SMG Industries Inc. - Quarter Report: 2020 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

For the quarterly period ended March 31, 2020

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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 June 26, 2020 was 17,380,108.

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

 EXPLANATORY NOTE

As disclosed in the Current Report on Form 8-K filed with the Securities and Exchange Commission (the “SEC”) on May 15, 2020 by SMG Industries Inc. (the “Company”), on March 4, 2020, the SEC issued an order (Release No. 34-88318) under Section 36 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), granting exemptions from specified provisions of the Exchange Act and certain rules thereunder, as amended by Release No. 34-88465 issued on March 25, 2020 (as amended, the “Order”). The Company is relying on the Order and was unable to file this Quarterly Report on Form 10-Q for the period ended March 31, 2020 (the “Quarterly Report”) on a timely basis due to the outbreak of, and local, state and federal governmental responses to, the novel coronavirus pandemic (“COVID-19”). The Company’s operations have experienced disruptions due to the circumstances surrounding COVID-19 including, but not limited to, suggested and mandated social distancing and stay home orders. These mandates and the resulting office closure have severely limited access to the Company’s facilities by the Company’s financial reporting and accounting staff involved in the preparation of the Quarterly Report and impacted the Company’s ability to fulfill required preparation and review processes and procedures with respect to the Quarterly Report. In light of the impact of the factors described above, the Company was unable to compile and review certain information necessary to permit the Company to timely file the Quarterly Report by May 15, 2020, the original filing deadline, without unreasonable effort and expense. This Quarterly Report on Form 10-Q is being filed in reliance on the SEC Order.

SMG INDUSTRIES INC.

Table of Contents

SMG INDUSTRIES INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

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

SMG INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

For the three months ended March 31, 2020 and 2019

(Unaudited)

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

SMG INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUIY (DEFICIT)

For the three months ended March 31, 2020 and 2019

(Unaudited)

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

SMG INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the three months ended March 31, 2020 and 2019

(Unaudited)

The accompanying notes are an integral part of these unaudited consolidated 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.

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.

On June 3, 2019, we entered into an Agreement and Plan of Share Exchange dated as of such date (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. 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 Palestine, Floresville, Waskom, Carthage, Odessa and Alice, Texas.

On February 27, 2020, we entered into a Membership Interest Purchase Agreements for the acquisition of all of the membership interests of each of 5J Oilfield Services LLC, a Texas limited liability company (“5J Oilfield”) and 5J Trucking LLC, a Texas limited liability company (“5J Trucking”) (5J Oilfield and 5J Trucking shall be collectively referred to herein as the “5J Entities”). 5J Oilfield and 5J Trucking services the drilling rig transportation and midstream heavy haul logistics market segments. 5J’s business includes transporting midstream compressors, production equipment and infrastructure components such as cement bridge beams with a fleet of more than 100 trucks, 200 trailers and 15 cranes. 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.

The accompanying unaudited interim consolidated 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, 2019 and 2018 with are included on a Form 10-K filed on May 29, 2020. 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, 2019 and 2018 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, 2020 2,860,000 of stock options, 1,763,335 of warrants, 4,000,000 shares issuable from Series A Preferred Stock, 4,806,388 shares issuable from Series B Preferred Stock and 6,500,000 shares issuable from convertible notes were considered for their dilutive effects.  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.

Recent Accounting Pronouncements

The Company does not believe that any recently issued effective pronouncements, or pronouncements issued but not yet effective, if adopted, would have a material effect on the accompanying financial statements.

NOTE 3 – GOING CONCERN

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, no adjustments to the financial statements have been made to account for this uncertainty. The Company concluded that the uncertainty surrounding the COVID-19 global pandemic, 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. 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 2020 and partly related to the Company cross-selling additional sales initiatives already implemented with the acquisition’s additional customer base. The Company believes that loans obtained under the Paycheck Protection Program in 2020 will be forgiven in accordance with the terms of the program.

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, 2020, one of our customers accounted for approximately 17% of our total gross revenues. No other customers exceeded 10% of revenues during the three months ended March 31, 2020.  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.

One customers accounted for approximately 13% of accounts receivable at March 31, 2020, and three customers accounted for approximately 48% of accounts receivable at December 31, 2019. No other customers exceeded 10% of accounts receivable as of March 31, 2020 and December 31, 2019. 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 March 31, 2020 and December 31, 2019 consisted of the following:

Depreciation expense for the three months ended March 31, 2020 and 2019 was $623,163 and $73,386 respectively.

Intangible assets

Intangible assets as of March 31, 2020 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, 2020 and December 31, 2019 consisted of the following:

Amortization expense for the three months ended March 31, 2020 and 2019 was $2,500 and $7,250, respectively. Future amortization of the intangible assets for the years ended December 31, 2020, 2021, 2022, 2023, 2024 and beyond are $10,000, $10,000, $10,000, $10,000, $10,000 and $81,242, respectively.

NOTE 7 – ACCRUED EXPENSES AND OTHER LIABILITIES

Accrued expenses as of March 31, 2020 and December 31, 2019 included the following:

NOTE 8 – NOTES PAYABLE

Notes payable included the following:

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 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 December 31, 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. On October 1, 2019, the Company issued 120,000 warrants with an exercise price of $0.15 and a term of ten years in exchange for a second extension of the maturity date of the note through March 30, 2020. The warrants were valued at $14,330 and will be amortized over the extension period of the note.

In June 2019, the Company issued a promissory note in the amount of $80,000 to an individual 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. On October 2, 2019, the Company issued 100,000 warrants with an exercise price of $0.15 and a term of ten years in exchange for a second extension of the maturity date of the note through March 30, 2020. The warrants were valued at $11,942 and will be amortized over the extension period of the note.

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.

On October 1, 2019, we entered into a second amendment to a unsecured 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. The warrants were valued at $4,777 and will be amortized over the extension period of the note. See Notes Payable – Unsecured table below.

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. See Note 8 – Stockholders’ Deficit.

On December 12, 2019, the Company issued a $50,000 12% secured promissory note. The note is due and payable in monthly installments of the principal and accrued interest with the first payment of $25,000 due on or before December 19, 2019. The remaining balance shall be paid in $5,000 monthly installments until maturity on June 3, 2020. On December 12, 2019, the Company issued 75,000 warrants with an exercise price of $0.15 and a term of ten years in exchange for a second extension of the maturity date of the note through June 3, 2020. The warrants were valued at $17,947 and will be amortized over the extension period of the note.

On January 23, 2020, the Trinity Services issued a secured promissory note for $1,272,780, which includes precomputed interest of $210,018. The note is due and payable in thirty six monthly installments of $35,355 commencing on March 25, 2020 and the final installment is due on February 25, 2023. The note is secured by machinery and equipment owned by SMG.

On February 27, 2020, the 5J Entities entered into a Master Lease Agreement with Utica Leaseco LLC (“Utica”) pursuant to which Utica refinanced substantially all of the 5J Entities equipment in the aggregate amount of $11,950,000 which amount was financed based on 75% of the net forced liquidation value of the equipment. Pursuant to the terms of the Utica Financing, the 5J Entities will pay a monthly fee to Utica for a period of 51 months, with a cash payment due at the end of the lease term in the amount of $831,880. The 5J Entities own all of the assets financed pursuant to the Utica Financing, subject to Utica’s security interest in all of the equipment of the 5J Entities pursuant to the terms of the security agreement. Each of the Company and Matthew Flemming, its CEO, have entered into guaranty agreements with Utica, whereby they have guaranteed all of the obligations of the 5J Entities under the Utica Master Lease Agreement, pursuant to the guaranty agreements. On May 19, 2020, the Company amended the Utica Master Lease agreement, whereby Utica agreed to accept a reduced monthly payment of $150,000 for six months starting in April 2020 and a monthly payment of $366,63.34 for 45 months, with a cash payment due at the end of the lease term in the amount of $831,880.

Future maturities of secured notes payable as of March 31, 2020 are as follows:

Notes Payable – Unsecured

Notes Payable (Related Party)

During the year ended December 31, 2019, Stephen Christian advanced $10,400 to the Company and was repaid $35,777 by the Company and received $25,279 of noncash advances from the Company. As of March 31, 2020 and December 31, 2019, $0 and $98 remained outstanding, respectively, with no specific repayment terms or stated interest rate.

Accounts Receivable Financing Facility (Secured Line of Credit)

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.

On February 27, 2020, the 5J Entities entered into a Revolving Accounts Receivable Assignment and Term Loan Financing and Security Agreement with Amerisource Funding Inc. (“Amerisource”) in the aggregate amount of $10,000,000 (“Amerisource Financing”).The Amerisource Financing provides for: (i) an equipment loan in the principal amount of $1,401,559 (“Amerisource Equipment Loan”), (ii) a bridge term facility in the amount of $550,690 (“Bridge Facility”), and (iii) an accounts receivable revolving line of credit up to $10,000,000 (“AR Facility”). The Company recorded $21,023 of deferred financing costs related to this note which will be amortized over the life of the loan. During the three months ended March 31, 2020, $1,752 of deferred financing cost related to this note have been amortized.

The AR Facility has been issued in an amount not to exceed $10,000,000, with the maximum availability limited to 85% of the eligible accounts receivable (as defined in the financing agreement). The AR Facility is paid for by the assignment of the accounts receivable of each of the 5J Entities and is secured by all instruments and proceeds related thereto. The AR Facility has an interest rate of 4.5% in excess of the prime rate per annum, an initial collateral management fee of 0.75% of the maximum account limit per annum, a non-usage fee of 0.35% assessed on a quarterly basis on the difference between the maximum availability under the AR Facility and the average daily revolving loan balance outstanding, and a one time commitment fee equal to $100,000 paid at closing. The AR Facility can be terminated by the 5J Entities with 60 days written notice. There is an early termination fee equal to two percent (2.0%) of the then maximum account limit if there are more than twelve (12) months remaining in term of the AR Facility, or one percent (1.0%) of the then maximum account limit if there twelve months or less remaining in the term of the AR Facility. The Company is a guarantor of the Amerisource Financing.

The balances under the above lines of credit was $6,274,222 and $845,036 as of March 31, 2020 and December 31, 2019, respectively.

Convertible Notes Payable

On February 27, 2020, the Company entered into a loan agreement with Amerisource Leasing Corporation for the sale of a 10% convertible promissory note in the principal amount of $1,600,000 (“Amerisource Note”) to Amerisource (“Amerisource Loan Agreement”). The Amerisource Note matures on February 27, 2023 and is convertible into shares of the Company’s common stock at a conversion price of $0.25 per share. The interest rate on the Amerisource Note increases to 11% per annum on February 27, 2021 and to 12% per annum on February 27, 2022. Interest shall be paid on a quarterly basis. In addition, 2,498,736 shares of the Company’s common stock were issued to the noteholder in connection with the sale of the Amerisource Note. The Amerisource Note may be prepaid at any time by the Company on 10 days-notice to the noteholder without penalty. The Company recorded $419,788 of deferred financing costs related to this note which will be amortized over the life of the loan. During the three months ended March 31, 2020, $11,661 of deferred financing cost related to this note have been amortized.

On September 28, 2018, the Company entered into a secured note purchase agreement with an individual 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, 2020, $12,900 of the discount was amortized. On February 27, 2020, the principal amount of $250,000 was converted into the Amerisource Note and is convertible into the Company’s common stock at a fixed exercise price of $0.25 per share anytime while the note is outstanding.

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

As of March 31, 2020, the convertible notes, net balance was $1,215,699 which includes current portion of convertible notes of $521,065. As of December 31, 2020, the convertible notes balance was $260,926.

NOTE 9 – STOCKHOLDERS’ DEFICIT

During the three months ended March 31, 2020, the Company issued 2,498,736 shares of the common stock were to the noteholder in connection with the sale of the Amerisource Note.

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. As of March 31, 2020, the Company has accrued $45,740 for the Series A preferred stock dividend.

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.

Preferred Stock – Series B Convertible Preferred stock

On February 20, 2020 the company filed a Certificate of Designation of Preferences, Rights and Limitations of 5% Series “B” Convertible Preferred Stock to create a new class of stock in connection with its pending acquisition. This Series B Convertible Preferred stock has designated 6,000 shares, has a stated value of $1,000 per share and was delivered to the seller of 5J Entities at closing.

The Series B 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 B Preferred Stock shall pay a five percent (5%) annual dividend on the outstanding Series B Preferred Stock, all of which shall be accrued until the Series B Preferred Stock has been converted.

At any time from issuance, the stated value of each outstanding share of Series B 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 $1.25 per share on the date on which the Holder notices a conversion. As of March 31, 2020, the Company has accrued $27,123 for the Series B preferred stock dividend.

All outstanding shares of Series B Preferred Stock, and accrued Dividends thereon, shall automatically convert into shares of the Corporation’s Common Stock on the date that is thirty-six (36) months after the date of the issuance

The Holders shall have the right to receive notice of any meeting of holders of Common Stock or Series B Preferred Stock and to vote upon any matter submitted to a vote of the holders of Common Stock or Series B 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:

On February 28, 2020, the Company issued 2,025,000 common stock options to 5J and SMG employees. The options vest equally over a three-year period starting on February 28, 2021.The stock options have an exercise price of $0.30 and a five-year term.

The weighted average remaining contractual life is approximately 2.96 years for stock options outstanding on March 31, 2020. At March 31, 2020 there was no intrinsic value of outstanding stock options.

Summary stock warrant information is as follows:

In March 2020, the Company granted 333,334 warrants to two debt holders with a ten-year term and an exercise price of $0.20. The warrants are fully vested at the time of issuance. The Company valued the warrants using the Black-Scholes model with the following key assumptions ranging from: Stock price, $0.18, Exercise price, $0.20, Term 10 years, Volatility 183.29%, Discount rate, 0.74%. During the three ended March 31, 2020, the fair value of $59,439 was recoded as a notes payable discount and will be amortized over the life of the notes payable.

The weighted average remaining contractual life is approximately 6.85 years for stock warrants outstanding on March 31, 2020. At March 31, 2020 there was no intrinsic value of outstanding stock warrants.

NOTE 11 – ACQUISITION

5J Entities

On February 27, 2020 we entered into a Membership Interest Purchase Agreements for the acquisition of all of the membership interests of each of 5J Oilfield Services LLC, a Texas limited liability company (“5J Oilfield”) and 5J Trucking LLC, a Texas limited liability company (“5J Trucking”) (5J Oilfield and 5J Trucking shall be collectively referred to herein as the “5J Entities”) (the “Transaction”). The total purchase price for the 5J Entities was $27.3 million. Due to the recent timing of the acquisition, the Company is currently in the process of determining the fair value of the net assets acquired and liabilities assumed.

Pursuant to the terms of the 5J Oilfield Membership Interest Purchase Agreement (“5J Oilfield Agreement”), we acquired 100% of the issued and outstanding membership interests from the sole member of 5J Oilfield (“5J Oilfield Member”), pursuant to which 5J Oilfield has become a wholly-owned subsidiary of SMG Industries Inc. Pursuant to the terms of the 5J Oilfield Agreement, we have: (i) paid the 5J Oilfield Member $6,840,000 in cash; (ii) issued 6,000 shares of our 5% Series B Convertible Preferred Stock (“Preferred Stock”), stated value $1,000 per share; (iii) assumed or refinanced the obligation for truck notes owed by 5J and its affiliates in the principal amount of $1,034,000 and paid off a community line of credit balance as of closing in the amount of $5.86 million; and (iv) caused 5J Oilfield to issue a note (“Seller Note”) to the 5J Oilfield Member in the principal amount of $2,000,000 (“5J Oilfield Purchase Price”).

The Preferred Stock issued in connection with the acquisition of the 5J Entities is convertible at $1.25 per share at any time after its issuance and shall automatically convert into shares of the Company’s common stock, par value $.001 per share, three years from the date of issuance. The Company shall pay a quarterly dividend of 5% per annum to the holder of the Preferred Stock, subject to certain conditions related to the EBITDA of the 5J Entities. In the event that the consolidated quarterly EBITDA of the 5J Entities is not in excess of the aggregate fixed monthly payments made to Amerisource (defined below) and Utica (defined below), the 5J Oilfield Member will have the option of accruing the dividend, or converting such amount due into shares of the Company’s common stock at the market price at such time. The holder of the Preferred Stock shall vote on all matters presented to the Company’s common stockholders on an as converted basis. 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 Transaction 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 acquisition of the 5J Entities 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 fair value of the Series B preferred shares issued to the seller was estimated using a Black Scholes option price model with various scenarios factoring in the rights of preferences of the preferred shares, the capital structure of the Company, a risk free rate of 1.07%, a volatility of 51% and a maturity period of three years. 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 months ended March 31, 2020 include revenue of $4,360,381 and net loss of $804,814 related to the operations of the 5J Entities since the acquisition date.

Trinity

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 expect to complete the closing of the acquisition of Trinity on or before June 21, 2019 (“Closing Date”). On the Closing Date, pursuant to the Exchange Agreement, we will acquire one hundred percent (100%) of the issued and outstanding membership interests of Trinity (“Trinity Membership Interests”) from the Trinity Member pursuant to which Trinity will become 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 will: (i) issue 2,000 shares of our 3% Series A Secured Convertible Preferred Stock (“Preferred Stock”), stated value $1,000 per share, (ii) pay $500,000 in cash to the Trinity Member, and (iii) assume 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 Preferred Stock was based on the Black-Scholes model with the following key assumptions ranging from: Stock price $0.50, Exercise price $0.42, Term 3 years, Volatility 36% and Discount rate of 1.7%.

The acquisition of Trinity is being accounted for as a business combination under ASC 805. The following information summarizes the purchase consideration and allocation of the fair values assigned to the assets at the purchase date:

The Company’s consolidated revenue and net loss for the three months ended March 31, 2020 include revenue of $845,896 and net loss of $199,412 related to the operations of Trinity since the acquisition date.

Unaudited Pro Forma Financial Information

The following schedule contains pro-forma consolidated results of operations for the three months ended March 31, 2020 and 2019 as if the 5J Acquisition and Trinity acquisition occurred on January 1, 2019. 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 acquisitions had taken place on the dates noted above, 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

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, 2020 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 March 31, 2020:

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, 2020:

At March 31, 2020 the Company had no additional leases which had not yet commenced.

The Company acquired six operating leases for equipment, office and warehouse space as part of the 5J Acquisition and recognized a right of use asset and operating lease liability of $1,510,897 as part of the purchase price accounting. The remaining terms of the acquired leases range from 36 and 60 months.

NOTE 15 – RELATED PARTY TRANSACTIONS

James Frye, who currently serves as President of our 5J subsidiary, and owns our $6 million Series B Convertible Preferred Stock, also owns or has control over 5J Properties LLC, an entity that is the lessor to three leases with the Company. These three leases located in Palestine, West Odessa and Floresville Texas all have similar five year terms with options for renewal. The current monthly rent for these leases totals approximately $14,250.

NOTE 16 – SUBSEQUENT EVENTS

In April 2020, 5J Oilfield Services LLC was informed by Hancock Whitney Bank, its lender, that they received approval from the U.S. Small Business Administration (“SBA”) to fund 5J’s request for a loan under the SBA’s Paycheck Protection Program (“PPP Loan”) created as part of the recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) administered by the SBA. In connection with the PPP Loan, 5J has entered into a two-year promissory note. Per the terms of the PPP Loan, 5J will receive total proceeds of $3,148,100 from the Hancock Whitney Bank. In accordance with the requirements of the CARES Act, 5J intends to use the proceeds from the PPP Loan primarily for payroll costs. The PPP Loan is scheduled to mature on April 22, 2022, has a 1.00% interest rate, and is subject to the terms and conditions applicable to all loans made pursuant to the Paycheck Protection Program as administered by the SBA under the CARES Act.

In April and May 2020, SMG Industries, Inc., Trinity Services, LLC, Jake Oilfield Solutions, LLC and MG Cleaner, LLC (the “Companies”) were informed by their lender, Prosperity Bank (the “Bank”), that the Bank received approval from the U.S. Small Business Administration (“SBA”) to fund the Companies’ request for loans under the SBA’s Paycheck Protection Program (“PPP Loan”) created as part of the recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) administered by the SBA. In connection with the PPP Loans, the Companies have entered into two-year promissory notes. Per the terms of the PPP Loans, SMG will receive total proceeds of $72,500, Trinity will receive total proceeds of $195,000, Jake will receive total proceeds of $21,200 and MG will receive total proceeds of $190,000 from the Bank. In accordance with the requirements of the CARES Act, the Companies intend to use the proceeds from the PPP Loans primarily for payroll costs. The PPP Loans are scheduled to mature on April 20, 2022 for SMG, April 28, 2020 for Trinity and May 1, 2022 for Jake and MG. The loans have a 1.00% interest rate and are subject to the terms and conditions applicable to all loans made pursuant to the Paycheck Protection Program as administered by the SBA under the CARES Act.

On May 15, 2020, the Company entered in a loan modification agreement with VFS US LLC. The agreement allowed for three months of nonpayment and modified the remaining future monthly payments. No other terms of the loan were modified.

On May 27, 2020, our wholly-owned subsidiary, Trinity Services, LLC executed a note with the United States Small Business Administration (“SBA”) for $150,000 in connection with the SBA’s economic injury disaster loan (“EIDL”) program. The note has a thirty year term, an annual interest rate of 3.75% and payments of $731.00 are due monthly beginning twelve months from the date of the Note. The Note grants the SBA a general security interest in Trinity Services’ collateral and has no penalty of prepayment.

Also on May 27, 2020, our wholly-owned subsidiary, MG Cleaners, LLC executed a note with the United States Small Business Administration (“SBA”) for $150,000 in connection with the SBA’s economic injury disaster loan (“EIDL”) program. The note has a thirty year term, an annual interest rate of 3.75% and payments of $731.00 are due monthly beginning twelve months from the date of the Note. The Note grants the SBA a general security interest in MG Cleaners’ collateral and has no penalty of prepayment.

On June 17, 2020, our wholly-owned subsidiary, Momentum Water Transfer Services LLC, executed a note with the United States Small Business Administration (“SBA”) for $90,000 in connection with the SBA’s economic injury disaster loan (“EIDL”) program. The note has a thirty year term, an annual interest rate of 3.75% and payments of $439.00 are due monthly beginning twelve months from the date of the Note. The Note grants the SBA a general security interest in Momentum’s collateral and has no penalty of prepayment.

As disclosed in the Current Report on Form 8-K filed with the Securities and Exchange Commission (the “SEC”) on May 15, 2020 by SMG Industries Inc. (the “Company”), on March 4, 2020, the SEC issued an order (Release No. 34-88318) under Section 36 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), granting exemptions from specified provisions of the Exchange Act and certain rules thereunder, as amended by Release No. 34-88465 issued on March 25, 2020 (as amended, the “Order”). The Company is relying on the Order and was unable to file this Quarterly Report on Form 10-Q for the period ended March 31, 2020 (the “Quarterly Report”) on a timely basis due to the outbreak of, and local, state and federal governmental responses to, the novel coronavirus pandemic (“COVID-19”). The Company’s operations have experienced disruptions due to the circumstances surrounding COVID-19 including, but not limited to, suggested and mandated social distancing and stay home orders. These mandates and the resulting office closure have severely limited access to the Company’s facilities by the Company’s financial reporting and accounting staff involved in the preparation of the Quarterly Report and impacted the Company’s ability to fulfill required preparation and review processes and procedures with respect to the Quarterly Report. In light of the impact of the factors described above, the Company was unable to compile and review certain information necessary to permit the Company to timely file the Quarterly Report by May 15, 2020, the original filing deadline, without unreasonable effort and expense. This Quarterly Report on Form 10-Q is being filed in reliance on the SEC Order.

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 5J Oilfield Services, LLC, 5J Trucking, LLC, 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, 2019.

Overview

We are a growth-oriented company focused in logistics, midstream & oilfield services market segments in the Southwest United States.  Our primary business objective is to grow our operations and create value for our stockholder’s through organic growth and strategic acquisitions. We have a ‘buy & build’ growth strategy of consolidating middle market companies and generating organic growth post-acquisition when possible from removing business constraints with strategic cross-selling of products and services across market segments benefiting us with higher utilization and customers with more efficient costs.  

Our wholly-owned operating subsidiaries that offer this range of products and services are:

These operating subsidiaries provide a range of logistics, midstream and oilfield services such as:

We are headquartered in Houston, Texas with facilities in Odessa, Floresville, Alice, Palestine, Carthage, and Waskom, Texas. Our web sites are www.SMGIndustries.com,  www.5Joilfield.net, www.5JTrucking.net, www.ts-oilfield.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 27, 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 Series A Convertible Preferred Stock, with a stated value of $1,000 per share, to the sole member of Trinity. The Series A Convertible Preferred Stock is convertible at a price of $0.50 per share and is convertible into an aggregate of 4,000,000 shares of the Company’s common stock.

On February 27, 2020, we acquired one hundred percent of the membership interests of each of 5J Oilfield Services LLC (“5J Oilfield”) and 5J Trucking LLC (“5J Trucking”), each a Texas limited liability company. The aggregate purchase price of 5J was $27.3 million, consisting of a combination of cash, notes, Series B Convertible Preferred Stock and the assumption and refinance of debt.

Recent Accounting Pronouncements

The Company does not believe that any recently issued effective pronouncements, or pronouncements issued but not yet effective, if adopted, would have a material effect on the accompanying financial statements.

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, 2019, included in the Company’s Form 10-K/A as filed with the SEC on June 8, 2020. 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 March 31, 2020 Compared to Three Months Ended March 31, 2019

Our sales for the three months ended March 31, 2020 were $5,976,400, an increase of approximately 241%, from $1,752,704 for the three months ended March 31, 2019. The increase in revenues for the three months ended March 31, 2020 was primarily attributable to the additional revenues of the 5J acquisition concluded on February 27, 2020 not present in the year ago comparable period.

During the three months ended March 31, 2020, cost of sales increased as a percentage of sales to 101% of revenues, or $6,016,636, compared to 84.5% of revenues or $1,480,715, for the comparable 2019 period. The increase in cost of sales as a percentage of revenues is primarily the result of the increased deprecation cost added from the 5J acquisition not present in the year ago comparable period.

For the three months ended March 31, 2020, selling, general and administrative expenses increased to $2,497,904, or 41.8% of sales, representing an increase of $1,659,280, from $838,624 or 47.8% of sales for the three months ended March 31, 2019. This increase in selling, general and administrative expenses as a percentage of sales in the first quarter of 2020 compared to the first quarter of 2019 was primarily due to higher sales covering more fixed costs within selling, general and administrative expenses partially offset by higher acquisition costs in the first quarter of 2020 of $1,490,358 resulting from the 5J acquisition.

Other expense, net was $447,091, an increase of $303,464 for the three months ended March 31, 2020 compared $143,627 in the first quarter in 2019. The increase in other expense during the three months ended March 31, 2020 resulted from higher interest expense with our revolving line of credit, funding agreements and notes payable, and higher amortization of debt discount, partially offset by a gain on settlement of liabilities compared to the three months ended March 31, 2019.

During the three months ended March 31, 2020 we incurred a net loss attributable to common shareholders of $3,021,354, or $0.19 per basic and diluted earnings per share. For the three months ended March 31, 2019 we incurred a net loss attributable to common shareholders of $710,262 or $0.06 per basic and diluted earnings per share. The net loss in the quarter ended March 31, 2020 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, including higher non-cash expenses of depreciation and amortization of debt discounts, compared to the first quarter 2019. The basic weighted average number of shares of common stock outstanding was 15,686,520 and 12,460,520 for the three months ended March 31, 2020 and 2019, respectively.

Liquidity and Capital Resources

As of March 31, 2020, our total assets were $37,885,910, comprised of $585,476 of cash and cash equivalents, $9,689,360 in accounts receivable, $18,410 in costs in excess of billings, $173,064 in inventory, prepaid and other current assets of $1,690,626, $23,127,812 in net property and equipment, $750,966 in other assets, $1,721,453 in ROU Asset – operating lease, and $128,743 in net intangible assets. This is an increase in total assets of $31,454,526 over the total assets at December 31, 2019 of $6,431,384. As of March 31, 2020, we have a working capital deficit of $8,250,571, compared to a working capital deficit of $4,062,860 at December 31, 2019.

During the three months ended March 31, 2020, we had cash used in operating activities of $2,481,844, compared to $63,553 of cash used in operating activities for the three months ended March 31, 2019. The net cash used in operating activities for the three months ended March 31, 2020 consists primarily of our net loss, changes in accounts receivable , changes in prepaid expenses and other current assets, and right of use operating lease liabilities, partially offset by increases to accrued expenses and other liabilities, accounts payable, depreciation and amortization, amortization of deferred financing costs, and impairment expense. During the three months ended March 31, 2019, we had cash used in operating activities of $63,553, The net cash used in operating activities for the three months ended March 31, 2019 consisted primarily of our net loss and changes in accounts receivable, and deferred revenue, partially offset by increases to accounts payable, depreciation and amortization, amortization of deferred financing costs, changes in accrued expenses and other liabilities and stock based compensation.

During the three months ended March 31, 2020, we had net cash used in investing activities of $6,405,046 from cash paid for the acquisition of 5J of $6,320,168 and $84,878 of cash paid for purchase of property and equipment during the period. During the three months ended March 31, 2019, we had net cash used in investing activities of $65,471 from cash paid for the purchase of equipment during the period.

Net cash provided by financing activities was $9,442,012 for the three months ended March 31, 2020, compared to net cash provided by financing activities of $197,848 for the three months ended March 31, 2019. Our net cash provided by financing activities for the three months ended March 31, 2020 resulted primarily from the net proceeds from our secured notes payable of $3,215,010, proceeds from our secured line of credit of $5,639,486, and the proceeds from the issuance of convertible notes payable of $1,350,000, which was partially offset by payments on notes payable related party of $35,777, payments on notes payable of $483,839, payment of deferred financing costs of $239,558 and payments on right of use liabilities – finance leases of $13,710.

Our net increase in cash for the three months ended March 31, 2020 was $555,122, as compared to a net cash increase of $68,824 in the three months ended March 31, 2019.

At March 31, 2020 and December 31, 2019, we had cash and cash equivalents of $585,476 and $30,354, respectively. Based on the company’s acquisition of 5J Oilfield Services LLC and 5J Trucking LLC on February 27, 2020, 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 2020.

 Our cash flows from operations and our available capital, including the accounts receivable line of credit with an accounts receivable lender established in February 2020 are presently sufficient to sustain our current level of operations for the next twelve months. At March 31, 2020 this line of credit had drawn approximately $6,006,463 of the $10,000,000 of availability. 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 March 31, 2020, 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 March 31, 2020 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.