Surge Holdings, Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019; filed May 12, 2020. The filing identifies the registrant as Surge Holdings, Inc. The company’s business spans telecommunications, financial technology, merchant software and digital advertising, focused primarily on underserved customers and small retailers. The filing was delayed under SEC COVID-19 relief provisions.
Financial results and position
| Metric | 2019 | 2018 |
|---|---|---|
| Revenue | $25.74 million | $15.24 million |
| Cost of revenue | $20.31 million | $8.57 million |
| Gross profit / margin | $5.44 million / 21.1% | $6.67 million / 43.8% |
| Operating loss | $7.77 million | $1.54 million |
| Net loss | $8.45 million | $1.54 million |
| Net loss per share | $0.09 | $0.02 |
| Cash used in operating activities | $6.53 million | $1.02 million |
- Revenue rose 69%, primarily reflecting $10.77 million from the ECS business and growth in Surge Logics and Surge Blockchain. True Wireless revenue fell by about $9.35 million, from $12.80 million to $3.45 million; management cited its decision to exit government-subsidized telecom and shift toward national, non-subsidized offerings.
- Gross profit declined 19%, as True Wireless gross profit fell substantially. SG&A increased 61% to $12.98 million, including higher staffing, contractors, marketing, bad-debt expense and a $547,000 one-time merchant-location activation fee.
- At year-end, cash was $346,040; current assets were $3.57 million and current liabilities $7.05 million, creating a $3.48 million working-capital deficit. Total assets were $9.99 million, total liabilities $14.69 million, and stockholders’ deficit $4.70 million.
- Debt maturities disclosed for 2020–2022 totaled $8.52 million, before debt discounts. Year-end liabilities included $4.44 million of net convertible notes, $2.21 million of long-term related-party debt, a $912,870 line of credit, and $736,172 of notes and current long-term debt. Debt carrying values and maturity totals may differ in scope.
- Financing provided $6.47 million of cash in 2019, including $3.21 million from common-stock and warrant sales. Cash nevertheless declined by $98,572 over the year.
Material changes and transactions
- In September 2019, the company acquired substantially all assets and specified liabilities of GBT’s ECS businesses for $5 million: a $4 million non-interest-bearing convertible note and 3,333,333 restricted shares valued at $1 million. ECS brought a network of over 9,800 retail locations and 160 independent sales organizations. The purchase-price allocation was reported as not yet finally valued in the filing.
- Revenue mix shifted considerably: ECS contributed $10.77 million in its partial-year period, while True Wireless contracted. Surge Logics generated $7.23 million in 2019 revenue.
- The company acquired a 40% interest in Centercom, a related-party service provider, for consideration recorded at $178,508. Centercom is controlled by a company officer/director; the company also reported $2.38 million of Centercom service billings in 2019.
- Common shares outstanding increased from 88.05 million to 102.19 million during 2019. Series C preferred shares increased to 721,598. The GBT note and other convertible securities, warrants and preferred stock create additional potential dilution.
Outlook, risks and unusual items
- Management projected the company could become cash-flow positive by the end of Q3 2020, relying on operating growth, collections of receivables and debt restructuring. This was a forward-looking target, not a reported result. Management said continued operations depended on executing its plan, increasing revenue, controlling expenses and potentially obtaining further financing; it gave no assurance financing would be available.
- The auditor issued an unmodified opinion on the financial statements but included a going-concern emphasis. The company reported recurring losses, negative working capital and COVID-19-related uncertainty regarding operations, supply chains and access to capital.
- Disclosure controls and internal control over financial reporting were deemed ineffective at December 31, 2019 due to inadequate segregation of duties and limited resources for financial reporting. The auditor did not express an opinion on internal-control effectiveness.
- Credit and collection risks are notable: one customer represented more than 16% of 2019 revenue, and one customer represented approximately 80% of year-end gross receivables. The allowance for doubtful accounts was $774,841.
- Related-party arrangements include $1.02 million of 2019 outsourced management fees paid to an entity owned by the CEO, telecom purchases from a company in which the CEO held an interest, and services from Centercom, controlled by another officer/director. The CEO also controlled voting power through common and preferred holdings.
- The filing describes a pending warrant-enforcement lawsuit and an FCC notice proposing a $5.50 million forfeiture related to alleged historical subscriber-line issues. Management disputed the FCC claim and said it believed any resulting amount would not materially affect financial position. The filing also cites regulatory, Lifeline-program, competitive, financing, dilution and COVID-19 risks.
- Subsequent to year-end, the company raised additional funds through debt transactions with stated rates generally between 14% and 18%, with shares also issued as consideration. It reported a January 2020 settlement terminating DigitizeIQ promissory notes and reducing liabilities by approximately $580,000 on an unaudited basis.
Investor verification priorities
- Verify actual post-filing cash generation, receivable collections and progress against the Q3 2020 cash-flow-positive target; assess the substantial operating cash outflow and working-capital deficit.
- Review the ECS purchase accounting, realized contribution to gross profit and integration progress, including the note’s conversion terms and debt repayment requirements.
- Reconcile outstanding debt, maturities, subsequent financings, related-party balances and potential share dilution from convertible notes, preferred stock and warrants.
- Assess the collectability and concentration of receivables, the large bad-debt provision, and customer concentration in revenue.
- Track remediation of control weaknesses and evaluate the significant related-party transactions and governance structure.
- Check developments in the FCC matter, pending litigation and COVID-19 effects. The filing does not provide a definitive outcome for these matters.