SurgePays, Inc. — Q1 2021 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three months ended March 31, 2021, compared with the three months ended March 31, 2020. SurgePays describes itself as a technology-driven provider of wholesale products and services to convenience and other neighborhood stores, with businesses spanning prepaid wireless, Lifeline service, payment services and digital marketing. Its distribution network reaches more than 8,000 outlets.
Financial performance and position
| Metric | Q1 2021 | Q1 2020 or comparison |
|---|---|---|
| Revenue | $10.99 million | $15.79 million; down 30% |
| Gross profit / margin | $1.13 million / 10.3% | $0.73 million / 4.6% |
| Operating loss | $2.11 million | $2.77 million |
| Net loss | $4.82 million; $0.04 per share | $3.06 million; $0.03 per share |
| Operating cash flow | $(3.44) million | $(1.04) million |
| Investing cash flow | $(2,615) | $(3,072) |
| Financing cash flow | $4.37 million | $1.14 million |
| Cash at period end | $1.60 million | $0.67 million at Dec. 31, 2020 |
| Total assets / liabilities | $8.79 million / $19.18 million | $7.33 million / $18.05 million at Dec. 31, 2020 |
| Working capital | Deficit of $12.42 million | Deficit of $14.05 million at Dec. 31, 2020 |
| Stockholders’ deficit | $10.39 million | $10.73 million at Dec. 31, 2020 |
Revenue declined primarily at ECS (down $2.83 million) and LogicsIQ (down $2.04 million), with a further decline in Surge Blockchain; True Wireless revenue increased $338,000. Gross profit improved $403,000, largely due to a reported $644,000 increase in True Wireless gross profit. Selling, general and administrative expense fell 6% to $3.02 million; advertising and marketing expense rose to $447,000 from $101,000.
Other expense increased to $2.71 million from $292,000. Interest expense rose to $1.30 million, and derivative expense was $1.78 million, partly offset by a $304,000 gain from the change in fair value of derivative liabilities. These items contributed to the larger net loss despite improved gross profit and lower operating loss.
Debt, liquidity and material changes
- The company reported $1.60 million in cash and a $12.42 million working-capital deficit at March 31. Current liabilities were $14.97 million, including $2.73 million of derivative liabilities, $3.62 million of related-party debt, and a $912,870 line of credit.
- Total liabilities increased $1.13 million from year-end. The debt-maturity schedule lists $9.88 million due, excluding debt discounts, including $7.58 million for the remainder of 2021 and $2.30 million in 2022.
- In March, SurgePays issued Evergreen Capital Management a $2.30 million-face convertible note for $2.00 million in proceeds, with a 15% original issue discount, a stated 5% annual rate in the transaction description, and a March 2022 maturity. Conversion terms include a $0.16 price and a lower default price tied to VWAP. The associated warrant covers up to 13,437,500 shares. The filing also records a substantial debt discount and derivative liability for the financing.
- Related-party notes payable to an entity owned by the CEO had $4.60 million principal outstanding at quarter-end, with additional accrued interest. The company also reported a $1.0 million secured line of credit that matured April 24, 2021; the filing does not clearly state its subsequent repayment or extension status.
- Financing activities included $1.51 million from common-stock sales, $1.26 million in related-party borrowings, and other note borrowings and repayments. Common shares outstanding were 152.85 million at March 31; the cover reports 151.78 million at May 14.
Outlook, risks and unusual items
- Management expected continuing net losses and did not expect positive operating cash flow until the fourth quarter of 2021. It anticipated funding operations through related- and non-related-party promissory notes, and attributed its expected improvement partly to easing COVID-19 effects and fuller implementation of its sales strategy. This is management’s expectation, not formal quantified guidance.
- Management said the company needed to borrow to meet basic operating costs and that economic uncertainty could make it harder to raise funds for planned acquisitions. The filing describes intense competition, variable demand and sales, and difficulty projecting results.
- Contingencies include an FCC proposed forfeiture of approximately $5.50 million, which management considers without merit; an Oklahoma regulatory case seeking a fine over $100,000 and possible license revocation; a Florida dispute with a claim exceeding $1.70 million; and other pending disputes, including litigation involving Glen Eagles. The company disputes the claims described. Subsequent to quarter-end, it reported satisfaction of a $793,147 Unimax judgment settlement.
- The company reported $1.78 million of derivative expense and volatile fair-value accounting for derivative liabilities. The Evergreen financing and other convertible or warrant-linked instruments may create material dilution; the filing lists 31.999 million potentially dilutive shares excluded from diluted EPS as anti-dilutive.
- Internal-control disclosures are inconsistent: management describes disclosure controls as effective in one passage, but elsewhere says controls were not effective due to lack of segregation of duties, an audit committee and documented controls. The risk-factors section says “Not applicable,” despite disclosed financing, regulatory and litigation risks.
Important facts investors should verify
- Cash-flow and liquidity discrepancies: the financial statements report operating cash use of $3.44 million and a $928,479 increase in cash, while MD&A gives operating cash use of $3.75 million and a $611,206 increase. MD&A also presents different current-liability and working-capital figures from the balance sheet. Reconcile these amounts to the filed statements and underlying records.
- Financing terms and maturity status: confirm the Evergreen note’s stated interest and conversion provisions, the line-of-credit status after its April 24, 2021 maturity, and the status of near-term debt maturities and subsequent financing.
- Share count and dilution: reconcile the March 31 share count with the lower May 14 cover-page count and assess potential issuance under convertible notes, warrants and other equity-linked instruments.
- Controls and contingencies: clarify management’s conflicting control-effectiveness statements and track developments in the FCC, Oklahoma, Florida, Glen Eagles and other disclosed matters.
- Outlook assumptions: assess whether the company can fund operations without continued borrowing and whether the projected Q4 2021 cash-flow improvement materialized.