Surgepays, Inc. quarterly report, Q1 FY2018

Business Context and Reporting Period

Surge Holdings, Inc. (the issuer named in the filing; the request identifies Surgepays, Inc.) filed this unaudited Form 10-Q for the quarter ended March 31, 2018. Its operations included digital advertising and lead generation through KSIX and DigitizeIQ, with new blockchain and cryptocurrency-mining activities. The company reported that its first mining farm, with 100 Antminer L3+ machines, was operating by quarter-end.

Financial Results and Liquidity

Cash from financing was $388,427, including $460,000 from stock sales and $71,573 of related-party debt repayment. Investing activities used $13,610 for property and equipment. The company reported a $1,932,890 working-capital deficit and an accumulated deficit of $8,273,276. Notes payable and long-term debt totaled $721,250; separate obligations included $241,000 of related-party notes, $390,948 of related-party advances, and a $336,726 credit-card liability. The filing does not provide a clear consolidated total for all these obligations.

Material Changes Versus the Prior Comparable Period

• Revenue declined about 2%, while gross profit fell about 42%, and gross margin contracted from 66.4% to 39.1%. Management attributed the margin decline mainly to blockchain costs exceeding blockchain revenue. New blockchain and crypto revenue partly offset lower KSIX and DigitizeIQ revenue.
• SG&A decreased 51% to $507,833, principally because Q1 2017 included substantial stock-based consultant costs related in part to the planned True Wireless transaction. Operating and net losses narrowed; lower interest expense and gains on derivative revaluation and debt settlement also contributed to the improved net loss.
• Operating cash use increased substantially year over year. Cash nevertheless rose by $27,925 during Q1, supported by equity financing.
• At March 31, 2018, common shares outstanding were reported as 79,888,784. The filing reports 231,749,200 shares outstanding as of May 7, 2018, following subsequent issuances.

Outlook, Risks, Contingencies, and Unusual Items

• Going concern: Management cited insufficient operating revenue, recurring losses, and the working-capital deficit as substantial uncertainty about continued operations. The company depended on raising equity, reducing debt, growing subsidiary cash flows, and completing the True Wireless transaction. The filing gives inconsistent timing for expected positive cash flow: after Q2 in the financial-statement note and by Q3 in MD&A. These are projections, not guarantees.
• True Wireless merger after quarter-end: On April 11, 2018, the company completed the merger. Consideration included 152,555,416 newly issued common shares intended to give TW holders 69.5% ownership, 3,000,000 Series A preferred shares, and a $3 million note bearing 3% interest and due December 31, 2018. The filing states total consideration of approximately $65.5 million. The post-closing shares and consideration represent a major change from the March 31 balance sheet.
• Other subsequent issuances: The company issued 525,000 common shares to consultants on April 25 and 1,156,587 shares in a settlement on May 7. Q1 itself included $460,000 of stock-unit sales and 92,105 shares issued for $35,000 of consulting fees.
• Debt and related parties: Several debt obligations were past due, including notes to former officers and notes associated with the DigitizeIQ acquisition; the company said it was renegotiating the latter. The CEO had advanced funds for working capital. A $68,973 unit-redemption note was settled for $10,000 cash, producing a reported $66,723 gain including accrued interest.
• Legal matters: West Publishing claimed $435,700 from DigitizeIQ; the company disputed the claim and the outcome was uncertain. A previously dismissed American Express action related to the $336,726 credit-card balance could potentially lead to an indemnification claim, though none had been made as of the filing.
• Controls: Management concluded disclosure controls were not effective, citing lack of segregation of duties, an audit committee, and documented controls. Management said it was developing controls following a change in management.
• The company reported no material off-balance-sheet arrangements and marked risk factors as not applicable in this filing. No formal revenue or earnings guidance was provided.

Important Facts for Investors to Verify

1. Reconcile the filing’s Q2 versus Q3 cash-flow-positive projections and assess whether financing and operating assumptions were achieved.
2. Review the True Wireless merger’s final share count, 69.5% ownership calculation, valuation, preferred-stock terms, and $3 million note obligations, including subsequent dilution.
3. Confirm current liquidity, cash burn, and the status, maturity, and terms of overdue and related-party obligations.
4. Track the West Publishing dispute and any potential indemnification exposure tied to the credit-card matter.
5. Assess whether the identified disclosure-control deficiencies have been remediated and whether operating results support the company’s growth plans.