Business context and reporting period
Surge Holdings, Inc. (the filing entity; the request identifies Surgepays, Inc.) reported unaudited results for the quarter and six months ended June 30, 2019. Its businesses include subsidized and discounted wireless services, merchant software and distribution, fintech initiatives, and digital media. The filing says the company had exited cryptocurrency and digital-asset operations.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $3.45 million | $4.05 million | $7.39 million | $7.49 million |
| Gross profit | $1.14 million | $1.89 million | $2.60 million | $3.57 million |
| Gross margin | 33.1% | 46.5% | 35.2% | 47.6% |
| Operating income (loss) | $(2.53) million | $(0.19) million | $(3.64) million | $0.22 million |
| Net income (loss) | $(2.47) million | $(0.38) million | $(4.12) million | $0.03 million |
For the first half, operating cash flow was $(3.29) million, compared with $0.44 million provided in 2018. Investing cash flow was zero; financing provided $4.29 million, including $2.98 million of common-stock proceeds. Cash increased by $0.99 million to $1.44 million.
At June 30, 2019, balance-sheet figures included total assets of $5.25 million, total liabilities of $7.07 million, and stockholders’ deficit of $1.82 million. Current assets of $3.79 million compared with current liabilities of $5.28 million, a working-capital deficit of $2.56 million. Reported borrowings included a $0.93 million line of credit, $0.53 million of notes payable/current debt, and $1.11 million of long-term related-party debt. The line of credit is secured by substantially all company assets and personally guaranteed by the majority voting shareholder.
Material changes versus prior comparable periods
- Q2 revenue fell 14.8% year over year and gross profit fell 39.4%; management attributed the declines primarily to lower True Wireless revenue. First-half revenue declined 1.2%, while gross profit declined 27.0%.
- SG&A increased 81.7% in Q2 and 89.4% for the first half. Drivers included higher advertising and marketing, compensation, contractors and consultants, and a $547,000 one-time AATAC location activation fee.
- Common shares outstanding increased from 88.0 million at December 31, 2018 to 98.0 million at June 30, 2019. The company sold 8.52 million shares and 4.04 million warrants during the first half for gross proceeds of $2.89 million; warrants are exercisable at $0.75 per share.
- The company acquired a 40% interest in Centercom, a related-party service provider, in January 2019 and recorded a first-half equity-method gain of $64,775.
Outlook, risks, contingencies, and unusual items
- Management expected to fulfill an initial $2.8 million of Android-phone and SIM-kit purchase orders in Q3 as part of a rollout targeting the AATAC network of up to 40,000 retail locations. It also targeted a Q3 launch of its SurgePays prepaid Visa card. These are management plans, not guaranteed outcomes.
- Management projected positive operating cash flow by year-end 2019, dependent on revenue growth, expense control, debt restructuring, and additional financing. It said it had arrangements with a FINRA-licensed broker and institutional investors to pursue equity funding, while acknowledging there was no assurance of success.
- The filing reports a $4.1 million first-half net loss and a $2.6 million working-capital deficit, and says the company must borrow to meet basic operating costs. Management’s ability to continue as a going concern depends on executing its plans and obtaining sufficient revenue or financing.
- The FCC had proposed a $5.50 million forfeiture concerning alleged ineligible subscriber-line support in 2012–2013. Management disputed the claim and believed any resulting amount would not materially affect the company; the matter remained a contingency.
- Other disclosed legal matters included a pending dispute over a purported warrant for 100,000 shares. The filing also reports related-party transactions, including management-affiliated service providers and the Centercom investment.
- Management said disclosure controls were ineffective because of inadequate segregation of duties, no audit committee, and insufficient documented controls. The company was developing controls; no other significant internal-control changes were reported for the quarter.
Important facts for investors to verify
- Confirm the status, timing, and actual economics of the AATAC rollout, the expected Q3 purchase-order fulfillment, and the prepaid Visa launch.
- Assess whether the company raised the financing needed to fund operations, reduce debt, and meet its stated Nasdaq objectives; verify the timing and dilution of any subsequent securities issuance.
- Reconcile liquidity and debt disclosures. The balance sheet reports $5.25 million of assets and $7.07 million of liabilities, while MD&A gives lower totals that appear to omit right-of-use lease assets and liabilities.
- Review the FCC forfeiture contingency, the pending warrant litigation, and the company’s progress in remediating ineffective disclosure controls.
- Evaluate related-party arrangements and the company’s reliance on related-party financing and service providers.