Surge Holdings, Inc. — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017, compared with FY 2016. The filing identifies the registrant as Surge Holdings, Inc.; this differs from the “Surgepays, Inc.” company name in the request metadata.
Business context
The company’s operating revenue came primarily from DigitizeIQ (DIQ), a digital advertising agency, and KSIX, a performance-based online advertising network. It also described planned blockchain and cryptocurrency-mining initiatives; the mining operation was still being developed. The proposed True Wireless acquisition had not closed by the filing date.
Financial performance and liquidity
| Metric | FY 2017 | FY 2016 |
|---|---|---|
| Revenue | $1.430 million | $3.297 million |
| Gross profit | $697,000 | $968,000 |
| Gross margin | 48.7% | 29.4% |
| Operating loss | $2.069 million | $3.107 million |
| Net loss | $1.980 million | $4.600 million |
| Net cash used in operations | $604,000 | $642,000 |
- Revenue fell about 57%. DIQ revenue declined 58%, attributed to the loss of a major advertiser; KSIX revenue fell 53%, attributed to a shift in advertisers and affiliates. DIQ’s gross margin improved to 54% from 20%, while KSIX’s declined to 40% from 47%.
- Cash was $216,000 at year-end. Current assets of $320,000 and current liabilities of $2.486 million produced a $2.167 million working-capital deficit. Total liabilities were $2.539 million, versus $4.172 million a year earlier; stockholders’ equity was $607,000, versus a $1.815 million deficit.
- Financing provided $903,000 of cash, while investing used $147,000. Year-end cash increased by $152,000. The company said it funded cash needs through private equity sales and short-term debt; much of its remaining debt was past due. Notes payable and long-term debt, including related-party debt, were reported at $1.094 million.
- Common shares outstanding increased from 57.3 million at December 31, 2016 to 88.3 million at December 31, 2017, reflecting equity issued for cash, services, debt and the True Wireless deposit.
Material changes, outlook and risks
- Lower operating expenses and interest expense, along with a $1.0 million gain on debt extinguishment, helped reduce the net loss. FY 2017 also included a $504,000 loss from changes in derivative fair value. The 2016 comparison included a $373,000 impairment charge.
- Going concern: The auditor cited substantial doubt about the company’s ability to continue as a going concern, based on recurring losses, operating cash outflows and the working-capital deficit. Management said it needed to raise $1–$1.5 million, restructure debt and complete the True Wireless acquisition to reach minimal viability. It projected positive operating cash flow by June 30, 2018 if those plans succeeded; there was no assurance they would.
- True Wireless transaction: The company reported $500,000 cash and 12 million shares already paid as a deposit. The March 2018 merger terms contemplated 151.7 million additional common shares, 3 million Series A preferred shares and a promissory note. The filing’s narrative describes a $3 million note, while its transaction-consideration table lists $1.5 million. The transaction remained subject to closing conditions and its terms could change.
- One customer generated 45% of FY 2017 revenue. A West Publishing lawsuit against DIQ sought $435,700; the company disputed the claim and the case remained pending. The company also disclosed a $336,726 credit-card liability and a possible, unasserted indemnification exposure related to a dismissed case.
- Disclosure controls and internal control over financial reporting were deemed ineffective because of a lack of segregation of duties. The company reported six full-time employees and limited trading liquidity for its OTCQB shares.
- The audited financial statements received an unmodified opinion, but the auditor’s report emphasized the going-concern uncertainty. No audit opinion was given on internal-control effectiveness.
Most important facts to verify
- Whether the company raised the capital it said was needed, restructured overdue debt and generated positive operating cash flow after the filing.
- Whether the True Wireless acquisition closed, what final consideration and debt terms applied, and how the $3 million versus $1.5 million note discrepancy was resolved.
- Whether the West Publishing dispute and any potential American Express-related indemnification exposure resulted in payments or liabilities.
- How the sharp revenue decline and 45% customer concentration developed after FY 2017, and whether DIQ and KSIX margins were sustainable.
- Whether internal-control deficiencies were remediated and what dilution resulted from subsequent share issuances and acquisition consideration.