7,020,385 8,752,926 7,654,845
Loss available to common
shareholders, per share
Basic $ (.16) $ (.62) $ (.03) $ (.08)
Diluted $ (.16) $ (.62) $ (.03) $ (.08)
See accompanying notes to consolidated financial statements.
5
SURGE COMPONENTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
August 31,
2 0 0 2 2 0 0 1
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(Unaudited) (Unaudited)
OPERATING ACTIVITIES:
Net loss $(1,438,862) $(4,358,423)
Adjustments to reconcile net
loss to net cash provided
by operating activities:
Depreciation and amortization 253,084 172,284
Loss on sale of marketable
securities 81,282 43,372
Provision for bad debts -- 10,000
Amortization of financial
consulting fees -- 2,170,838
Loss on investment in MailEncrypt -- 607,188
Issuance of stock for services -- 28,125
Minority interest 33,191 --
Deferred rent 15,220 --
CHANGES IN OPERATING ASSETS AND LIABILITIES:
Accounts receivable (64,176) 1,345,735
Inventory 333,428 (171,671)
Prepaid expenses and other assets (17,043) 578,776
Accounts payable (326,293) 43,705
Accrued expenses and taxes (312,947) (84,686)
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NET CASH FLOWS FROM OPERATING ACTIVITIES (1,443,116) 385,243
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INVESTING ACTIVITIES
Collections of amounts due under
repurchase agreement 837,477 --
Purchase of marketable securities (28,132) (87,776)
Acquisition of fixed assets (23,515) (1,241,669)
Proceeds from sale of
marketable securities 900,590 1,250,000
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NET CASH FLOWS FROM INVESTING ACTIVITIES 1,686,420 (79,445)
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FINANCING ACTIVITIES
Collections from stock
subscription receivable 4,000 --
Repurchase of shares (31,150) --
Proceeds from exercise of stock options -- 36,238
Proceeds from loans payable 282,605 --
Purchase of treasury stock -- (650,000)
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NET CASH FLOWS FROM FINANCING ACTIVITIES 255,455 (613,762)
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NET CHANGE IN CASH 498,759 (307,964)
CASH AT BEGINNING OF PERIOD 1,030,181 2,906,446
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CASH AT END OF PERIOD $1,528,940 $ 2,598,482
========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Income taxes paid $ 9,527 $ 8,375
========== ===========
Interest paid $ 23,418 $ 25,844
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Conversion of convertible debt
into common stock $ -- $ 7,000,000
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Conversion of accrued interest
into common stock $ -- $ 151,883
========== ===========
See accompanying notes to consolidated financial statements.
6
SURGE COMPONENTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
In the opinion of management, the accompanying consolidated financial
statements of Surge Components, Inc.("Surge"), Challenge/Surge, Inc.
("Challenge"), Superus Holdings, Inc. ("Superus"), Mail Acquisition
Corp. ("Mail"), SolaWorks, Inc., Surge/Lelon LLP and Surge Components,
Ltd. (collectively the "Company") contain all adjustments necessary to
present fairly the Company's financial position as of August 31, 2002
and the related statements of operations and comprehensive loss for the
nine and three months ended August 31, 2002 and cash flows for the nine
months ended August 31, 2002 and 2001.
The consolidated results of operations for the nine and three months ended
August 31, 2002 and 2001 are not necessarily indicative of the results to
be expected for the full year.
Except as follows, the accounting policies followed by the Company are set
forth in Note B to the Company's financial statements included in its
Annual Report on Form 10-KSB, for the fiscal year ended November 30, 2001.
In July 2000, Surge entered into a joint venture agreement with Lelon
Electronics Corp. (a supplier of component parts to Surge) to form
Surge/Lelon LLP, a Delaware limited liability partnership. The Company
has membership interests in the joint venture totaling 55%. Operations
commenced in August 2002. These operations have been consolidated with
those of the Company. The ownership of Lelon Electronics in this joint
venture, totaling 45%, has been reported as a minority interest.
In May 2002, Surge and an officer of Surge have become sole owners of
Surge Components, Limited, a Hong Kong corporation. Under current Hong
Kong law, Surge Components, 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 Components, Limited started doing business in July 2002. These
operations have been consolidated with those of the Company.
NOTE 2 - SETTLEMENT AGREEMENT
In April 2002, in connection with a Mutual Release, Settlement,
Standstill and Non-Disparagement Agreement by and among the Company
and Equilink Capital Partners, LLC, Robert DePalo, Old Oak Fund Inc.
and Kenneth Orr (collectively, the "Investors"), among other provisions,
the Investors transferred back to the Company 252,000 shares of common
stock, 19,300 shares of Series C preferred stock, and certain warrants,
representing all of the Company's securities held by the Investors, and
agreed, among other things, not to purchase any securities of the Company
and not to disparage the Company in any manner, in exchange for $225,000
($100,000 paid upon signing of the agreement and two payments of $62,500
due on July 1, 2002 (which was paid) and
7
SURGE COMPONENTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
NOTE 2 - SETTLEMENT AGREEMENT (CONTINUED)
November 1, 2002), in settlement of potential claims relating to services
provided by the Investors. The shares are being held in escrow until the
final payment has been made. In addition, the Company and the Investors
mutually agreed to release each other from all claims each party had, now
has, or in the future might have against the other. The Company recorded
a charge of approximately $193,850 to income during the quarter ending May
31, 2002, in connection with the settlement.
NOTE 3 - DUE UNDER REPURCHASE AGREEMENT
In September 2001, the Company entered into an agreement with Maple Chase,
Corp. ("Maple Chase"), a subsidiary of Invensys Plc pursuant to which the
Company paid approximately $1,250,000 for certain inventory held by Maple
Chase who agreed to repay the Company, in non-interest bearing installments
over 12 months for such inventory (the "Repurchase Agreement"). For
accounting purposes, the amount paid by the Company under the Repurchase
Agreement is being treated as a one-year financing. As of August
31, 2002, the Company had received approximately $1,033,000.
In October 2002, the Company received the final scheduled payment
of approximately $217,000.
NOTE 4 - REPURCHASE OF SHARES
In March 2002, the Company entered into agreements with two shareholders
to settle a dispute as to the form of payment of interest on certain 12%
Convertible Promissory Notes. The Company will pay these shareholders
an aggregate of $32,854, of which $18,000 has been paid, in exchange for
17,522 shares of Surge common stock issued to them for converted interest.
NOTE 5 - PREFERRED DIVIDENDS
The dividends on the Non-Voting Redeemable Convertible Series C
Preferred Stock totaling $15,500 for the semiannual period ended December
31, 2001 have not been paid. The Company has accrued these dividends.
Dividends on these shares for the semiannual period ended June 30, 2002
have not been declared. The Company has accrued dividends for the
semiannual period ended June 30, 2002 totaling $10,675.
8
SURGE COMPONENTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
NOTE 6 - SEC INVESTIGATION
During the year ended November 30, 2000 and the quarter ended February
28, 2001, the Company made certain potentially questionable payments of
approximately $2,137,000 and $774,000, respectively. These payments are
currently the subject of an investigation by the Securities and Exchange
Commission. The recipient of these payments repaid $1,000,000 to the
Company in the quarter ending May 31, 2001, which was included in
other income.
In May 2001, the law firm Mintz Levin Cohn Ferris Glovsky and Popeo, P.C.,
was engaged to assist in an investigation concerning the payments and to
recommend policies to prevent any similar future payments. Due, in part to
the previously disclosed resignation of our outside counsel and such counsel's
refusal to be interviewed as part of the investigation, the Company was unable
to confirm what legal advice was rendered as to the making of such payments.
The investigation did not uncover any additional payments similar to the
previously disclosed "potentially questionable payments". The Company has
taken steps to ensure that such payments are not made in the future,
including requiring that payments above $5,000 not be made to any party
except a party on a list approved by our audit committee, requiring
co-signatures on each check for more than $10,000 and adopting a
Code of Conduct. Except for proceedings relating to the SEC inquiry
commenced in October 2001, the Company is not aware of any pending
proceedings relating to the questionable payments. There can be no
assurance that these potentially questionable payments and related
investigation will not lead to other proceedings.
NOTE 7- LOAN PAYABLE
In July 2002, the Company obtained financing with an asset-based lender
totaling $1,000,000. Borrowings under the financing agreement accrue
interest at the greater of the prime rate plus two percent (2.0%) or
6.75%. The Company will 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 loan account. The loan 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. The Company is currently in default
of the tangible net worth financial covenant. The Company has
obtained a waiver from the lender regarding its rights pertaining
to the default for the quarter ended August 31, 2002.
9
Item 2. Management's Discussion and Analysis or Plan of Operation.
Statements contained in this report include "forward-looking statements"
within the meaning of such term in Section 27A of the Securities Act of 1933
and Section 21E of the Securities Exchange Act of 1934. Forward-looking
statements involve known and unknown risks, uncertainties and other factors
which could cause actual financial or operating results, performances or
achievements expressed or implied by such forward-looking statements not
to occur or be realized. Such forward-looking statements generally are
based on our best estimates of future results, performance or achievements,
based upon current conditions and the most recent results of the companies
involved and their respective industries. Forward-looking statements
may be identified by the use of forward-looking terminology such as
"may," "will," "project," "expect," "believe," "estimate," "anticipate,"
"intends," "continue," "potential," "opportunity" or similar terms,
variations of those terms or the negative of those terms or other
variations of those terms or comparable words or expressions.
Potential risks and uncertainties include, among other things,
such factors as:
- our business strategies and future plans of operations,
- general economic conditions in the United States and elsewhere, as
well as the economic conditions affecting the industries in which
we operate,
- political and regulatory matters affecting the foreign countries
in which we operate or purchase goods and materials,
- the market acceptance and amount of sales of our products and
services,
- the extent that our distribution network and marketing programs
achieve satisfactory response rates,
- the effect of the current surplus of electronic component parts in the
broker distributor market on sales by our Challenge subsidiary,
- our historical losses,
- the competitive environment within the electronic components industry,
- our ability to raise additional capital, if and as needed,
- the cost-effectiveness of our product development activities,
- the extent of any further investigations or proceedings with respect to
the potentially questionable payments.
10
Shareholders and others reading this report should carefully
consider such risks, uncertainties and other information, disclosures
and discussions which contain cautionary statements identifying important
factors that could cause actual results to differ materially from those
provided in the forward-looking statements. We undertake no obligation to
publicly update or revise any forward-looking statements, whether as a
result of new information, future events or otherwise. Readers are
urged to carefully review and consider the various disclosures made
by the Company in this Report and the Company's Annual Report on Form
10-KSB for the year ended November 30, 2001, both of which have been
filed with the Commission. These reports attempt to advise
interested parties of the risks and factors that may affect
the Company's business, financial condition and results of
operations and prospects.
Results of Operations
Consolidated net sales for the nine months ended August 31, 2002
decreased by approximately $4,535,000, or 35%, to $8,363,000 as
compared to consolidated net sales of $12,898,000 for the nine
months ended August 31, 2001. Consolidated net sales for the
three months ended August 31, 2002 increased by $57,000, or
2%, to $3,000,000 as compared to consolidated net sales of
$2,944,000 for the three months ended August 31, 2001.
The net sales for the nine months ended August 31, 2002 for
Surge exclusive of our Challenge subsidiary decreased by approximately
$1,207,000, or 18%, when compared to Surge's net sales for the nine months
ended August 31, 2001. Net sales for the three months ended August 31,
2002 for Surge decreased by $64,000, or 4%, when compared to the three
months ended August 31, 2001. The Company had lower sales during the
current nine and three month periods as a result of a slowdown
in the electronics industry.
Net sales for the nine months ended August 31, 2002 for
Challenge decreased by approximately $3,328,000, or 54%, when compared
to the nine months ended August 31, 2001. Net sales for the three months
ended August 31, 2002 for Challenge increased by $121,000, or 14%, when
compared to the three months ended August 31, 2001. Challenge continues
to experience depressed sales due to a slowdown in manufacturing among
computer, telecommunications and phone manufacturers. This slowdown is
expected to adversely affect Challenge's sales for at least the
remainder of calendar year 2002. Any future improvements in sales
and possible profitability are expected to be based on future
demand and supply for Challenge's product mix.
11
Our gross profit for the nine months ended August 31, 2002
decreased by approximately $1,547,000, or 41%, as compared to the
nine months ended August 31, 2001. Our gross profit for the three
months ended August 31, 2002 decreased by approximately $491,000,
or 40%, as compared to the three months ended August 31, 2001.
Gross profits as a percentage of net sales decreased to
approximately 26% in the nine months ended August 31, 2002
from approximately 29% in the nine months ended August 31, 2001.
The decrease in our gross profit was a result of decreased sales
from the economic slowdown of electronic components. The decrease
in gross profit percentage is due to industry pricing pressures
requiring us to lower our prices.
General and administrative expenses for the nine months
ended August 31, 2002 decreased by approximately $2,476,000,
or 49%, as compared to the nine months ended August 31, 2001.
For the three months ended August 31, 2002, general and
administrative expenses decreased by approximately $654,000,
or 47%, as compared to the three months ended August 31, 2001.
The decrease is primarily due to costs associated with funding
the operations of MailEncrypt, which was unwound during the
fourth quarter of the fiscal year ended November 30, 2001,
and overhead attributable to Superus, which was inactive since
the second quarter of 2001 and has subsequently filed
for bankruptcy protection under Chapter 7 of the United States
Bankruptcy Code. Superus incurred approximately $1,495,000
of expenses relating to salaries, rent, professional fees,
public relations and consulting fees for the nine month period
ended August 31, 2001.
Selling and shipping expenses for the nine months ended
August 31, 2002, decreased by approximately $237,000, or 24%, as
compared to the nine months ended August 31, 2001. For the three
months ended August 31, 2002, selling and shipping expenses decreased
by approximately $31,000, or 11%, as compared to the three months
ended August 31, 2001. This decrease primarily is due to the decreased
sales commissions resulting from lower sales in the current fiscal year.
Financial consulting fees for the nine months ended August 31, 2001
were approximately $2,171,000, representing the cost of the securities
issued in payment of such fees. These fees and expenses were incurred in
connection with an agreement with our investment banker regarding services
through May 2001 and reimbursement of expenses. During the nine months
ended August 31, 2002, the Company paid $75,000 to an investment banker
for work performed during the second fiscal quarter. Also in April
2002, the Company entered into a settlement with an investment banker,
as more fully explained below in the Liquidity and Capital Resources section.
12
Investment income decreased by approximately $163,000, or 79%,
for the nine months ended August 31, 2002, as compared to the nine months
ended August 31,2001. Investment income decreased by approximately $38,000,
or 83%, for the three months ended August 31, 2002, as compared to the three
months ended August 31, 2001. This decrease is primarily related to our use
of cash and cash equivalents to fund losses and the reduction of interest
rates on our invested funds.
Interest expense decreased approximately $315,000 or 93% for the nine
months ended August 31, 2002 as compared to the nine months ended
August 31, 2001. Investment expense decreased by approximately
$210,000, or 94%, for the three months ended August 31, 2002, as
compared to the three months ended August 31, 2001. This decrease
primarily is related to our conversion of our private placement
notes as of December 31, 2000. In July 2001, in order to avoid disputes,
we decided to accrue additional interest on the convertible notes
through the dates the notes were converted. Previously interest
was accrued only to December 31, 2000.
As a result of the foregoing, the Company on a consolidated
basis had a net loss of approximately $1,439,000 for the nine months ended
August 31, 2002, or $(.16) per share,as compared to approximately
$4,358,000 for the nine months ended August 31, 2001, or $(.62) per
share. The Company had a consolidated net loss of approximately
$279,000 for the three months ended August 31, 2002, as compared
to consolidated net loss of approximately $645,000 for the three
months ended August 31, 2001.
Liquidity and Capital Resources
Working capital decreased by $1,199,000 during the nine months
ended August 31, 2002 from $3,896,000 at November 30, 2001, to
$2,697,000, at August 31, 2002. This decrease resulted primarily from
the decrease in marketable securities, inventory and amounts due under
a repurchase agreement as partially offset by a decrease in accounts
payable and accrued expenses. Our current ratio decreased from 2.1:1
at November 30, 2001, to 1.9:1 at August 31, 2002. Inventory turned
2.8 times during the nine months ended August 31, 2002 as compared
to 2.9 times during the nine months ended August 31, 2001. The
average number of days to collect receivables increased from 50
days to 54 days.
In July 2002, the Company entered into a financing agreement with
an asset-based lender providing for borrowing up to $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 will 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. We are
currently in default of the tangible net worth financial
covenant. We obtained a waiver from the lender regarding
its rights pertaining to the default for the quarter ended
August 31, 2002.
13
We continue to incur substantial operating costs. These
costs principally consist of rent, payroll, professional fees,
insurance premiums and marketing related charges. Our ability
to operate profitably in the future depends on increasing sales
levels and decreasing our expenses. To accomplish this goal,
we are continuing to streamline our operations and are reviewing
other possible reductions.
During the nine months ended August 31, 2002, we had net
cash used in operating activities of approximately $1,443,000
as compared to net cash provided by operating activities of
approximately $385,000 in the nine months ended August 31, 2001.
The increase in cash used in operating activities resulted from
the Company's net loss, a decrease in accrued expenses and accounts
payable and an increase in prepaid expenses and income taxes,
partially offset by a decrease in accounts receivable and
inventory.
We had net cash provided by investing activities of approximately
$1,686,000 for the nine months ended August 31, 2002, as compared to
$79,000 used in investing activities for the nine months ended August
31, 2001. The net cash provided by investing activities during the nine
months ended August 31, 2002 resulted primarily from the sale
of marketable securities and collection of amounts due under
a repurchase agreement ($837,000).
We anticipate that in the ordinary course of business our
current cash position, marketable securities available for sale
and our asset based financing will be sufficient to meet our
current financial requirements over the next twelve months.
We had net cash provided by financing activities of
approximately $255,000 for the nine months ended August 31,
2002, as compared to net cash used in financing activities
of approximately $614,000 for the nine months ended August
31, 2001. The cash provided by financing activities during
the nine months ended August 31, 2002 was primarily a result
of borrowing funds under the credit line. The cash used in
financing activities during the nine months ended August 31,
2001 was a result of the proceeds from the exercise of stock
options and the Company purchasing treasury stock.
As a result of the foregoing, the Company had a net
increase in cash and equivalents of approximately $499,000
during the nine months ended August 31, 2002, as compared
to a net decrease in cash and equivalents of approximately
$308,000 for the nine months ended August 31, 2001.
14
In April 2002, in connection with a Mutual Release, Settlement,
Standstill and Non-Disparagement Agreement by and among the Company
and Equilink Capital Partners, LLC, Robert DePalo, Old Oak Fund Inc.
and Kenneth Orr (collectively, the "Investors"), the Investors
transferred back to the Company 252,000 shares of common stock,
19,300 shares of Series C preferred stock, and certain warrants,
representing all of the Company's securities held by the Investors,
and agreed, among other things, not to purchase any securities of
the Company and not to disparage the Company in any manner, in
exchange for $225,000 ($100,000 paid upon signing of the agreement
and two payments of $62,500 due on July 1, 2002 (which has been paid)
and November 1, 2002), in settlement of potential claims relating
to services provided by the Investors. The shares are being held
in escrow until the final payment has been made. In addition, the
Company and the Investors mutually agreed to release each other
from all claims each party had, now has, or in the future might
have against the other. The Company recorded a charge of
approximately $194,000 to income during the quarter ending
May 31, 2002, in connection with the settlement.
In March 2002, the Company entered into an agreement
with two shareholders to settle a dispute as to the form of payment
of interest on certain 12% Convertible Promissory Notes. The Company
agreed to pay these shareholders an aggregate of $32,854, of which
$18,000 has been paid, in exchange for 17,522 shares of Surge
common stock issued to them for converted interest.
In July 2000, Surge entered into a joint venture agreement with
Lelon Electronics Corp. (a supplier of component parts to Surge)
to form Surge/Lelon LLP, a Delaware limited liability partnership.
The Company has membership interests in the joint venture totaling 55%.
Operations commenced operations in August 2002. These operations have
been consolidated with those of the Company. The ownership of Lelon
Electronics in this joint venture, totaling 45%,
has been reported as a minority interest.
In May 2002, Surge and an officer of Surge have become sole
owners of Surge Components, Limited, a Hong Kong corporation.
As of May 31, 2002, there has been no activity in Surge Components,
Limited. Under current Hong Kong law, Surge Components, 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. Operations commenced in July 2002.
These operations have been consolidated with those of the Company.
15
Critical Accounting Policies and Estimates
The preparation of financial statements and related disclosures
in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions
that affect the amounts reported in the unaudited Consolidated
Financial Statements and accompanying notes. Estimates are used for, but
not limited to, the accounting for the allowance for doubtful accounts,
inventories, income taxes and loss contingencies. Management bases
its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances. Actual
results could differ from these estimates under different assumptions
or conditions.
The Company believes the following critical accounting policies,
among others, may be impacted significantly by judgment, assumptions and
estimates used in the preparation of the unaudited Consolidated
Financial Statements:
Revenue is recognized 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 allowance for doubtful accounts is maintained to provide for
losses arising from customers' inability to make required payments.
If there is a deterioration of our customers' credit worthiness and/or
there is an increase in the length of time that the receivables are
past due greater than the historical assumptions used, additional
allowances may be required. During February 2002, the Company
obtained $2,000,000 of credit insurance covering most of its customers.
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 shipped from the supplier.
The Company, at August 31, 2002, has a reserve against slow
moving and obsolete inventory of approximately $1,032,000.
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. Income taxes are
reported under the liability method pursuant to SFAS No. 109
"accounting for income taxes". A valuation allowance is provided
when the likelihood of realization of deferred tax
assets is not assured.
Inflation And Increasing Interest Rates
In the past two fiscal years, inflation has not had a significant
impact on our business. We have generally been able to offset the impact
of rising costs through purchase price reductions and increases in
selling prices. 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.
16
Item 3. Controls and Procedures.
Within the 90 days prior to the date of this report, the Company
carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's
Chief Executive Officer and Chief Financial Officer,of the
effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to Exchange Act
Rule 13a-14. Based upon the evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective. There were
no significant changes in the Company's internal controls or
in other factors that could significantly affect these controls
subsequent to the date of their evaluation.
17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
As disclosed in our public filings and in Note 6 to the financial
statements contained in this Quarterly Report, there have been certain
potentially questionable payments, which led to the delisting of the
Company's stock from Nasdaq and which are currently the subject of
an informal inquiry by the Securities and Exchange Commission
which began in October 2001. There can be no assurance that the
potentially questionable payments and related investigations will
not lead to any other proceedings and we have not received any
threats of litigation related to such events.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
3.1 Certificate of Incorporation of the Company, as amended. (1)
3.2 By-Laws of the Company. (1)
10.1 Financing Agreement, dated July 2, 2002, by and among Surge
Components, Inc. and Rosenthal & Rosenthal, Inc.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
-----------------
(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.
(b) Reports on Form 8-K. None.
18
SIGNATURES
In accordance with the requirements of the Securities Exchange
Act of 1934, the registrant caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SURGE COMPONENTS, INC.
By:/s/ Steven J Lubman
-------------------
Steven J. Lubman
Vice President, Secretary
and Director
(Principal Financial Officer)
Dated: October 21, 2002
By:/s/ Ira Levy
--------------------
Ira Levy
Chief Executive Officer,
President and Director
(Principal Executive Officer)
Dated: October 21, 2002
19
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Ira Levy, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Surge
Components, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present
in all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filling date
of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation
of internal controls which could adversely affect the registrant's
ability to record, process,summarize and report financial data and
have identified for the registrant's auditors any material weaknesses
in internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant's internal
controls.
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: October 21, 2002
/s/Ira Levy
-------------------
Name: Ira Levy
Title: Chief Executive Officer and
Chief Financial Officer
(Principal Executive Officer
and Principal Financial Officer)