SPRS 10-Q Quarterly Report Aug. 31, 2013 | Alphaminr
SURGE COMPONENTS INC
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SPRS 10-Q Quarter ended Aug. 31, 2013

Balance Sheet
Cash Flow
Income Statement
SURGE COMPONENTS INC
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10-Q 1 form10q.htm SURGE COMPONENTS, INC. FORM 10-Q 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, 2013
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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
As of October 15, 2013, there were 9,060,012 outstanding shares of the Registrant's Common Stock, $.001 par value.

SURGE COMPONENTS, INC
Page
PART I - FINANCIAL INFORMATION
3
3
5
6
8
21
24
24
PART II - OTHER INFORMATION
25
25
25
25
25
25
25
26
PART I Financial Information



SURGE COMPONENTS, INC. AND SUBSIDIARIES

(unaudited)
August 31,
November 30,
2013
2012
ASSETS
Current assets:
Cash
$
3,114,048
$
3,443,964
Accounts receivable - net of allowance for
doubtful accounts of $51,559 and $34,676
5,635,636
3,962,034
Inventory, net
3,759,198
2,788,958
Prepaid expenses and income taxes
182,187
106,364
Deferred income taxes
311,089
315,197
Total current assets
13,002,158
10,616,517
Fixed assets – net of accumulated depreciation and amortization of $2,164,772 and $2,126,238
73,030
80,629
Deferred income taxes
1,244,355
1,260,788
Other assets
11,652
7,370
Total assets
$
14,331,195
$
11,965,304

See notes to consolidated financial statements
SURGE COMPONENTS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited)
(Continued)
August 31, November 30,
LIABILITIES AND SHAREHOLDERS' EQUITY
2013
2012
Current liabilities:
Accounts payable
$ 3,311,288 $ 1,921,631
Accrued expenses and taxes
665,054 600,903
Accrued salaries
233,454 475,184
Total current liabilities
4,209,796 2,997,718
Deferred rent
34,269 27,893
Total liabilities
4,244,065 3,025,611
Commitments and contingencies
Shareholders' equity
Preferred stock - $.001 par value stock, 5,000,000 shares authorized:
Series A – 260,000 shares authorized, none outstanding, non-voting, convertible, redeemable.
Series B – 200,000 shares authorized, none outstanding, voting, convertible, redeemable.
Series C–100,000 shares authorized, 23,700 and 23,700 shares issued and outstanding, redeemable,  convertible, and a liquidation preference of $5 per share
24 24
Common stock - $.001 par value stock, 75,000,000 shares authorized, 9,060,012 and 9,060,012 shares issued and outstanding
9,060 9,060
Additional paid-in capital
23,120,277 23,082,844
Accumulated deficit
(13,042,231 ) (14,152,235 )
Total shareholders' equity
10,087,130 8,939,693
Total liabilities and shareholders' equity
$ 14,331,195 $ 11,965,304
See notes to consolidated financial statements.
SURGE COMPONENTS, INC. AND SUBSIDIARIES

(Unaudited)
Nine Months Ended
August 31,
Three Months Ended
August 31,
2013
2012
2013
2012
Net sales
$ 18,033,342 $ 16,891,754 $ 6,955,770 $ 6,059,072
Cost of goods sold
12,936,597 11,930,233 5,079,602 4,326,069
Gross profit
5,096,745 4,961,521 1,876,168 1,733,003
Operating expenses:
Selling and shipping expenses
1,514,226 1,598,747 513,407 554,448
General and administrative expenses
2,377,194 2,335,915 807,919 744,257
Depreciation and amortization
38,534 41,334 13,940 13,996
Total operating expenses
3,929,954 3,975,996 1,335,266 1,312,701
Income before other income (expense) and income taxes
1,166,791 985,525 540,902 420,302
Other income:
Investment income
3,439 1,777 1,036 734
Other income
3,439 1,777 1,036 734
Income before income taxes
1,170,230 987,302 541,938 421,036
Income taxes
48,376 212,764 1,602 10,289
Net income
1,121,854 774,538 540,336 410,747
Dividends on preferred stock
11,850 11,850 5,925 5,925
Net income available to common shareholders
$ 1,110,004 $ 762,688 $ 534,411 $ 404,822
Net income per share available to common shareholders:
Basic
$ .12 $ .08 $ .06 $ .04
Diluted
$ .11 $ .08 $ .06 $ .04
Weighted Shares Outstanding:
Basic
9,060,012 9,044,285 9,060,012 9,060,012
Diluted
9,668,621 9,673,922 9,668,621 9,689,649

See notes to consolidated financial statements.
SURGE COMPONENTS, INC. AND SUBSIDIARIES

(unaudited)
Nine Months Ended
August 31,
August 31,
2013
2012
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income
$
1,121,854
$
774,538
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization
38,534
41,334
Stock compensation expense
37,433
25,434
Deferred income taxes
20,541
189,525
Allowance for doubtful accounts
16,883
5,000
CHANGES IN OPERATING ASSETS AND LIABILITIES:
Accounts receivable
(1,690,485)
19,151
Inventory
(970,240)
(7,655)
Prepaid expenses and income taxes
(75,823)
30,172
Other assets
(4,282)
(1,644)
Accounts payable
1,389,657
385,966
Deferred rent
6,376
8,760
Accrued expenses
(189,429
)
(136,465)
NET CASH FLOWS USED IN OPERATING ACTIVITIES
(298,981)
1,334,106
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of fixed assets
(30,935
)
(11,339
)
NET CASH FLOWS PROVIDED BY INVESTING ACTIVITIES
(30,935
)
(11,339
)
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Consolidated Statements Of Cash Flows
(Continued)
(unaudited)
Nine Months Ended
August 31,
2013
August 31,
2012
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercising stock options
$
-
$
6,250
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
-
6,250
NET CHANGE IN CASH
(329,916)
1,329,017
CASH AT BEGINNING OF PERIOD
3,443,964
1,905,455
CASH AT END OF PERIOD
$
3,114,048
$
3,234,472
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Income taxes paid
$
48,376
$
47,745
Interest paid
$
-
$
-
NONCASH INVESTING AND FINANCING ACTIVITIES:
Accrued dividends on preferred stock
$
11,850
$
11,850

See notes to consolidated financial statements.
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 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.

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 in these interim consolidated financial statements for the nine months ended August 31, 2013 and August 31, 2012 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 a long term supply agreement with one of our 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 $2,088,000 and $2,550,000 for the nine months ended August 31, 2013 and August 31, 2012 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 $452,734 and $215,644 for the nine months ended August 31, 2013 and August 31, 2012 respectively.

The Company performs ongoing credit evaluations of its customers and maintains reserves for potential credit losses.
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(3) Revenue Recognition (continued) :

The Company and its subsidiaries currently have agreements with several distributors. There are no provisions for the granting of price concessions in any of the agreements.  Revenues under these distribution agreements were approximately $2,931,000 and $2,830,000 for nine months ended August 31, 2013 and August 31, 2012 respectively.

(4) Inventories :
Inventories, which consist solely of products held for resale, are stated at the lower of cost (first-in, first-out method) or market.  Products are included in inventory when the Company obtains title and risk of loss on the products, primarily when shipped from the supplier. Inventory in transit principally from foreign suppliers at August 31, 2013 approximated $1,264,000. The Company, at August 31, 2013, has a reserve against slow moving and obsolete inventory of $559,458.. From time to time the Company’s products are subject to legislation from various authorities on environmental matters.
(5) Depreciation and Amortization :

Fixed assets are recorded at cost.  Depreciation is generally calculated 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.
9
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(6) Concentration of Credit Risk :

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of accounts receivable.  The Company maintains substantially all of its cash balances in a limited number of financial institutions.   At August 31, 2013 and November 30, 2012, the Company's uninsured cash balances totaled approximately $1,920,075 and $1,341,304, 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. See Note G.

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, 2009, and state tax examinations for years before fiscal years ending November 30, 2008. 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 months ended August 31, 2013 and August 31, 2012.

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 :
The carrying amount of cash balances, accounts receivable, accounts payable and accrued expenses approximate their fair value based on the nature of those items. Estimated fair values of financial instruments are determined using available market information and appropriate valuation methodologies.  Considerable judgment is required to interpret the market data used to develop the estimates of fair value, and accordingly, the estimates are not necessarily indicative of the amounts that could be realized in a current market exchange.
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

The Company classifies shipping costs as a component of selling expenses.  Shipping costs totaled $11,826 and $10,468 for the nine months ended August 31, 2013 and August 31, 2012 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, 2013 and August 31, 2012 totaled 331,391and 316,363, respectively.

(14) Stock Based Compensation

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. The adoption of the new guidance in the first quarter of fiscal 2013 had no 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. The adoption of the new guidance in the first quarter of fiscal 2013 had no impact on our consolidated financial position, results of operations or cash flows.
(16) Reclassifications:

Certain amounts included in 2012 financial statements have been reclassified to conform to the 2013 presentation.
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
NOTE C - FIXED ASSETS

Fixed assets consist of the following:
August 31,
November 30,
2013
2012
Furniture and Fixtures
$
322,586
$
321,099
Leasehold Improvements
932,091
909,014
Computer Equipment
983,125
976,754
Less-Accumulated Depreciation
(2,164,772
)
(2,126,238
)
Net Fixed Assets
$
73,030
$
80,629

Depreciation and amortization expense for the nine months ended August 31, 2013 and August 31, 2012 was $38,534 and $41,334, respectively.

NOTE D -  ACCRUED EXPENSES
Accrued expenses consist of the following:

August 31,
November 30,
2013
2012
Commissions
$
268,827
$
238,003
Preferred Stock Dividends
188,707
176,857
Interest
102,399
102,399
Other accrued expenses
105,121
83,644
$
665,054
$
600,903
In March 2000, the Company completed a $7,000,000 private placement of convertible notes.  The face value of the notes was converted into common stock in July 2001 pursuant to the automatic conversion provisions of the notes.   However, approval by holders of the notes was required to convert the interest accrued on the notes to common stock. The accrued interest set forth in the Company’s financial statements relates to the portion of the accrued interest for which note holder approval was not obtained and therefore not converted into common stock.  No additional interest accrues on these amounts and none of the accrued interest was repaid during any of the periods presented.
NOTE E – RETIREMENT PLAN

In June 1997, the Company adopted a qualified 401(k) retirement 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 $898,000 at November 30, 2012. Pension expense for the nine months ended August 31, 2013 and August 31, 2012 was $4,673 and $2,766, respectively.
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

NOTE F – SHAREHOLDERS’ EQUITY
[1] Preferred Stock :

In February 1996, the Company amended its Certificate of Incorporation to authorize the issuance of 1,000,000 shares of preferred stock in one or more series. In August 2010, the number of preferred shares authorized for issuance was increased to 5,000,000 shares.
In January 2000, the Company authorized 260,000 shares of preferred stock as Non-Voting Redeemable Convertible Series A Preferred Stock (“Series A Preferred”). None of the Series A preferred stock is outstanding as of August 31, 2013.

In November 2000, the Company authorized 200,000 shares of preferred stock as Voting Redeemable Convertible Series B Preferred Stock (“Series B Preferred”). None of the Series B Preferred Stock is outstanding as of August 31, 2013.

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 our 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 $188,707 have not been declared or paid for the semiannual periods ended December 31, 2001 through the semiannual payment due June 30, 2013.  The Company has accrued these dividends.
In April 2002, in connection with a Mutual Release, Settlement, Standstill and Non-Disparagement Agreement 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 plus accrued dividends for $50,000.

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

At August 31, 2013 there are 23,700 shares of Series C Preferred issued and outstanding.
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

NOTE F – SHAREHOLDERS’ EQUITY (Continued)
[2] 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, directors or consultants to the Company to purchase an aggregate of 1,500,000 common shares.
Stock option incentive plan activity for the six months ended August 31, 2013 is summarized as follows:
Weighted
Average
Shares
Exercise Price
Options outstanding December 1, 2011
685,000
$
0.25
Options issued in the year ended November 30, 2012
50,000
$
0.51
Options exercised in the year ended November 30, 2012
(25,000
)
$
0.25
Options cancelled in the year ended November 30, 2012
(7,000
)
$
1.15
Options outstanding at August 31, 2013
703,000
$
0.37
Options exercisable at August 31, 2013
677,000
$
0.34

Stock Compensation

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.

In July 2012, the Company granted a stock option to one non-officer director to purchase 50,000 shares of common stock at an exercise price of $0.51, the market price of the common stock on the date of the grant.  This option vested immediately and expires in five years.  The fair value of this stock option is estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: expected volatility of 35% (based on stock volatility of public company industry peers); average risk-free interest rate of 0.67% (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) and no expected dividend yield.

The weighted average grant date fair value of the stock options granted during the year ended November 30, 2012 was $0.82.  During the nine months ended August 31, 2013, the Company recorded stock based compensation totaling $17,433 as a result of these stock option grants.

The intrinsic value of the exercisable options at August 31, 2013 totaled $268,750.  At August 31, 2013 the weighted average remaining life of the stock options is 2.59 years.  At August 31, 2013, there was $11,617 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 .375 years.
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

NOTE F – SHAREHOLDERS’ EQUITY (Continued)
[3] 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.

[4] Compensation of Directors

In May 2010, the Company issued 12,000 shares of its common stock to each non-officer director as compensation for services on the Board of Directors. These shares were valued at $0.18 per share, the closing price of the common stock on the over-the-counter market. Starting April 1, 2012, the amount directors each receive for their services on the Board of Directors was increased from $200 a month to $2,000 a month. 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. In July 2012, a stock option was granted to one non-officer director to purchase 50,000 shares of common stock at an exercise price of $0.51.  (See Note F[2] for disclosure on the valuation and terms of these options). In May 2012, one non-officer director exercised an option and acquired 25,000 shares of common stock for $6,250.
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.

The Company’s deferred income taxes are comprised of the following:
August 31,
November 30,
2013
2012
Deferred Tax Assets
Net operating loss
$
3,850,454
$
4,606,652
Allowance for bad debts
16,842
11,853
Inventory
303,328
311,730
Deferred Rent
13,687
10,186
Depreciation
182,810
187,302
Total deferred tax assets
4,367,121
5,127,723
Valuation allowance
(2,811,677
)
(3,551,738
)
Deferred Tax Assets
$
1,555,444
$
1,575,985

The valuation allowance for the deferred tax assets relates principally to the uncertainty of the utilization of deferred tax assets and was calculated in accordance with the provisions of ASC 740, which requires that a valuation allowance be established or maintained when it is “more likely than not” that all or a portion of deferred tax assets will not be realized. This valuation is based on management estimates of future taxable income. Although the degree of variability inherent in the estimates of future taxable income is significant and subject to change in the near term, management believes, that the estimate is adequate. The estimated valuation allowance is continually reviewed and as adjustments to the allowance become necessary, such adjustments are reflected in the current operations.
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
NOTE G – INCOME TAXES (CONTINUED)
The valuation allowance decreased by approximately $740,000 during the nine months ended August 31, 2013. This change in the valuation allowance is based on management estimates of future taxable income. The degree of variability inherent in the estimates of future taxable income is significant and subject to change in the near term. The Company reviews its estimates of future taxable income in each reporting period and adjustments to the valuation allowance are reflected in the current operations.

The Company's income tax expense consists of the following:
Nine Months Ended
August 31,
2013
August 31,
2012
Current:
Federal
$
22,285
$
193,860
States
26,091
18,904
48,376
212,764
Deferred:
Federal
-
-
States
-
-
-
-
Provision for income taxes
$
48,376
$
212,764
The Company files a consolidated income tax return with its wholly-owned subsidiaries and has net operating loss carryforwards of approximately $12,900,000 for federal and state purposes, which expire through 2020. 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,
August 31,
2013
2012
U.S Federal Income tax statutory rate
34
%
34
%
Valuation allowance
(32)
%
(14)
%
State income taxes
2
%
2
%
Other
-
-
Effective tax rate
4
%
22
%
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 $160,000 for the year ended November 30, 2012, 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 May 2013, the Company entered into a lease to rent office space and a warehouse in Hong Kong for two years. Annual minimum rental payments for this space are approximately $51,200.

The Company’s future minimum rental commitments at August 31, 2013 are as follows:
Twelve Months Ended
August 31,
2014
$
214,287
2015
$
211,620
2016
$
171,725
2017
$
175,159
2018
$
178,662
2019 & thereafter
$
398,843
$
1,350,296

Net rental expense for the nine months ended August 31, 2013 and August 31, 2012 were $225,262 and $184,628 respectively, of which $194,391 and $112,240 respectively, was paid to the Related Company.
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, 2014 (renewable on each July 30th for an additional one year period) with two officers 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 through August 31, 2013 totaling $150,000.  The agreements also contain 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 either officer 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 no customers who accounted for 10% of net sales for the nine months ended August 31, 2013 and one customer who accounted for 10% of net sales for the nine months ended August 31, 2012.  The Company had two customers who accounted for 12% and 13% of accounts receivable at August 31, 2013 and one customer who accounted for 19% of accounts receivable at November 30, 2012.

NOTE K- MAJOR SUPPLIERS

During the nine months ended August 31, 2013 and August 31, 2012 there was one foreign supplier accounting for 51% and 42% of total inventory purchased.

The Company purchases substantially all of its products overseas.  For the nine months ended August 31, 2013, the Company purchased 60% of its products from Taiwan, 13% from Hong Kong, 22% from elsewhere in Asia and less than 1% overseas outside of Asia. The Company purchases the balance of its products in the United States.

NOTE L - EXPORT SALES

The Company’s export sales were as follows:
Nine Months Ended
August 31,
August 31,
2013
2012
Canada
1,343,052
2,041,882
China
2,927,658
3,178,617
Other Asian Countries
522,738
1,079,456
South America
438,786 26,229
Europe
669,430
112,047
Revenues are attributed to countries based on location of customer.
SURGE COMPONENTS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
NOTE M – LINE OF CREDIT

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 accrued interest at 2.56% over the LIBOR rate. The line was collateralized by all the Company’s assets and included working capital and tangible net worth covenants. The credit line expired in March 2013.  The Company did not renew the credit line since it does not believe that such additional funds are required at this time.
This report contains forward-looking statements. All statements other than statements of historical facts contained herein, 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 our Annual Report on Form 10-K. Also, these forward-looking statements represent our estimates and assumptions only as of the date of the filing of this report. 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 Company operates with two sales groups, Surge Components (“Surge”) and Challenge Electronics (“Challenge”). Surge is a supplier of electronic products and components. These products include capacitors, which are electrical energy storage devices, and discrete semiconductor components, such as 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 sold by Surge are typically utilized in the electronic circuitry of diverse products, including, but not limited to, automobiles, audio products, temperature control products, lighting products, energy related products, computer related products, various types of consumer products, garage door openers, household appliances, power supplies and security equipment. These products are sold to both original equipment manufacturers, commonly referred to as OEMs, who incorporate them into their products, and to distributors of the lines of products we sell, who resell these products within their customer base. These products are manufactured predominantly in Asia by approximately sixteen independent manufacturers. We act as the master distribution agent utilizing independent sales representative organizations in North America to sell and market the products for one such manufacturer pursuant to a written agreement. When we act as a sales agent, the supplier who sold the product to the customer that we introduced to such supplier will pay us a commission. The amount of the commission is determined on a sale by sale basis depending on the profit margin of the product. Commission revenue totaled $452,734 and $215,644 for the nine months ended August 31, 2013 and August 31, 2012 respectively.

Challenge engages in the sale of electronic components, including audible components, alarms, chimes and battery related products. Challenge has increased the types of products it sells because some of its suppliers introduced new products, and it has also sourced other products from new suppliers. As a result, we are continually trying to expand our product line. In 2002 we started to import products and sold these under the Challenge name. It started with a line of transducers, and then we added battery snaps, and coin cell holders. Since 2002, we have increased our imported private label product mix to include buzzers, speakers, microphones, resonators, filters, and discriminators. Our suppliers customize many of the products we sell for many customers based on the customers’ own designs and those our suppliers redesign for them at our suppliers’ factories. We have an experienced design engineer on our staff with thirty years of experience who works with our suppliers on such redesigns. We continue to expand the product mix we sell. We sell these products through independent representatives that earn a 5-6% commission rate on the gross sale of the products we sell in their area. We also are working with local, regional, and national distributors to sell these products to local accounts in every state.
The Company has a Hong Kong office to effectively handle the transfer business from United States customers purchasing and manufacturing in Asia after designing the products in the United States. This office has strengthened the Company’s global capabilities and service to its customer base.
The electronic components industry has changed, from one of strong demand to now one of moderate demand. Management expects 2014 to continue with the moderate demand for components which started in 2012. Due to this worldwide reduction in demand, the Company could feel the effects of potentially reduced demand for its products.
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 customers, 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 from our factory to our customer, revenue is recognized when product is shipped from the Company’s supplier. The Company acts as a sales agent for certain customers buying direct from one of its suppliers. The Company reports these commissions as revenues in the period earned.
The Company performs ongoing credit evaluations of its customers and maintains reserves for potential credit losses.
Inventory Valuation
Inventories are recorded at the lower of cost or market. Write-downs of inventories to market value are based on stock rotation, historical sales requirements and obsolescence as well as in the changes in the backlog. Reserves required for obsolescence were not material in any of the periods in the financial statements presented. 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 $38,000.
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.

Income Taxes

We have made a number of estimates and assumptions relating to the reporting of a deferred income tax asset to prepare our financial statements in accordance with generally accepted accounting principles. These estimates have a significant impact on our valuation allowance relating to deferred income taxes. Our estimates could materially impact the financial statements.

Results of Operations
Comparison of nine and three months ended August 31, 2013 and August 31, 2012
Consolidated net sales for the nine months ended August 31, 2013 increased by $1,141,588 or 7%, to $18,033,342 as compared to net sales of $16,891,754 for the nine months ended August 31, 2012. Consolidated net sales for the three months ended August 31, 2013 increased by $896,698 or 15% to $6,955,770 as compared to net sales of $6,059,072 for the three months ended August 31, 2012. We largely attribute the increase primarily to increased business with existing customers as well as increased business from new customers, offset by decreases in sales by two of the Company's distributors.
Our gross profit for the nine months ended August 31, 2013 was $5,096,745, an increase of $135,224, or 3%, as compared to $4,961,521 for the nine months ended August 31, 2012. Gross profit as a percentage of net sales, or profit margin, decreased to 28.3% for the nine months ended August 31, 2013 compared to 29.4% for the nine months ended August 31, 2012. Our gross profit for the three months ended August 31, 2013 was $1,876,168, an increase of $143,165 or 8%, as compared to $1,733,003 for the three months ended August 31, 2012. Our profit margin for the three months ended August 31, 2013 decreased to 27.0% compared to 28.6% for the three months ended August 31, 2012. The Company attributes the increase in gross profit to the increase in sales and attributes the decrease in profit margin to two main distributors having shifted to lower profit margin items, as well as an increase in volume of a lower profit margin item from one existing customer as compared to the nine months ended August 31, 2012, which was comprised of more higher profit margin items. The increase in volume from our existing customer relates to a new product line of the customer. There is no assurance that the customer will continue this product line or that the customer will continue to purchase components for the product line from us.

Selling and shipping expenses for the nine months ended August 31, 2013 was $1,514,226, a decrease of $84,521, or 5%, as compared to $1,598,747 for the nine months ended August 31, 2012. Selling and shipping expenses for the three months ended August 31, 2013 was $513,407, a decrease of $41,041 or 7% as compared to $554,448 for the three months ended August 31, 2012. The decrease was due to a decrease in commission expenses due to higher non commissionable sales, and auto expenses offset by the Company hiring an additional salesperson and increased travel expenses.

General and administrative expenses for the nine months ended August 31, 2013 was $2,377,194, an increase of $41,279, or 2%, as compared to $2,335,915 for the nine months ended August 31, 2012. The increase is due to the increase in rent, salaries, allowance for doubtful accounts,general insurance expenses and an increase in director’s fees that took effect in April of 2012 as partially offset by the reduction in officer bonus accrual, office and promotion expenses and expenses from the Company’s 30th Anniversary party in 2012. General and administrative expenses for the three months ended August 31, 2013 was $807,919, an increase of $63,662 or 9% as compared to $744,257 for the three months ended August 31, 2012. The increase is due to the hiring of additional employees and increased costs of insurance, rent, an increase in allowance for doubtful accounts as well as increases in computer and consulting expenses as partially offset by the decrease in professional fees, as well as decreases in office and maintenance expenses.

Depreciation expense for the nine months ended August 31, 2013 was $38,534, a decrease of $2,800 or 7%, as compared to $41,334 for the nine months ended August 31, 2012. Depreciation expense for the three months ended August 31, 2013 was $13,940, a decrease of $56 or less than 1%, as compared to $13,996 for the three months ended August 31, 2012. The decrease is due to assets becoming fully depreciated.

Income tax expense for the nine months ended August 31, 2013 was $48,376, a decrease of $164,388, or 77% as compared to $212,764 for the nine months ended August 31, 2012. Income tax expense for the three months ended August 31, 2013 was $1,602, a decrease of $8,687 or 84% as compared to $10,289 for the three months ended August 31, 2012. The decrease is a result of management’s revised estimate of future taxable income and the related impact on the reported deferred tax.

As a result of the foregoing, net income for the nine months ended August 31, 2013 was $1,121,854, compared to the net income of $774,538 for the nine months ended August 31, 2012. As a result of the foregoing, net income for the three months ended August 31, 2013 was $540,336 as compared to $410,747 for the three months ended August 31, 2012.
Liquidity and Capital Resources

As of August 31, 2013 we had cash of $3,114,048, and working capital of $8,792,362. We believe that our working capital levels are adequate to meet our operating requirements during the next twelve months.

We had net cash flow used in operating activities of $(298,981) for the nine months ended August 31, 2013, as compared to net cash flow from operating activities of $1,334,106 for the nine months ended August 31, 2012. The decrease in cash flow from operating activities resulted from an increase in accounts receivable, as well as an increase in inventory due to an increase in excess inventory that we hold for certain customers, as partially offset by an increase in net income, and an increase in accounts payable

We had net cash flow used in investing activities of $(30,935) for the nine months ended August 31, 2013, as compared to net cash flow used in investing activities of $(11,339) for the nine months ended August 31, 2012. The Company purchased new equipment and furniture for their new offices in Hong Kong during the nine months ended August 31, 2013.

We had net cash flows provided by financing activities of $0 for the nine months ended August 31, 2013, as compared to net cash flow provided by financing activities of $6,250 for the nine months ended August 31, 2012. The increase in cash flow from financing activities resulted from a non-executive board member exercising an option and acquiring 25,000 shares of common stock during the nine months ended August 31, 2013.

As a result of the foregoing, the Company had a net decrease in cash of $329,916 for the nine months ended August 31, 2013, as compared to a net increase in cash of $1,329,017 for the nine months ended August 31, 2012.
In June 2011, the Company replaced its existing credit line with a line of credit with JP Morgan Chase Bank totaling $1,000,000. Borrowings under the line accrued interest at 2.56% over the LIBOR rate. The line was collateralized by all the Company’s assets and included working capital and tangible net worth covenants. The credit line expired in March 2013. The Company did not renew the credit line since it does not believe such additional funds are required at this time.

The Company intends to maintain its current cash along with cash generated from operations to fund its current operations and to execute its plans, which may include potential merger and acquisition activities and investments to expand the Company’s core businesses.

The table below sets forth our contractual obligations, including long-term debt, operating leases and other long-term obligations, as of August 31, 2013.
Payments due
0 – 12
13 – 36
37 – 60
More than
Contractual Obligations
Total
Months
Months
Months
60 Months
Long-term debt
$
-
$
--
$
--
$
--
$
--
Operating leases
$
1,350,296
214,287
383,345
353,821
398,843
Employment agreements
$
412,500
412,500
--
--
--
Total obligations
$
1,762,796
$
626,787
$
383,345
$
353,821
$
398,843

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.
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements.
Not Applicable.


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 principal 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, 2013 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 the three months ended August 31, 2013, 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.
OTHER INFORMATION
There are no legal proceedings to which the Company or any of its property is the subject.

Not applicable.


None


None.

Not applicable
None.
ITEM 6. EXHIBITS.
Exhibit Number
Description
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.
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 15, 2013
By:
/s/ Ira Levy
Name: Ira Levy
Title: Chief Executive Officer (Principal Executive Officer,
Principal Financial Officer and Principal Accounting Officer)
26
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