Surge Holdings, Inc. (identified in the request as SurgePays, Inc.) — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. The filing’s registrant name is Surge Holdings, Inc. Financial statements are unaudited.
Business context
The company operates telecom, digital media and financial-technology businesses serving financially underserved customers. Results include ECS, acquired in 2019 and consolidated in 2020; ECS provides prepaid wireless loads, check cashing and SIM activation. Surge Logics provides digital advertising and lead-generation services.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $14.51 million | $3.45 million | $30.30 million | $7.39 million |
| Gross profit | $1.11 million | $1.14 million | $2.10 million | $2.60 million |
| Gross margin | 7.7% | 33.1% | 6.9% | 35.2% |
| Operating loss | $3.94 million | $2.53 million | $6.71 million | $3.64 million |
| Net loss | $2.43 million | $2.47 million | $5.48 million | $4.12 million |
| Basic and diluted loss per share | $0.02 | $0.03 | $0.05 | $0.04 |
- Revenue rose 320% in Q2 and 310% in the first half, largely from ECS revenue of $9.06 million in Q2 and $18.80 million year to date, plus growth at Surge Logics. Gross profit nevertheless fell in both comparisons as cost of revenue grew faster than sales.
- Q2 SG&A included $1.63 million of bad-debt expense, attributed to receivables from the initial SurgePays Portal rollout. Interest expense increased to $701,000 in Q2 and $1.18 million for the first half, primarily due to higher borrowings.
- Other income included a $2.56 million first-half gain on settlement of liabilities, including a $2.08 million gain associated with conversion of the GBT note. This materially offset operating losses.
Cash, liquidity and debt
- At June 30, cash was $339,797; current assets were $1.54 million and current liabilities were $11.06 million, leaving a $9.52 million working-capital deficit. Total assets were $8.17 million, total liabilities $15.13 million, and the balance sheet reported a stockholders’ deficit of $6.96 million.
- For the first half, operating cash use was $2.23 million, investing cash use was $2,836, and financing provided $2.23 million. Cash declined by $6,243 from $346,040 at year-end 2019.
- The balance sheet included a $912,870 line of credit, $725,301 of net current convertible notes and current debt, $887,312 of notes and long-term debt before classification between current and long-term portions, and $2.21 million of long-term related-party debt. The company reported $1.45 million of derivative liabilities. Debt maturities, excluding debt discounts, total $6.17 million; $1.26 million is due in the remainder of 2020 and $3.16 million in 2021.
- Debt financing included multiple 14% notes with equity-linked conversion provisions and shares or warrants issued as additional consideration. The company also reported a $498,082 Bank3 PPP loan and a $150,000 SBA loan. The filing gives conflicting timing descriptions for receipt of the PPP funds; see verification points below.
Changes, outlook and risks
- The ECS acquisition substantially changed the revenue mix and added retail distribution reach. Surge Logics generated $9.91 million of first-half revenue, compared with $2.38 million a year earlier; True Wireless and Blockchain revenue declined from prior-year levels.
- Management said it expected to become cash-flow positive by the end of Q3 2020, relying on operating growth, receivables collections and debt restructuring. It also anticipated possible debt or equity financing and continued acquisitions. These are forward-looking expectations, not reported results.
- Management stated that substantial doubt considerations depended on implementing the business plan, generating sufficient revenue, controlling expenses and potentially raising additional funds. It warned that COVID-19 could affect the economy, supply chain and access to capital. The company also said it needed to borrow to meet basic operating costs.
- Disclosure controls were reported as ineffective due to inadequate segregation of duties, no audit committee and insufficiently documented controls; management said control development was in progress. Related-party relationships include management-owned service providers and loans, and a director/officer’s controlling interest in Centercom, which provides services to the company.
- The company disclosed a longstanding FCC proposed forfeiture of $5.50 million relating to alleged ineligible subscriber lines in 2012–2013. Management considered it without merit and said any resulting amount would not materially affect financial position. The filing also describes settlement of DigitizeIQ disputes and termination of related notes.
Important facts to verify
- Reconcile inconsistencies in the filing: the balance sheet reports stockholders’ deficit of $6.96 million, while MD&A states $6.74 million; MD&A also gives a different net-loss amount in its deficit discussion. Segment operating-loss totals do not exactly match the consolidated statement.
- Confirm the PPP loan’s timing and accounting: MD&A says the $498,082 loan closed April 17, 2020, while a subsequent-events note says PPP funds were received after period-end.
- Assess receivables quality and bad-debt accounting, including the $1.63 million bad-debt charge, the reported $814,578 net receivable balance, and the stated zero allowance at June 30.
- Review debt maturities, default and conversion terms, derivative-liability valuations, dilution exposure, and the company’s capacity to meet near-term obligations.
- Evaluate the sustainability and cash impact of the reported settlement gains, related-party dealings, and management’s Q3 cash-flow-positive projection; also monitor remediation of ineffective controls and the FCC contingency.