SMGI SMG Industries Inc (QB)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1 — BACKGROUND AND BASIS OF PRESENTATION

SMG Industries Inc. (the “Company” or “SMG”) is a corporation established pursuant to the laws of the State of Delaware on January 7, 2008. The Company original business was the acquisition and stockpile of a rare metal known as Indium used in cell phones and other industrial applications. The Company eventually sold its stockpile and distributed most of the proceeds to its stockholders via special dividends and share repurchases.

On September 19, 2017, the Company entered the domestic oilfield services market and executed an Agreement and Plan of Share Exchange with MG Cleaners LLC, a Texas based product and services company focused on drilling rig contractors and oilfield customers.

On September 19, 2017, SMG acquired one hundred percent of the issued and outstanding membership interests of MG Cleaners LLC pursuant to which MG Cleaners LLC became our wholly-owned subsidiary. In connection with the acquisition, we issued 4,578,276 shares and agreed to pay $300,000 in cash to the Managing MG Member, Stephen Christian, payable with $250,000 at closing and the remaining $50,000 paid upon the completion of the Company’s sale of a minimum of $500,000 of its securities in a private offering to investors. The $50,000 liability was recorded as an Accounts Payable – Related Party on the balance sheet. On January 30, 2018 the Company changed its name from SMG Indium Resources Ltd. to its present name SMG Industries Inc.

The merger was accounted for as a reverse acquisition with MG Cleaners LLC being treated as the accounting acquirer. As such, the historical information for all periods presented prior to the merger date relate to MG Cleaners LLC. Subsequent to the merger date, the information relates to the consolidated entities of SMG with its subsidiary MG Cleaners LLC.

The Company today is a growth-oriented oilfield services company that operates throughout the domestic Southwest United States. Through its wholly-owned operating subsidiaries, the Company offers an expanding suite of products and services across the oilfield market segments of drilling, completions and production.

MG Cleaners LLC., serves the drilling market segment with proprietary branded products including detergents, surfactants and degreasers (such as Miracle Blue ^® ) as well as equipment and service crews that perform on-site repairs, maintenance and drilling rig wash services. SMG's oil tools rental division includes an inventory of more than 800 bottom hole assembly (BHA) oil tools such as stabilizers, drill collars, crossovers and bit subs rented to oil companies and their directional drillers. SMG's frac water management division, known as Momentum Water Transfer, focuses in the completion or fracing market segment providing high volume above ground equipment and temporary infrastructure to route water used on location for fracing. SMG Industries, Inc. headquartered in Houston, Texas has facilities in Carthage, Odessa and Alice, Texas.

The accompanying unaudited interim financial statements of SMG Industries Inc. (“we”, “our”, “SMG” or the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America and should be read in conjunction with the audited financial statements and notes thereto for the years ended December 31, 2018 and 2017 with are included on a Form 10-K filed on April 1, 2019. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements which would substantially duplicate the disclosures contained in the audited financial statements for years ended December 31, 2018 and 2017 have been omitted.

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basic and Diluted Net Loss per Share

The Company presents both basic and diluted net loss per share on the face of the statements of operations. Basic net loss per share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Diluted per share calculations give effect to all potentially dilutive shares of common stock outstanding during the period, including stock options and warrants, and using the treasury-stock method. If anti-dilutive, the effect of potentially dilutive shares of common stock is ignored. For the three months ended March 31, 2019, 630,000 of stock options, 525,001 of warrants and 500,000 shares issuable from convertible notes were considered for their dilutive effects. For the three months ended March 31, 2018, 500,000 of stock were considered for their dilutive effects.

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02). Under ASU No. 2016-2, an entity is required to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. ASU No. 2016-02 offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. For public companies, The Company adopted this standard on January 1, 2019 using the modified retrospective method. The new standard provides a number of optional practical expedients in transition. The Company elected the ‘package of practical expedients’, which permitted the Company not to reassess under the new standard its prior conclusions about lease identification, lease classification and initial direct costs; and all of the new standard’s available transition practical expedients.

On adoption, the Company recognized additional operating liabilities of $287,519, with corresponding Right of Use assets of the same amount based on the present value of the remaining minimum rental payments under current leasing standards for its existing operating leases. The Company’s existing capital lease under ASC 840 is classified as a finance lease under ASC 842, with a total finance liability of $94,280 at adoption. See Note 12 for additional information on leases.

The new standard also provides practical expedients for a company’s ongoing accounting. The Company elected the short-term lease recognition exemption for its leases. For those leases with a lease term of 12 months or less, the Company will not recognize ROU assets or lease liabilities. The Company also made an accounting policy election to combine lease and non-lease components of operating leases for all asset classes.

NOTE 3 – GOING CONCERN

The Company considered its going concern disclosure requirements in accordance with ASC 240-40-50. The Company concluded that its negative working capital and negative cash flows from operating are conditions that raised substantial doubt about the Company’s ability to continue as a going concern. Without a successful plan in place from management these conditions could negatively impact the Company’s ability to meets its financial obligations over the next year. In response, the Company has implemented a plan to alleviate such substantial  concern  as follows. The Company  plans to  continue to generate additional revenue (and improve cash flows from operations) partly related to the Company’s  acquisition of an additional operating company in  2018 and partly related to the Company  cross-selling additional  sales initiatives already implemented  with the acquisition’s additional customer base . In addition, there were several one-time expenses in 201 8  related to expansion to the new region and related to the  product line acquisition in September 2018 and the operating company acquisition in December 2018.  As a result,  following this plan  substantial doubt about the Company’s ability to continue as a going concern is alleviated.

NOTE 4 – REVENUE

Disaggregation of revenue

The Company disaggregates revenue between services and products revenue. All revenues are currently in the southern region of the United States.

Customer Concentration and Credit Risk

During the three months ended March 31, 2019, three of our customers accounted for approximately 57% of our total gross revenues, with two customers each accounting for 21% and another accounting for 15%. No other customers exceeded 10% of revenues during 2019. During the three months ended March 31, 2018, three of our customers accounted for approximately 66% of our total gross revenues, with individual customers accounting for 30%, 20% and 16%. No other customers exceeded 10% of revenues during 2018.

Two customers accounted for approximately 54% of accounts receivable at March 31, 2019, and three customers accounted for approximately 51% of accounts receivable at December 31, 2018. No other customers exceeded 10% of accounts receivable as of March 31, 2019 and December 31, 2018. The Company believes it will continue to reduce the customer concentration risks by engaging new customers and increasing activity of existing less active customers and smaller, newer customer relationships. While the Company continues to acquire new customers in an effort to grow and reduce its customer concentration risks, management believes these risks will continue for the foreseeable future.

Depreciation expense for the three months ended March 31, 2019 and 2018 was $73,386 and $14,286  respectively.

Intangible assets

Intangible assets as of December 31, 2018 are related to the acquisition of the RigHands™ assets and the acquisition of tradenames of Momentum Water Transfer Services LLC.

Intangible assets at March 31, 2019 and December 31, 2018 consisted of the following:

Amortization expense for the three months ended March 31, 2019 and 2018 was $7,250 and $1,100, respectively. Future amortization of the intangible assets for the years ended December 31, 2019, 2020, 2021, 2022, 2023 and beyond are $21,500, $29,000, $29,000, $29,000, $29,000 and $184,894, respectively.

On October 15, 2010, the former managing member of MG Cleaners purchased MG Cleaners from the previous membership interest owners. In connection with that transaction, a $450,000 seller note was issued to the sellers. The note bears an interest rate of 8% and principal and interest payments are made monthly. The remaining principal balance of $307,391 was refinanced by the note holder in January 2015, bearing an interest rate of 6.00%, with principal and interest payments due monthly. The note is secured by the land and building originally occupied by SMG, and said property is no longer occupied.

On August 14, 2017, we refinanced a note payable for $66,348. The unsecured note bears an interest rate of 7.25% per annum, has 47 monthly payments of $1,400, with a balloon payment of $12,086 at maturity on August 1, 2021. The refinanced amount is identical to the remaining principal balance under the previous loan, thus no gain or loss has been recognized.

On February 2, 2017, we refinanced two truck notes existing with a community bank for one new note of $53,610. The term was principal and interest payments monthly over 42 months with an interest rate of 6%. The note is secured by certain trucks and equipment of the Company. The refinanced amount is identical to the remaining principal balance under the previous loan.

On January 2, 2018, we financed a truck with a note to a bank. The $41,481 note has an interest rate of 6.29% and payments of principal and interest are paid monthly. The note is secured by the truck purchased. This note matures in January 2023.

On December 7, 2018, the Company issued and sold secured promissory notes in the aggregate principal amount of $300,000 to three separate purchasers. In addition to the issuance of the Notes an aggregate of 500,000 warrants (“Warrants”) were issued to the purchasers of the Notes. The Warrants are exercisable for a period of five years and are exercisable at $0.40 per share. Interest on the Notes shall be paid to the purchasers at a rate of 10.0% per annum, paid on a quarterly basis, and the maturity date of the Note is one year after the issuance date. The Notes are secured by all of the assets of the Company and the assets of MWTS, subject to prior liens and security interests. The warrants were valued at $203,337 and recorded as a discount to the notes payable. The discount will be amortized over the life of the notes payable.

On December 7, 2018 the Company issued a 6% note to the MWTS Member in the amount of $800,000 as part of the purchase price for MWTS. The note requires monthly payment of $7,500, matures December 8, 2023 and is secured by all the assets of the Company subject to prior security interests.

On January 11, 2019 the Company issued a 10% note to a shareholder who controls approximately 8.8%. The note matures on December 7, 2019 and is secured by a junior lien against the Company assets.

Funding Advance Agreements – included with secured notes

On June 27, 2018, the Company re-financed and paid off a prior liability due to Libertas Funding LLC. The new facility had an original principal balance of $347,500. Payments of principal and interest are paid daily. This note matures in May 2019. During the three months ended March 31, 2019, $30,544 of debt discount was amortized to interest expense.

Future maturities of secured notes payable as of March 31, 2019 are as follows:

Notes Payable (Related Party )

On February 12, 2018, the Company’s wholly-owned subsidiary, MG Cleaners LLC (“ MG ”) entered into an Intellectual Property Sale Agreement (“ Agreement ”) with Stephen Christian, MG’s President, for the purchase of RigHands™ an industrial strength hand cleaner product line. RigHands™ is a trademarked branded product which is focused on the oilfield and industrial markets. MG issued a promissory note to Mr. Christian for the purchase price in the amount of $150,000. The note bears interest at the rate of 5% per year and is payable in 36 equal monthly installments of $4,496. As of March 31, 2018, $88,932 remains outstanding with $50,642 included as a current liability.

During the three months ended March 31, 2019, Stephen Christian advanced $21,800 to the Company and was repaid $30,242 by the Company. As of March 31, 2019 and December 31, 2018, $0 and $8,443 remained outstanding, respectively, with no specific repayment terms or stated interest rate.

Accounts Receivable Financing Facility (Secured Line of Credit)

On May 31, 2017, the Company entered into a $1 million revolving accounts receivable financing facility with Crestmark Bank. The financing facility provides for MG to have access to the lesser of (i) $1 million or (ii) 85% of the net amount of eligible receivables (as defined in the financing agreement). The financing facility is paid for by the assignment of MG’s accounts receivable to Crestmark Bank and is secured by MG’s assets. The financing facility has an interest rate of 7.25% in excess of the prime rate reported by the Wall Street Journal per annum, with a floor minimum rate of 11.5%.  Interest and maintenance fees will be calculated on the higher of the average monthly loan balance from the prior month or a minimum average loan balance of $200,000. The financing facility is for an initial term of two-years and will renew on a year to year basis, unless terminated in accordance with the financing agreement. Pursuant to the terms of the financing facility, Crestmark has been granted a security interest in all of our assets and the assets of MG and we have agreed to guaranty all amounts due under the facility upon an event of default, however, the guaranty does not restrict the Company’s ability to incur debt in connection with its operations. On August 13, 2018, MG entered into amendment #2 of the Crestmark Bank financing facility which increased the advance rate of which Crestmark would lend on Eligible accounts receivables to 90% from 85%. On January 9, 2019, we entered into amendment #3 of the Crestmark Bank financing facility whereby we increased the size of the line of credit to $1.5 million from $1 million and added our frac water subsidiary as an additional borrower with its accounts receivable. We are guarantors of the financing facility and our subsidiaries as borrowers have cross-collateralized their accounts receivable with this facility.  The balance of this line of credit was $655,275 and $593,888 as of March 31, 2019 and December 31, 2018, respectively.

As part of our arrangement with Crestmark Bank our customers pay accounts receivable directly to a lock-box. Crestmark Bank is then paid back for prior advances on the Company’s Eligible Receivables. During the three months ended March 31, 2019, the Company received total cash proceeds of $1,449,426 and repaid $1,419,539 of the Line of Credit via Crestmark Bank withholding amount collected in our lock-box. In addition, Crestmark withheld $31,500 to pay for interest and fees.  Net proceeds received during the three months ended March 31, 2019 on this facility were $61,387.

During the three months ending March 31, 2018, the Company received total cash proceeds of $850,213 and repaid $741,114 of the Line of Credit via Crestmark Bank withholding amount collected in our lock-box. In addition, Crestmark withheld $15,709 to pay for interest and fees. Net proceeds received during the three months ending March 31, 2018 on this facility were $124,808.

Convertible Notes Payable

On September 28, 2018, the Company entered into a secured note purchase agreement with an individual accredited investor for the purchase and sale of a convertible promissory note (“Convertible Note”) in the principal amount of $250,000. The Convertible Note is convertible at any time after the date of issuance into shares of the Company’s common stock at a conversion price of $0.50 per share. Interest on the Note shall be paid to the investor at a rate of 8.5% per annum, paid on a quarterly basis, and the maturity date of the Convertible Note is two years after the issuance date. The Convertible Note is secured by all of the assets of the Company, subject to prior liens and security interests. The Company evaluated the Convertible Note and determined is a conventional convertible instrument. As a result, a beneficial conversion feature was calculated as $100,000 at the time of issuance and recorded as a discount. During the three months ended March 31, 2019, $11,875 of the discount was amortized.

NOTE 9 – COMMON STOCK

During the first quarter of 2019, the Company issued 27,046 of its restricted common stock in settlement of $8,572 of liabilities. The fair value of the common stock issued was $12,579 resulting in a loss on settlement of $4,007.

During the first quarter of 2019, the Company issued 936,000 shares of its restricted common stock for proceeds of $234,000 from accredited investors.

During the year ended December 31, 2018, the Company issued a total of 80,000 common shares to three consultants for services. During the three months ended March 31, 2019, the Company recognized expense of $20,375 related to these services.

The weighted average remaining contractual life is approximately 2.9 years for stock options outstanding on March 31, 2019. At March 31, 2019 there was $79,500 in intrinsic value of outstanding stock options. During the three months ended March 31, 2019 and 2018 share based compensation expense of $14,045 and $0 was recognized, respectively.

Summary Stock warrant information is as follows:

The weighted average remaining contractual life is approximately 4.7 years for stock warrants outstanding on March 31, 2019. At March 31, 2019 there was $30,000 in intrinsic value of outstanding stock warrants.

NOTE 11 – ACQUISITION

On December 7, 2018 (“Closing Date”), we entered into an Agreement and Plan of Share Exchange dated as of such date (the “Exchange Agreement”) with Momentum Water Transfer Services LLC, a Texas limited liability company (“MWTS”) and the sole member of MWTS (the “MWTS Member”). On the Closing Date, pursuant to the Exchange Agreement, we acquired one hundred percent (100%) of the issued and outstanding membership interests of MWTS (“MWTS Membership Interests”) from the MWTS Member pursuant to which MWTS became our wholly owned subsidiary (“Acquisition”). In accordance with the terms of the Exchange Agreement, and in connection with the completion of the Acquisition, on the Closing Date we issued 550,000 shares of our common stock, par value $0.001 per share, paid $308,000 in cash, issued a short term payable of $53,710 that is due on demand and issued a 6% note to the MWTS Member in the amount of $800,000 in exchange for all of the issued and outstanding MWTS Membership Interests.

The following schedule contains pro-forma consolidated results of operations for the three months ended March 31, 2018 as if the acquisitions occurred on January 1, 2018. The pro forma results of operations are presented for informational purposes only and are not indicative of the results of operations that would have been achieved if the acquisition had taken place on January 1, 2018, or of results that may occur in the future.

NOTE 12 – COMMITMENTS AND CONTINGENCIES

Employment Agreements

On October 31, 2017, and made effective September 20, 2017, the Company entered into an employment agreement with Stephen Christian, the former Managing Member, and current President, of our subsidiary MG Cleaners LLC. The term is for three years with a monthly salary of $8,333 for the first six months of the effective date and $10,000 a month thereafter. Other terms include payment of Mr. Christian’s health care insurance, use of a company truck and other customary benefits. Termination without cause, as defined in the agreement, grants Mr. Christian six months’ severance pay.

On October 31, 2017, and made effective October 1, 2017, the Company entered into an employment agreement with Matthew Flemming, our Chief Executive Officer. The term is for three years with a monthly salary of $15,000 for the period. The terms of the agreement also include providing health care, auto allowance of $750 per month if a car is not provided by the Company, and other customary benefits. Termination without cause, as defined in the agreement, grants Mr. Flemming six months’ severance pay.

Litigation

In May 2018, MG Cleaners LLC, a wholly owned subsidiary of SMG Industries, Inc. was sued in the US District Court for the Western District of Texas, Houston Division, Civil action no. 4:18-cv-00016; Christopher Hunsley et. al. vs MG Cleaners LLC. Five former employees of MG Cleaners, the Plaintiffs, filed claims under the Fair Labor Standards Act (FLSA) asserts amongst other things unpaid overtime wages. The Company adamantly denies these claims.

SMG Industries has litigated this matter for several months and considered a range of outcomes for this matter and determined that management’s best estimated amount to settle this matter is for $40,000  probably during the fiscal year 2019. As such, management believes it is appropriate to accrue for this on our year end 2018 financial statements.

From time to time, SMG may be subject to routine litigation, claims, or disputes in the ordinary course of business. Other than the above listed matter, in the opinion of management; no other pending or known threatened claims, actions or proceedings against SMG are expected to have a material adverse effect on SMG’s financial position, results of operations or cash flows. SMG cannot predict with certainty, however, the outcome or effect of any of the litigation or investigatory matters specifically described above or any other pending litigation or claims. There can be no assurance as to the ultimate outcome of any lawsuits and investigations.

NOTE 13 – LEASES

The Company has operating and finance leases for sales and administrative offices, motor vehicles and certain machinery and equipment. The Company’s leases have remaining lease terms of 1 year to 4 years. For purposes of calculating operating lease liabilities, lease terms may be deemed to include options to extend the lease when it is reasonably certain that the Company will exercise those options. Some leasing arrangements require variable payments that are dependent on usage, output, or may vary for other reasons, such as insurance and tax payments. The variable lease payments are not presented as part of the initial ROU asset or lease liability. The Company's lease agreements do not contain any material restrictive covenants.

The components of lease cost for operating and finance leases for the three months ended March 31, 2019 were as follows:

Supplemental cash flow information related to leases was as follows:

At adoption of ASC 842, the Company recognized right of use assets and liabilities for operating leases of $287,519. The Company’s existing capital lease under ASC 840 is classified as a finance lease under ASC 842. The Company also entered into two new operating leases for two vehicles. Each lease is for a period of four years, with monthly payments of $875 per vehicle. The Company recognized initial right of use assets and right of use operating lease liabilities of $65,266 in total for these vehicles.

During the three months ended March 31, 2019, the Company entered into a new lease for a forklift that was determined to be a finance lease under ASC 842. The lease is for a period of three years, with monthly payments of $671. The Company capitalized an asset and right of use finance lease liability of $19,901 related to this finance lease.

The following table summarizes the lease-related assets and liabilities recorded in the consolidated balance sheets at March 31, 2019:

The Company utilizes the incremental borrowing rate in determining the present value of lease payments unless the implicit rate is readily determinable.

The following table provides the maturities of lease liabilities at March 31, 2019:

At March 31, 2019, the Company had no additional leases which had not yet commenced.

Future minimum lease payments for operating leases accounted for under ASC 840, "Leases," with remaining non-cancelable terms in excess of one year at December 31, 2018 were as follows:

NOTE 14 – RELATED PARTY TRANSACTIONS  

On September 19, 2017, in connection with the acquisition, we issued 4,578,276 shares and agreed to pay $300,000 in cash to the Managing MG Member, Stephen Christian, payable with $250,000 at closing and the remaining $50,000 paid upon the completion of the Company’s sale of a minimum of $500,000 of its securities in a private offering to investors. As of March 31, 2019 and December 31, 2018 amounts due under this arrangement are $0 and $21,000, respectively.

The Company has engaged the services of Mr. John Boylan effective February 11, 2019, whereby Mr. Boylan will be paid as a consultant to the Company in connection with its mergers and acquisition strategy, whereby Mr. Boylan shall provide us with mergers and acquisition support including economic analysis, financial modeling and due diligence. Mr. Boylan will be paid $13,000 per month for his services.