SMG Industries Inc. - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

For the quarterly period ended September 30, 2019

OR

For the transition period from ______________ to ______________

Commission File Number 000-54391

periods beginning after December

SMG INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

(713) 821-3153

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x     No  ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   x  Yes     ¨   No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨  No x

The number of shares of Common Stock, par value $0.001 per share, outstanding as of November 14, 2019 was 14,881,372.

Securities registered pursuant to Section 12(b) of the Act:

SMG INDUSTRIES INC.

Table of Contents

SMG INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

(unaudited)

The accompanying notes are an integral part of these consolidated unaudited financial statements

SMG INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

For the three and nine months ended September 30, 2019 and 2018

(unaudited)

The accompanying notes are an integral part of these consolidated unaudited financial statements

SMG INDUSTRIES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIT

For the nine months ended September 30, 2019 and 2018

(unaudited)

The accompanying notes are an integral part of these consolidated unaudited financial statements

SMG INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the nine months ended September 30, 2019 and 2018

(unaudited)

The accompanying notes are an integral part of these consolidated unaudited financial statements

SMG INDUSTRIES, INC.

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 company focused on selling products and services to 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 its Managing MG Member, 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. Trinity Services LLC provides lease roads, location and pad development using construction equipment to build drilling pad locations and well site services using a work over rig to perform services on existing wells. SMG Industries, Inc. headquartered in Houston, Texas has facilities in Carthage, Waskom, 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 which are included on our 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 nine months ended September 30, 2019, 820,000 of stock options, 895,001 of warrants, 4,000,000 shares issuable from Series A Preferred Stock and 600,000 shares issuable from convertible notes were considered for their dilutive effects. For the nine months ended September 30, 2018, 1,165,000 of convertible notes, stock options and warrants 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 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 2019 and partly related to the Company cross-selling additional sales initiatives already implemented with the acquisition’s additional customer base. In addition, costs at the Company’s frac water division were reduced in 2019 bringing them more in line with current revenues in that area. 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 nine months ended September 30, 2019, three of our customers accounted for approximately 38% of our total gross revenues, with customers each accounting for 16%, 12% and 10% respectively. No other customers exceeded 10% of revenues during the nine months ended September 30, 2019.  During the nine months ended September 30, 2018, two of our customers accounted for approximately 52% of our total gross revenues, with individual customers accounting for 21% and 31%.  No other customers exceeded 10% of revenues during the 2018 period.

Three customers accounted for approximately 48% of accounts receivable at September 30, 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 September 30, 2019 and December 31, 2018. The Company believes it will continue to reduce the customer concentration risks by engaging new customers and by increasing activity with existing, less active customers and relatively 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.

NOTE 5 - INVENTORY

Inventory consisted of the following components:

NOTE 6 – LONG-LIVED ASSETS

Property and equipment at September 30, 2019 and December 31, 2018 consisted of the following:

Depreciation expense for the nine months ended September 30, 2019 and 2018 was $317,036 and $60,658 respectively.

Intangible assets

Intangible assets as of September 30, 2019 are related to the acquisition of the RigHands™ assets and the acquisition of tradenames of Momentum Water Transfer Services LLC.

Intangible assets at September 30, 2019 and December 31, 2018 consisted of the following:

Amortization expense for the nine months ended September 30, 2019 and 2018 was $21,748 and $6,275, respectively. Future amortization of the intangible assets for the years ended December 31, 2019, 2020, 2021, 2022, 2023 and beyond are $29,000, $29,000, $29,000, $29,000, $29,000 and $184,894, respectively.

NOTE 7 – ACCRUED EXPENSES AND OTHER LIABILITIES

Accrued expenses as of September 30, 2019 and December 31, 2018 included the following:

NOTE 8 – NOTES PAYABLE

Notes payable included the following:

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 $100,000 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. In April 2019, the Company issued 511,370 shares of its restricted common stock with a fair value of $203,525 to settle this $100,000 note payable and $2,274 accrued interest in full. The transaction resulted in a loss on settlement of $101,251.

In May 2019, the Company issued a promissory note in the amount of $100,000 with a maturity date of July 1, 2019 to an individual accredited investor. The Company issued a five-year warrant to purchase 100,000 shares of the Company’s common stock at a fixed price of $0.30. The warrants were valued $44,091 and recorded as a debt discount that was fully amortized as of September 30, 2019. On June 18, 2019, the Company issued 150,000 warrants with an exercise price of $0.30 and a term of ten years in exchange for an extension of the maturity date of the note through September 30, 2019. The warrants were valued at $67,223 and will be amortized over the extension period of the note. The promissory note is currently past due. The Company is negotiating an extension with the note holder.

In June 2019, the Company issued a promissory note in the amount of $80,000 to an individual accredited investor. The Company issued a ten-year warrant to purchase 120,000 shares of the Company’s common stock at a fixed price of $0.30 per share. The warrants were valued at $53,780 and recorded as a debt discount. As of September 30, 2019, $53,780 was amortized leaving a discount balance of $0. The promissory note is currently past due. The Company is negotiating an extension with the note holder.

On July 26, 2019, the Company paid a vendor payable that totaled $247,637, by issuing a promissory note in the name of its frac water company Jake Oilfield Solutions LLC for $123,819. The interest rate was 7% with principal and interest due at maturity July 25, 2020. The remaining balance of $123,818 was converted into 353,766 shares of SMG’s restricted common stock.

On September 20, 2019, the Company issued a $200,000 12% promissory note. The note is due and payable in three monthly installments, the first two installments are interest only and the third and final installment for the balance of the principal and accrued interest is due at maturity December 20, 2019.

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 matured in May 2019 and was paid in full. During the nine months ended September 30, 2019, $43,411 of debt discount was amortized to interest expense.

Future maturities of secured notes payable as of September 30, 2019 are as follows:

Notes Payable – Unsecured

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 September 30, 2019 and December 31, 2018, $63,935 and $101,220 remains outstanding with $51,932 and $54,307, respectively included as a current liability.

During the nine months ended September 30, 2019, Stephen Christian advanced $201,661 to the Company and was repaid $210,103 by the Company. As of September 30, 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 11, 2017, SMG Industries, Inc., formerly SMG Indium Resources Ltd., (the “Borrower”) entered into a $1 million revolving accounts receivable financing facility with Crestmark Bank. The financing facility provides for the Borrower to have access to the lesser of (i) $1 million or (ii) 85% of Net Amount of Eligible Receivables (as defined in the financing agreement). The financing facility is paid for by the assignment of the Borrower’s accounts receivable to Crestmark Bank and is secured by the Borrower’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%. There were no loan origination or closing fees and we paid $1,330 to Crestmark to reimburse them for documentation, legal and audit fees. 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. If the facility is terminated prior to the first anniversary, Borrower is obligated to pay Crestmark Bank a fee of $20,000 and if terminated after the first anniversary and prior to the second anniversary then Borrower shall pay a fee of $5,000. After the second anniversary of the financing facility, no exit fee is due. Crestmark has a senior security interest in the Borrower’s assets. The balance of this line of credit was $1,348,916 and $593,888 as of September 30, 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 nine months ended September 30, 2019, the Company received total cash proceeds of $1,851,690 and repaid $1,830,831 of the Line of Credit via Crestmark Bank withholding amount collected in our lock-box. In addition, Crestmark withheld $74,352 to pay for interest and fees.  Net proceeds received during the nine months ended September 30, 2019 on this facility were $95,211.

During the nine months ended September 30, 2018, the Company received total cash proceeds of $2,919,038 and repaid $2,837,610 of the Line of Credit via Crestmark Bank withholding amount collected in our lock-box. In addition, Crestmark withheld $53,509 to pay for interest and fees. Net proceeds received during the nine months ending September 30, 2018 on this facility were $134,937.

On June 19, 2019, each of MG Cleaners LLC (“MG”), Trinity Services LLC (“Trinity”) and Jake Oilfield Solutions LLC (“Jake”), each of which is a wholly-owned subsidiary of the Company, entered into separate revolving accounts receivable financing facilities (collectively the “AR Facility”) with Catalyst Finance L.P. (“Catalyst”). The AR Facility was funded on June 27, 2019. The new AR Facility with Catalyst was used to pay off the Crestmark facility in full. The AR Facility provides for the Company, through MG, Trinity and Jake, to have access to up to 90% of the net amount of eligible receivables (as defined in the financing agreement). The AR Facility is paid for by the assignment of the accounts receivable of each of MG, Trinity and Jake to Catalyst and is secured by all instruments and proceeds related thereto. The AR Facility has an interest rate of 2.25% in excess of the prime rate reported by the Wall Street Journal per annum, plus a financing fee equal to 0.20% of the receivable balance every 15 days, with a maximum cumulative rate of 1.6%.   There are no origination fees, monitoring or early termination fees. The AR Facility can be terminated by the Company with thirty days written notice. The Company is a guarantor of the financing facility and our subsidiaries as borrowers have cross-collateralized their accounts receivable with this facility.

On June 27, 2019, an accounts receivable financing company funding a total of $1,317,304 pursuant to the AR facility. Of the amounts funded $500,000 was paid directly to the seller of Trinity, $43,219 was used to pay off notes payable of MG Cleaners, $714,239 was used to pay off the Crestmark liability and the remaining $59,846 was deposited to the Company’s bank account.

The balances under the above lines of credit was $1,348,916 and $593,888 as of September 30, 2019 and December 31, 2018, respectively.

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 nine months ended September 30, 2019, $36,295 of the discount was amortized.

In April 2019, the Company issued a convertible promissory note in the amount of $50,000 to an individual accredited investor. The note bears an interest rate of 8 ½ %, payable in cash quarterly, matures in two years and is convertible at any time into shares of the Company’s common stock at a fixed conversion price of $0.50 (fifty cents) per share.

NOTE 9 – COMMON AND PREFERRED STOCK

During the year ended December 31, 2018, the Company issued a total of 80,000 common shares to three consultants for services. During the nine months ended September 30, 2019, the Company recognized expense of $31,896 related to these services. In May 2019, the Company issued a total of 200,000 common shares to consultants for services. During the nine months ended September 30, 2019, the Company recognized expense of $38,449 related to these services.

During the nine months ended September 30, 2019, the Company issued 393,312 shares of its restricted common stock in settlement of $138,012 of liabilities. The fair value of the common stock issued was $124,685 resulting in a gain on settlement of $13,328.

During the nine months ended September 30, 2019, the Company issued 1,436,000 shares of its restricted common stock for proceeds of $359,000 from accredited investors.

In April 2019, the Company issued 511,370 shares of its restricted common stock to settle a $100,000 note payable and accrued interest of $2,474 in full that was originally issued in January 2019.

Preferred Stock – Series A Convertible Preferred stock

On June 4, 2019 the company filed a Certificate of Designation of Preferences, Rights and Limitations of 3% Series “A” Convertible Preferred Stock to create a new class of stock in connection with its pending acquisition. This Series A Convertible Preferred stock has designated 2,000 shares, has a stated value of $1,000 per share and was delivered to the seller of Trinity Services LLC at closing.

The Series A Preferred Stock shall, with respect to dividend distributions and distributions upon liquidation, winding up or dissolution of the Corporation, rank senior to all classes of Common Stock and to each other class of Capital Stock of the Corporation or series of Preferred Stock of the Corporation existing or hereafter created. The Series A Preferred Stock shall pay a three percent (3%) annual dividend on the outstanding Series A Preferred Stock, all of which shall be accrued until the Series A Preferred Stock has been converted.

At any time from issuance, the stated value of each outstanding share of Series A Preferred Stock, plus accrued dividends thereon, shall be convertible (in whole or in part), at the option of the Holder into shares of the Company’s Common Stock at a fixed conversion price of $0.50 per share on the date on which the Holder notices a conversion. 

All outstanding shares of Series A Preferred Stock shall automatically convert into shares of the Company’s Common Stock upon the earlier to occur of: (i) twelve months after the date of issuance of the Series A Preferred Stock; or (ii) six months after the date of issuance of the Series A Preferred Stock, provided that (a) all shares of the Company’s Common Stock issued upon conversion may be sold under Rule 144 or pursuant to an effective registration statement without a restriction on resale, and (b) the average closing price of the Company’s Common Stock has been at least of $0.60 per share during the twenty (20) trading days prior to the date of conversion.

The Holders shall have the right to receive notice of any meeting of holders of Common Stock or Series A Preferred Stock and to vote upon any matter submitted to a vote of the holders of Common Stock or Series A Preferred Stock, on an as-converted basis. Except as otherwise expressly set forth in the Certificate of Incorporation (including this Certificate of Designation), the Holders shall vote on each matter submitted to them with the holders of Common Stock and all other classes and series of Capital Stock entitled to vote on such matter, taken together as a single class, if any.

NOTE 10 – STOCK OPTIONS AND WARRANTS

Summary stock option information is as follows:

During the nine months ended September 30, 2019 the Company issued 100,000 common stock options to each of the three independent directors. The options vest immediately, have an exercise price of $0.45 and a five-year term.

The weighted average remaining contractual life is approximately 3.23 years for stock options outstanding on September 30, 2019. At September 30, 2019 there was $66,300 in intrinsic value of outstanding stock options. During the nine months ended September 30, 2019 and 2018 share based compensation expense of $147,431 and $42,012 was recognized, respectively.

Summary Stock warrant information is as follows:

The weighted average remaining contractual life is approximately 5.73 years for stock warrants outstanding on September 30, 2019. At September 30, 2019 there was $78,760 in intrinsic value of outstanding stock warrants.

NOTE 11 – ACQUISITION

Trinity Services LLC

On June 3, 2019 we entered into an Agreement and Plan of Share Exchange dated as of such date (the “Trinity Exchange Agreement”) with Trinity Services LLC, a Louisiana limited liability company (“Trinity”) and the sole member of Trinity (the “Trinity Member”). We completed the closing of the acquisition of Trinity on June 26, 2019 (“Closing Date”). On the Closing Date, pursuant to the Exchange Agreement, we acquired one hundred percent (100%) of the issued and outstanding membership interests of Trinity (“Trinity Membership Interests”) from the Trinity Member pursuant to which Trinity became our wholly owned subsidiary (“Trinity Acquisition”). In accordance with the terms of the Trinity Exchange Agreement, and in connection with the completion of the Acquisition, on the Closing Date we: (i) issued 2,000 shares of our 3% Series A Secured Convertible Preferred Stock (“Preferred Stock”), stated value $1,000 per share, (ii) paid $500,000 in cash to the Trinity Member, and (iii) assumed approximately $850,000 in notes related to equipment owned by Trinity (“Purchase Price”).

The Preferred Stock is convertible at $0.50 per share at any time after the issuance thereof and is secured by all of the unencumbered assets of Trinity. All outstanding shares of Preferred Stock shall automatically convert into shares of the Company’s common stock upon the earlier to occur of: (i) twelve months after the date of issuance of the Preferred Stock; or (ii) six months after the date of issuance of the Preferred Stock, provided that (a) all shares of the Company’s common stock issued upon conversion of the Preferred Stock may be sold under Rule 144 or pursuant to an effective registration statement without a restriction on resale, and (b) the average closing price of the Company’s common stock has been at least of $0.60 per share during the twenty (20) trading days prior to the date of conversion.

All of the shares of Preferred Stock, and the shares of the Company’s Common Stock underlying the Preferred Stock, issued in connection with the Acquisition are restricted securities, as defined in paragraph (a) of Rule 144 under the Securities Act of 1933, as amended (the “Securities Act”). Such shares were issued pursuant to an exemption from the registration requirements of the Securities Act, under Section 4(a)(2) of the Securities Act and the rules and regulations promulgated thereunder. The Preferred Stock issued has a stated value of $2,000,000. The fair value of the shares was based on an as if converted to common stock basis.

The acquisition of Trinity is being accounted for as a business combination under ASC 805. The Company is continuing to gather evidence to evaluate what identifiable intangible assets were acquired, such as a customer list, and the fair value of each, and expects to finalize the fair value of the acquired assets within one year of the acquisition date. The following information summarizes the provisional purchase consideration and preliminary allocation of the fair values assigned to the assets at the purchase date:

The Company’s consolidated revenue and net loss for the three and nine months ended September 30, 2019 include revenue of $1,098,191 and $1,148,63, respectively and net income of $100,374 and $65,855, respectively related to the operations of Trinity since the acquisition date.

Momentum Water Transfer Services

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 (“MWTS 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.

Unaudited Pro Forma Financial Information

The following schedule contains pro-forma consolidated results of operations for the three and nine months ended September 30, 2019 and 2018 as if the Trinity acquisition occurred on January 1, 2018 and as if the MWTS Acquisition had occurred on January 1, 2017. 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 as of 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 and EVP of SMG. 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. In May 2019, the Company adjusted the pay to $14,167 per month.

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, expected to be settled during the fiscal year 2019. As such, management believes it is appropriate to accrue for this in our 2019 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 and nine months ended September 30, 2019 were as follows:

Supplemental cash flow information related to leases was as follows:

The following table summarizes the lease-related assets and liabilities recorded in the consolidated balance sheets at September 30, 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 September 30, 2019:

At September 30, 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:

During the nine months ended September 30, 2019, the Company entered into two new leases for forklifts that were determined to be finance leases under ASC 842. One lease is for a period of three years, with monthly payments of $671 and the second lease is for a period of 48 months with monthly payments of $644. The Company capitalized an asset and right of use finance lease liability of $43,888 related to these finance leases.

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. The Company also acquired an operating lease for office and warehouse space as part of the Trinity Acquisition and recognized a right of use asset and operating lease liability of $87,900 as part of the purchase price accounting. This lease is for a term of 60 months with a monthly payment of $2,000.

NOTE 14 – RELATED PARTY TRANSACTIONS

On September 19, 2017, in connection with the acquisition of MG Cleaners, we issued 4,578,276 shares and agreed to pay $300,000 in cash to its Managing MG Member 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 September 30, 2019 and December 31, 2018 amounts due under this arrangement are $0 and $21,000, respectively.

The Company engaged the services of a Director, Mr. John Boylan, effective February 11, 2019, whereby Mr. Boylan was paid as a consultant to the Company in connection with its mergers and acquisition work, whereby Mr. Boylan provided us with mergers and acquisition support including economic analysis, financial modeling and due diligence. Mr. Boylan was paid $13,000 per month for his services. In June 2019 Mr. Flemming, Mr. Boylan and Mr. Christian were each awarded a bonus of $12,500 related to their efforts in closing the Trinity acquisition.

On July 30, 2019 the Company appointed R. Michael Villarreal to the Board of Directors filling the position left by the passing in early July 2019 of Director John Boylan. The Company appointed Mr. Boylan Board member Emeritus status in honor of his service to the Company.

NOTE 15 – SUBSEQUENT EVENTS

On October 1, 2019, we entered into a second amendment to a secured promissory note to extend the maturity of the secured note held by a stockholder to June 30, 2020 and capitalizing the accrued interest of $4,559 where the total principal of the promissory note is now $44,559. All other terms of the note remained. In connection with this amendment, we issued a new common stock purchase warrant for 40,000 shares, with a ten-year term and a fixed exercise price of $0.15 per share and customary other provisions.(Note to Document: This is also discussed in the second item of Notes Payable – Unsecured)

On October 4, 2019, we sold for $30,000 property categorized on our balance sheet as an asset held for sale. This vacant property acquired by MG Cleaners years earlier is located in Carthage, Texas and not a part of our current operations. The original MG Cleaners seller note was secured by this property and received the proceeds of this sale of approximately $30,000. The seller note had a balance of $147,608 at the time of the sale of property. The remainder of the note was retired and paid in full by issuing 400,000 restricted shares of our common stock.

Subsequent to September 30, 2019, we issued 30,000 shares of our restricted common stock and 25,000 fully vested common stock options with a five-year term and exercisable at $0.25 for accounting consulting services.

On October 2, 2019 we entered into a premium finance note on behalf of Trinity’s insurance renewal for its $125,377 annual premium. At execution, $21,009 was paid down with ten equal payments for the remainder and a 5.5% per annum interest rate.

On October 28, 2019 we entered into a premium finance note on behalf of the Company for its insurance renewal for its $114,993 annual premium. At execution, $21,073 was paid down with ten equal payments for the remainder and a 6.5% per annum interest rate.

In November 2019, we received a total of $630,080, net of closing costs, in return for an assignment and transfer to a specialty finance company of a specified percentage of the proceeds of each collection of future receipts received by us, collectively "Future Receipts" until the finance company has received the purchased amount of $910,000. This transaction is accounted for as a short term secured loan, with deferred financing costs of $279,920 recognized on the date of incurrence as a discount. Pursuant to the agreement we have discounted early payoff options.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Cautionary Note Regarding Forward-Looking Statements

Unless otherwise indicated, the terms “SMG Industries,” “SMG,” the “Company,” “we,” “us,” and “our” refer to SMG Industries Inc., and our wholly-owned subsidiaries MG Cleaners LLC, Momentum Water Transfer Services LLC, Jake Oilfield Solutions LLC, Trinity Services LLC and our SMG Oil Tools division.  In this Quarterly Report on Form 10-Q, we may make certain forward-looking statements, including statements regarding our plans, strategies, objectives, expectations, intentions and resources that are made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995.

The statements contained in this Quarterly Report on Form 10-Q that are not historical fact are forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995), within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended.  Forward-looking statements may be identified by the use of forward-looking terminology such as “should,” “could,” “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” “intends,” “continue,” or similar terms or variations of those terms or the negative of those terms.  These statements appear in a number of places in this Form 10-Q and include statements regarding the intent, belief or current expectations of SMG Industries Inc. Forward-looking statements are merely our current predictions of future events. Investors are cautioned that any such forward-looking statements are inherently uncertain, are not guaranties of future performance and involve risks and uncertainties. Actual results may differ materially from our predictions. There are a number of factors that could negatively affect our business and the value of our securities, including, but not limited to, fluctuations in the market price of our common stock; changes in our plans, strategies and intentions; changes in market valuations associated with our cash flows and operating results; the impact of significant acquisitions, dispositions and other similar transactions; our ability to attract and retain key employees; changes in financial estimates or recommendations by securities analysts; asset impairments; decreased liquidity in the capital markets; and changes in interest rates. Such factors could materially affect our Company's future operating results and could cause actual events to differ materially from those described in forward-looking statements relating to our Company. Although we have sought to identify the most significant risks to our business, we cannot predict whether, or to what extent, any of such risks may be realized, nor is there any assurance that we have identified all possible issues that we might face.  We assume no obligation to update our forward-looking statements to reflect new information or developments. We urge readers to carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission (“SEC”) that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business including the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018.

Overview

We are a growth-oriented oilfield services company that operates throughout the Southwest United States. Through our wholly-owned operating subsidiaries, we offer an expanding suite of products and services across the 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. Our SMG rental division includes an inventory of approximately 800 bottom hole assembly (BHA) oil tools such as stabilizers, drill collars, crossovers and bit subs rented to oil companies and directional drillers. Our frac water management division, known as Momentum Water Transfer Services LLC, focuses on the completion or fracing market segment providing high volume above ground equipment and temporary infrastructure to route water used on location for fracing. Trinity Services LLC performs lease road, location build, pad drilling sites and frac pits for its customers. Trinity also performs well site services with work-over and swab rigs.

We are headquartered in Houston, Texas with facilities in Odessa, Carthage, Waskom and Alice, Texas. Our web sites are  www.SMGIndustries.com, www.MGCleanersllc.com and www.MomentumWTS.com.

On September 19, 2017, we entered into an exchange agreement with all of the members of MG Cleaners, LLC (“MG”) pursuant to which we acquired one hundred percent of the issued and outstanding membership interests of MG (“MG Membership Interests”) pursuant to which MG became our wholly-owned subsidiary. In connection with the acquisition, we issued 4,578,276 shares and agreed to pay $300,000 in cash ($250,000 in cash at closing) to the MG Members.

The acquisition of MG Cleaners LLC by SMG Industries Inc. (formerly SMG Indium Resources Ltd.) on September 19, 2017, was accounted for as a reverse acquisition with MG Cleaners as the acquirer of SMG Industries for accounting purposes. The financial statements presented in this Annual Report on Form 10-K are presented as a continuation of the operations of MG Cleaners LLC with one adjustment to retroactively adjust the membership interests of MG Cleaners LLC to reflect the legal capital of SMG Industries prior to the September 19, 2017 acquisition, and one adjustment to eliminate the accumulated deficit of SMGI in accordance with the recapitalization of MG. 

On September 27, 2018, we acquired approximately 800 downhole oil tools which include stabilizers, crossovers, drilling jars, roller reamers and bit subs, including both non-mag and steel units in exchange for the issuance of an aggregate of one million (1,000,000) shares of our common stock to the sellers.

On December 7, 2018, we acquired one hundred percent of the issued and outstanding membership interests (“MWTS Membership Interests”) of Momentum Water Transfer Services LLC, a Texas limited liability company (“MWTS”) pursuant to which MWTS became our wholly-owned subsidiary (the “MWTS Acquisition”). In connection with the MWTS Acquisition, we issued 550,000 shares of our common stock, paid $361,710 in cash to the MWTS Members and issued a note payable to the MWTS Member in the aggregate amount of $800,000.

On June 26, 2019, we acquired one hundred percent of the issued and outstanding membership interests (“Trinity Membership Interests”) of Trinity Services LLC, a Louisiana limited liability company (“Trinity”) pursuant to which Trinity became our wholly-owned subsidiary (the “Trinity Acquisition”). In connection with the Trinity Acquisition, we issued 2,000 shares of our 3% Series A Secured Convertible Preferred Stock (“Preferred Stock”), stated value $1,000 per share, paid $500,000 in cash to the Trinity Member, and we assumed approximately $850,000 in notes related to equipment owned by Trinity.

As a result of our acquisition of MG, MWTS, Trinity and the downhole oil tools, our growth-oriented oilfield service company can expand the service lines and market segments of which it focuses in the onshore domestic United States market. Through our operating subsidiaries we offer the following products and services:

For the Drilling Market Segment:

lease road build drilling pad site development and reserve pit construction;

rig wash of drilling rigs;

product sales including degreasers, surfactants and detergents, that remove oil based mud from drilling rigs;

rig cleaning equipment sales including industrial pressure washers;

parts sales for our installed base on equipment;

Mechanic and service repair crews for cleaning equipment on location for drilling rig operators;

rentals of equipment on day rates or other terms for drilling rig contractors to clean rigs; and

Down hole bottom hole assembly (BHA) tools such as stabilizers, drill collars and cross over subs to directional driller and operators.

For the Completions Market Segment:

Frac water transfer services that provide for sending high volumes of water from a source such as a pond, river, lake or frac pit to a frac location using miles of lay flat frac hose, pumps and equipment; and

Frac pit construction.

 For the Production Market Segment:

Well site services including work over rigs and swab rigs that perform jobs to keep oil and gas operators wells running.

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 13 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. 

Critical Accounting Policies and Estimates

The preparation for financial statements and related disclosures in conformity with United States generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. For a description of our significant accounting policies, see the Company’s audited financial statements for the year ended December 31, 2018, included in the Company’s Form 10-K as filed with the SEC on April 1, 2019. Of these policies, the following are considered critical to an understanding of the Company’s condensed financial statements as they require the application of the most difficult, subjective and complex judgments: (1) Use of Estimates, (2) Share-Based Payment Arrangements, and (3) Income Taxes. Management will base its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions.

Results of Operations

Three Months Ended September 30, 2019 Compared to Three Months Ended September 30, 2018

Our sales for the three months ended September 30, 2019 were $2,064,516, an increase of approximately 101%, from $1,026,949 for the three months ended September 30, 2018. The increase in revenues for the three months ended September 30, 2019 was primarily attributable to the additional revenues of the Trinity Services LLC acquisition concluded on June 27, 2019 not present in the year ago comparable period.

During the three months ended September 30, 2019, cost of sales increased as a percentage of sales to 78.5% of revenues, or $1,621,841, compared to 56.8% of revenues or $582,922, for the comparable 2018 period. The increase in cost of sales as a percentage of revenues is primarily the result of the net margin mix impacted by the Trinity Services acquisition not present in the year ago period, and higher parts costs associated with our MG Cleaners business.

For the three months ended September 30, 2019, selling, general and administrative expenses increased to $815,871, or 39.5% of sales, representing an increase of $148,594, from $667,277 or 64.9% of sales for the three months ended September 30, 2018. This decrease in selling, general and administrative expenses as a percentage of sales in the third quarter of 2019 over the third quarter of 2018 was primarily due to higher sales covering more fixed costs within SG&A partially offset by higher sales costs and wages.

Other expense, net was $232,979, an increase of $176,535 for the three months ended September 30, 2019 compared to the third quarter in 2018. The increase in other expense during the three months ended September 30, 2019 resulted from higher interest expense with our revolving line of credit, funding agreements and notes payable, partially offset by a gain on settlement of liabilities compared to the three months ended September 30, 2018.

During the three months ended September 30, 2019 we incurred a net loss of $606,175, or $0.04 per basic and diluted earnings per share. For the three months ended September 30, 2018 we incurred a net loss of $279,694 or $0.03 per basic and diluted earnings per share. The net loss in the quarter ended September 30, 2019 resulted primarily from higher cost of revenues and selling, general and administrative expenses resulting in a loss from operations as well as higher interest expenses, compared to the third quarter 2018. The basic weighted average number of shares of common stock outstanding was 14,332,823 and 10,336,470 for the three months ended September 30, 2019 and 2018, respectively.

Nine Months Ended September 30, 2019 Compared to Nine Months Ended September 30, 2018

Our sales for the nine months ended September 30, 2019 were $4,911,401, an increase of 53.8%, from $3,192,432 for the nine months ended September 30, 2018. The increase in revenue for the nine months ended September 30, 2019 is primarily attributable to the additional revenues from the Trinity Services acquisition on June 27, 2019, not present in the year ago period. Additionally, the frac water operations acquired in December 2018, contributed revenues in 2019, not included in the comparable nine month period ended September 30, 2018.

During the nine months ended September 30, 2019, cost of sales increased as a percentage of sales to 81.4% of revenues, or $3,999,156, compared to 54.6% of revenues or $1,742,431, for the comparable 2018 period. The increase in cost of sales as a percentage of revenues is primarily the result of the addition of Trinity Services lower net gross margins, as well as one-time cost overruns and related third party equipment repairs in our s frac water services division in the first half of 2019, expenses associated with discontinuing the lower margin rig supply business, higher vendor rental expense, higher contract labor in connection with the impact of transitional costs related to the frac water operations, higher parts costs imposed by federal tariffs, wage inflation with direct personnel, increased freight, shipping and fuel expenses along with increased depreciation expense from added equipment with our rental fleet.

For the nine months ended September 30, 2019, selling, general and administrative expenses increased to $2,491,317, or 50.7% of sales, an increase of $809,058, from $1,682,589, or 52.7% of sales for the nine months ended September 30, 2018. This increase in selling, general and administrative expenses in the nine month period ended September 30, 2019 over the nine month period ended September 30, 2018 was primarily due to higher professional fees, one-time acquisition costs, operating lease expense from new accounting treatment, increased wage expense from an M&A advisor, added insurance expense. The remaining increase was attributable to non-cash stock-based compensation, and deferred financing costs during the third quarter 2019, partially offset by lower travel and entertainment expenses, and truck and auto expense.

 Other expense, net was $718,275, an increase of $542,467 for the nine months ended September 30, 2019 compared to the comparable period in 2018. The increase in other expense during the nine months ended September 30, 2019 resulted from higher interest expense with our revolving line of credit, funding agreements and notes payable, and loss on settlement of liabilities, compared to the nine months ended September 30, 2018.

During the nine months ended September 30, 2019 we incurred a net loss of $2,297,347, or $0.17 per basic and diluted earnings per share. For the nine months ended September 30, 2018 we incurred a net loss of $408,066 or $0.04 per basic and diluted earnings per share. The net loss in the nine month period ended September 30, 2019 resulted primarily from lower gross margins from higher cost of sales expenses, increased sales, general and administrative expense, and increased interest expense, compared to the comparable period in 2018. The basic weighted average number of shares of common stock outstanding was 13,493,944 and 9,986,415 for the nine months ended September 30, 2019 and 2018, respectively.

Liquidity and Capital Resources

As of September 30, 2019, our total assets were $7,464,347, comprised of $13,353 in cash, $1,967,075 in accounts receivable, $149,413 in inventory, $30,000 in assets held for sale, other current assets of $136,951, $4,342,037 in net property and equipment, and $307,908 in net intangible assets. This is an increase in total assets of $3,937,900 over the total assets at December 31, 2018 of $3,526,447. As of September 30, 2019, we have a working capital deficit of $2,851,664, compared to a working capital deficit of $1,421,715 at December 31, 2018.

During the nine months ended September 30, 2019, we had cash used in operating activities of $585,205, compared to $179,466 of cash used in operating activities for the nine months ended September 30, 2018. The net cash used in operating activities for the nine months ended September 30, 2019 consists primarily of our net loss, right of use operating lease liabilities, deferred revenue and inventory changes, partially offset by increases to accounts payable, depreciation and amortization, stock based compensation, as well as amortization of right of use assets operating leases accrued expenses and other liabilities. During the nine months ended September 30, 2018, we had cash used in operating activities of $179,466, The net cash used in operating activities for the nine months ended September 30, 2018 consisted primarily of our net loss and changes in accounts receivable, account payable, related party and other current assets, partially offset by increases to amortization of deferred financing costs, accounts payable, depreciation and share based payments.

During the nine months ended September 30, 2019, we had net cash used in investing activities of $612,819 from cash paid for the acquisition of Trinity Services and cash paid for the purchase of equipment during the period. During the nine months ended September 30, 2018, we had net cash used in investing activities of $81,869 from cash paid for the purchase of equipment during the period offset by proceeds from the sale of equipment.

Net cash provided by financing activities was $1,209,769 for the nine months ended September 30, 2019, compared to net cash provided by financing activities of $426,973 for the nine months ended September 30, 2018. Our net cash provided by financing activities for the nine months ended September 30, 2019 resulted primarily from the net proceeds from our secured line of credit of $711,809, proceeds from sales of our common stock of $359,000, the proceeds from the issuance of notes payable of $480,000, which was partially offset by payments on notes payable of $275,936 and payments on note payable related party of $170,967, and payments on right of use liabilities – finance leases of $48,376.

Our net increase in cash for the nine months ended September 30, 2019 was $11,745, as compared to a net cash increase of $165,638 in the nine months ended September 30, 2018.

At September 30, 2019 and December 31, 2018, we had cash and cash equivalents of $13,353 and $1,608, respectively. Based on the company’s acquisition of Trinity Services at the end of the second quarter 2018, current revenue, and anticipated gross margin improvement from cost cutting measures implemented, along with anticipated new growth from cross selling our customers, we believe cash flow will improve during the remainder of 2019.

Our cash flows from operations and our available capital, including the accounts receivable line of credit with an accounts receivable lender established in June 26, 2019 are presently sufficient to sustain our current level of operations for the next twelve months. At September 30, 2019 this line of credit had drawn approximately $1,348,916. Although our line of credit has no specific cap of an amount it functions as a percentage of eligible accounts receivables. Additionally, we believe we will need to raise additional funds in order to meet the growth, capital expenditures and acquisitions planned for our business through the next twelve months. Currently we are not a party to any binding agreement with respect to potential investments in, or acquisitions of businesses, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

 Historically, we have funded our capital expenditures internally through cash flow, leasing and financing arrangements. We intend to continue to fund future capital expenditures through cash flow, as well as through capital available to us pursuant to our line of credit, capital from the sale of our equity securities and through commercial leasing and financial programs.

Off-Balance-Sheet Transactions

We are not party to any off-balance-sheet transactions.

Contractual Commitments

None

Item 3.  Qualitative and Quantitative Disclosures about Market Risk.

We are a smaller reporting company and, therefore, we are not required to provide information required by this item.

Item 4.  Controls and Procedures.

Evaluation of Disclosure Controls and Procedures: Our management carried out an evaluation of the effectiveness and design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended (the Exchange Act). Based on that evaluation, our Chief Executive Officer and interim Chief Financial Officer has concluded that, at September 30, 2019, such disclosure controls and procedures were not effective.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that the information required to be disclosed in our reports filed or submitted under the Exchange Act is accumulated and communicated to management including our Chief Executive Officer and Interim Chief Financial Officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.

Limitations on the Effectiveness of Controls: Our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Our Chief Executive Officer and Interim Chief Financial Officer has concluded, based on his evaluation as of the end of the period covered by this Quarterly Report that our disclosure controls and procedures were not sufficiently effective to provide reasonable assurance that the objectives of our disclosure control system were met.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal controls over financial reporting that occurred during the three month period ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 

PART II – OTHER INFORMATION

None.

We are a smaller reporting company and, therefore, we are not required to provide information required by this item.

None.

None.

Not applicable.

None.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.