SurgePays, Inc. (formerly Surge Holdings, Inc.) — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. The unaudited consolidated results include the ECS businesses acquired in 2019; the company changed its name to SurgePays, Inc. on October 29, 2020.
Business context and financial performance
The company serves financially underserved customers through prepaid wireless and fintech services, retail merchant software and distribution, and digital marketing. ECS provides prepaid wireless loads, check cashing and SIM activation. Its inclusion materially increased reported revenue, so year-over-year growth is not solely organic.
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $12.80 million | $4.90 million | $43.10 million | $12.30 million |
| Gross profit | $1.59 million | $1.88 million | $3.68 million | $4.48 million |
| Gross margin | 12.4% | 38.3% | 8.5% | 36.4% |
| Operating loss | $1.62 million | $1.14 million | $8.33 million | $4.78 million |
| Net loss | $2.50 million | $1.15 million | $7.98 million | $5.27 million |
| Basic and diluted loss per share | $0.02 | $0.01 | $0.07 | $0.06 |
Q3 revenue rose 161%, primarily reflecting $8.28 million of ECS revenue and higher Surge Logics revenue, partly offset by lower True Wireless and Blockchain revenue. Nine-month revenue rose 251%, including $27.08 million from ECS. Gross profit nevertheless declined in both comparison periods, and gross margin contracted sharply as cost of revenue rose.
Nine-month SG&A increased 21% to $11.14 million, including $1.63 million of bad-debt expense, versus $7,841 a year earlier. Interest expense rose to $2.35 million from $93,157. The nine-month results also included a $2.56 million gain on settlement of liabilities, a $529,294 derivative expense, and a $405,413 gain from changes in derivative fair value.
Cash flow, debt and liquidity
- Cash was $421,315 at September 30, 2020, versus $346,040 at December 31, 2019. Operating cash use was $3.38 million for the first nine months, partly funded by $3.44 million of financing cash inflows. Investing activities provided $10,812.
- The balance sheet reports current assets of $1.20 million and current liabilities of $11.97 million, implying a $10.77 million working-capital deficit. Management likewise reports a $10.77 million deficit, but gives current assets as $1.18 million in its discussion.
- Total liabilities were $16.57 million, compared with assets of $7.66 million, and stockholders’ deficit was $8.91 million. The filing lists $7.28 million of future debt maturities, excluding debt discounts; the balance sheet also shows a $912,870 line of credit and substantial related-party and convertible debt.
- Convertible borrowing generated significant noncash financing costs and derivative accounting. Derivative liabilities were reported at approximately $1.42 million at quarter-end. Common shares outstanding increased from 102.2 million at year-end 2019 to 116.2 million at September 30, and 118.9 million as of November 12, 2020.
- The company received a $498,082 PPP loan and $636,000 in SBA Economic Injury Disaster Loans. PPP forgiveness was expected by the company but was not established as completed in the filing.
Management outlook, risks and unusual items
Management projected that the company would become cash-flow positive by the end of Q1 2021, relying on operating growth, collection of receivables and restructuring current debt. It said additional debt or equity financing might be available, but gave no assurance. This is management’s projection, not a reported result or guarantee. Management stated that operations at the then-current level required borrowing to meet basic costs and that going-concern viability depended on executing its plan, generating revenue, controlling expenses and potentially raising capital.
Key risks include the severe working-capital deficit, ongoing losses, debt maturities and financing dependence, COVID-19 effects on the economy, supply chain and capital access, competition, and customer and receivable concentration. One customer represented more than 12% of 2020 revenue; one customer accounted for approximately 47% of gross receivables at quarter-end. The company also reported that disclosure controls were not effective because of inadequate segregation of duties, no audit committee and insufficiently documented controls.
Material items include the ECS acquisition and related debt conversion: the $4.0 million GBT note was converted in June into 8.0 million shares, with a reported $2.08 million settlement gain. The company settled a Unimax dispute for $785,000 payable over 24 months. It also disclosed an FCC notice proposing a $5.50 million forfeiture related to alleged ineligible subscriber lines; management disputed the claim and said it did not expect a material effect. Related-party relationships include borrowings from entities owned by company officers and substantial service purchases from CenterCom, which is controlled by a company director and officer.
Most important facts to verify
- Reconcile the filing’s conflicting balance-sheet figures: the statements show total assets of $7.66 million and current assets of $1.20 million, while MD&A gives $7.64 million and $1.18 million, respectively. Confirm the correct values and whether the differences affect related disclosures.
- Assess the sustainability and cash conversion of ECS-driven revenue, the sharp gross-margin decline, and the large bad-debt expense and receivable concentration.
- Check cash availability, debt maturities and payment extensions, conversion terms, potential dilution, and the feasibility of management’s Q1 2021 cash-flow-positive projection.
- Confirm the status of PPP forgiveness, the Unimax settlement payments, and the FCC forfeiture matter.
- Review remediation of ineffective disclosure controls and governance, and the terms and oversight of related-party financing and CenterCom transactions.