SMGI SMG Industries Inc (CE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1 — BACKGROUND AND BASIS OF PRESENTATION

 SMG Industries Inc. (“we”, “our”, the “Company” or “SMG”) is a corporation established pursuant to the laws of the State of Delaware on January 7, 2008. The Company’s 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.

We are a growth-oriented Transportation Services company focused on the domestic logistics market.

SMG is headquartered in Houston, Texas with facilities in Floresville, Henderson, Odessa, Palestine, Tomball, and Victoria, Texas.

In March 2020, the World Health Organization declared COVID-19 a pandemic. Throughout 2020 and into 2021, many variants of the virus arose. We are still assessing the impact COVID-19 and related variants (together, “COVID-19”) may have on our business, but there can be no assurance that this analysis will enable us to avoid part or all of any impact from the spread of COVID-19 or its consequences, including downturns in business sentiment generally.  The extent to which the COVID-19 pandemic and global efforts to contain its spread will impact our operations will depend on future developments, which are highly uncertain and cannot be predicted at this time, and include the duration, severity and scope of the pandemic and the actions taken to contain or treat the COVID-19 pandemic.

The accompanying unaudited interim consolidated financial statements of SMG Industries Inc. 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 consolidated financial statements and notes thereto for the years ended December 31, 2020 and 2019 with are included on a Form 10-K filed on April 19, 2021. 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 consolidated financial statements which would substantially duplicate the disclosures contained in the audited consolidated financial statements for years ended December 31, 2020 and 2019 have been omitted.

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The Company prepares its consolidated financial statements on the accrual basis of accounting. The accompanying consolidated financial statements include the accounts of the Company and its wholly subsidiaries, 5J Trucking LLC, 5J Oilfield Services LLC, 5J Specialized LLC, 5J Transportation LLC and 5J Brokerage LLC (together referred to as “5J”), Momentum Water Transfer Services, LLC Jake Oilfield Solutions LLC and Trinity Services LLC (“Trinity”), all of which have a quarter end of March 31 and fiscal year end of December 31. All intercompany accounts, balances and transactions have been eliminated in the consolidation.

Acquisition Accounting

The Company’s acquisitions are accounted for using the purchase acquisition method of accounting whereby purchase price is allocated to tangible and intangible assets acquired and liabilities assumed based on fair value. The excess of the fair value of the consideration conveyed over the fair value of the net assets acquired is recorded as goodwill. The consolidated financial statements for the fiscal years presented include the results of operations for the 5J Entities and Trinity acquisitions from the date of acquisition.

Fair Value of Financial Instruments

The carrying value of short-term instruments, including cash, accounts payable and accrued expenses, and short-term notes approximate fair value due to the relatively short period to maturity for these instruments. The long-term debt approximate fair value since the related rates of interest approximate current market rates.

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. The Company utilizes a three-level valuation hierarchy for disclosures of fair value measurements, defined as follows:

Level 1: inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets

Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.

Level 3: inputs to the valuation methodology are unobservable and significant to the fair value

The Company does not have any assets or liabilities that are required to be measured and recorded at fair value on a recurring basis.

Discontinued Operations

In December 2020 we sold MG and decided to cease the operations of Trinity. A component of an entity that is disposed of by sale or ceasing of operations is reported as discontinued operations if the transaction represents a strategic shift that will have a major effect on an entity's operations and financial results. As such, MG and Trinity are reported as discontinued operations.

Assets and liabilities of the discontinued operations are aggregated and reported separately as assets and liabilities of discontinued operations in the Consolidated Balance Sheets as of March 31, 2021 and December 31, 2020. The results of discontinued operations are aggregated and presented separately in the Consolidated Statements of Operations as net loss from discontinued operations for the three months ended March 31, 2021 and 2020. The cash flows of the discontinued operations are reflected as cash flows of discontinued operations within the Company’s Consolidated Statements of Cash Flows for the three months ended March 31, 2021 and 2020.

Amounts presented in discontinued operations have been derived from our consolidated financial statements and accounting records using the historical basis of assets, liabilities, results of operations, and cash flows of Trinity and MG Cleaners. The discontinued operations exclude general corporate allocations.

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, 2021, 2,060,000 of stock options, 1,763,335 of warrants, 4,000,000 shares issuable from Series A Preferred Stock and 29,413,660 shares issuable from convertible notes were considered for their dilutive effects. 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. As a result of the Company’s net losses for the three months ended March 31, 2021 and 2020, all potentially dilutive instruments were excluded as their effect would have been anti-dilutive.

Reclassification

Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation.

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 consolidated financial statements have been prepared assuming that the Company will continue as a going concern and, no adjustments to the consolidated 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 operations 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) in connection with its anticipated growth related to the Company’s February 2020 acquisition of 5J and its expanded revenue lines in heavy haul, super heavy haul, drilling rig mobilization, commodity freight, and brokerage services. The Company believes that loans obtained under the Paycheck Protection Program in 2020 and 2021 will be forgiven in accordance with the terms of the program.

NOTE 4 – REVENUE

Disaggregation of revenue

All of the Company’s revenue from continuing operations is currently generated from services. As such no further disaggregation of revenue information is provided. All revenues are currently in the southern region of the United States.

Customer Concentration and Credit Risk

During the three months ended March 31, 2021, one of our customers accounted for approximately 12% of our total gross revenues. No other customers exceeded 10% of revenues during the three months ended March 31, 2021.  No customer accounted for 10% of accounts receivable as of March 31, 2021 and one customer accounted for 10% of accounts receivable as of December 31, 2020. During the three months ended March 31, 2020, one of our customers accounted for approximately 18% of our total gross revenues. No other customers exceeded 10% of revenues during the three months ended March 31, 2020.

Depreciation expense for the three months ended March 31, 2021 and 2020 was $1,418,401 and $542,493, respectively.

Effective March 9, 2021, the Company entered into a third amendment and surrender agreement with Utica requiring weekly payments of $23,750 until May 28, 2021. Upon the occurrence of an event of default under such amendment, and after the expiration of any cure period related to any such default, the surrender agreement entered into between the parties shall govern the surrender of the ownership and possession of the 5J equipment to Utica, or their designee, pursuant to the terms of the Lease agreement between the parties. The surrender agreement directs any third party in possession of any of such equipment to surrender the equipment in their possession to Utica and for Lessee to comply with any related paperwork requests to transfer ownership of the equipment to Utica. The surrender agreement shall terminate on the earlier to occur of: (i) June 25, 2021, or (ii) the occurrence of an event of default, that is not cured within any applicable cure period. From June 4, 2021 to June 25, 2021 the weekly payments shall increase to $112,000 per week, and thereafter commencing on July 27, 2021 the payments shall be $448,000 per month.

On April 22, 2020, 5J Oilfield Services LLC received cash proceeds of $3,148,100 from the Hancock Whitney Bank. In accordance with the requirements of the CARES Act, 5J and used the proceeds from the PPP1 Loan primarily for payroll costs. The PPP1 Loan is scheduled to mature on August 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.

On January 28, 2021, the 5J Oilfield Services LLC received proceeds of $1,769,002 under the SBA PPP2 program. On February 3, 2021, Jake Oilfield Solutions LLC received proceeds of $35,000 under the SBA PPP2 program. On February 4, 2021, SMG Industries, Inc. received proceeds of $70,000 under the SBA PPP2 program.

The PPP2 loans mature 5 years from the date of the notes and bear interest at 1%. Payments of principal and interest payments begin one year and one month from the dates of the notes and are in 60 equal monthly installments. The loans 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. In accordance with the requirements of the CARES Act, the Company intends to use the proceeds from the PPP2 Loans primarily for payroll costs.

Unsecured Notes Payable – Discontinued Operations

On April 28,2020, Trinity, received proceeds of $195,000 under the SBA PPP1 program. In accordance with the requirements of the CARES Act, the Companies used the proceeds from the PPP1 Loan primarily for payroll costs. 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. The PPP Loan was scheduled to mature on, August 28, 2020. The Trinity loan was forgiven February 16, 2021. The Trinity loan was included in Current Liabilities-Discontinued Operations on the Company’s December 31, 2020 Consolidated Balance Sheet and the gain on the forgiveness of the loan is included in loss from discontinued operations on the Company’s Consolidated Statement of Operations for the three months ended March 31, 2021.

Accounts Receivable Financing Facility (Secured Line of Credit)

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 deferred financing costs of $223,558 recognized on the date of incurrence as a discount. During the three months ended March 31, 2021, $26,688 of debt discount was amortized to interest expense, and unamortized discount was $98,158 as of March 31, 2021. Amerisource is a related party of the Company due to its holdings of common stock and convertible debt of the Company and has an officer on the Board of Directors of the Company.

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 $3,718,730 and $4,046,256 as of March 31, 2021 and December 31, 2020, respectively.

Convertible Notes Payable

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 8.50 %, 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.

On February 27, 2020, the Company entered into a loan agreement with Amerisource Leasing Corporation, which has an equity ownership of 13.9% and is considered a related party, for the sale of a 10% convertible promissory note in the principal amount of $1,600,000 (“Amerisource Stretch Note”). The Amerisource Stretch 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 Stretch 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 with a fair value of $419,788 were issued to the noteholder in connection with the sale of the Amerisource Note. The Company recorded deferred financing costs of $419,788 recognized on the date of incurrence as a discount and will be amortized over the life of the loan. During the three months ended March 31, 2021, $34,982 of debt discount was amortized to interest expense, and there was $268,198 of unamortized discount as of March 31, 2021. The Amerisource Stretch Note may be prepaid at any time by the Company on 10 days-notice to the noteholder without penalty.

During the year ended December 31, 2020, the Company entered into secured note purchase agreements with nine individual investors for the purchase and sale of convertible promissory notes (“Convertible Notes”) in the principal amount of $2,019,000. The Convertible Notes are convertible at any time after the date of issuance into shares of the Company’s common stock at a conversion price of $0.10 per share. Interest on the Convertible Notes shall be paid to the investors at a rate of 10.0% per annum, paid on a quarterly basis, and the maturity date of the Convertible Notes is two years after the issuance date. The Convertible Notes are secured by all of the assets of the Company, subject to prior liens and security interests. The Company also issued a total of 3,028,500 shares of common stock to the investors. The Company recognized a debt discount of $1,057,710 which is equivalent to the relative fair value of the 3,028,500 common shares and the beneficial conversion feature on the Convertible Notes. During the three months ended March 31, 2021, the Company received $150,000 of cash and $112,071 of expenses paid on behalf of the Company in the form of new convertible notes under the terms above from related parties. The lender received 393,107 shares of the Company’s restricted common stock. The Company recognized debt discount of $175,051 based on the relative fair value of these shares and the beneficial conversion feature on the convertible notes. During the three months ended $151,984 of debt discount was amortized to interest expense.

Of the $2,228,071 principal amount, $1,931,071 of the convertible notes are held by investors who are considered related parties, primarily existing debt holders. As of March 31, 2021, there was $921,847 of unamortized discount remaining.

As of March 31, 2021, the convertible notes net balance was $2,741,321, consisting of long term convertible notes payable of $2,691,321, and current portion of convertible notes of $50,000. As of December 31, 2020, the convertible notes net balance was $2,467,335 consisting of long term convertible notes payable of $2,417,335 and current portion of convertible notes of $50,000.

Future maturities of all the Company’s debt as of March 31, 2021 are as follows:

NOTE 8 – STOCKHOLDERS’ DEFICIT

During the three months ended March 31, 2021, a total of 393,107 shares of common stock were issued to a related party pursuant to the convertible notes payable described in Note 7.

The weighted average remaining contractual life is approximately 2.5 years for stock options outstanding on March 31, 2021. At March 31, 2021 there was no intrinsic value to the outstanding stock options.

During the three months ended March 31, 2021 and 2020, the Company recognized $17,973 and $2,895 of stock-based compensation, respectively, related to outstanding stock options. At March 31, 2021, the Company had $142,783 of unrecognized expenses related to options.

Summary Stock warrant information is as follows:

The weighted average remaining contractual life is approximately 5.85 years for stock warrants outstanding on March 31, 2021. At March 31, 2021 the aggregate intrinsic value of outstanding stock warrants was $30,117.

NOTE 10 – DISPOSITION OF BUSINESSES

Trinity Services LLC

In December 2020, management decided to sell or dissolve Trinity. All assets and liabilities of Trinity are classified as assets and liabilities of discontinued operations and included within net loss from discontinued operations. The Company plans to auction the fixed assets in 2021 and recorded an impairment of $983,660 during the year ended December 31, 2020 to reflect expected proceeds from this auction.

The Company’s Consolidated Statements of Operations reflect in discontinued operations Trinity’s revenues and net loss from discontinued operations for the quarter ended March 31, 2021 of $104,440 and $54,180, respectively, compared to the first quarter ended March 31, 2020 of $845,896 and $199,412, respectively. The net losses exclude general corporate allocations.

MG Cleaners LLC

On December 22, 2020, the Company, as the sole member of MG Cleaners LLC (“MG”), entered into a share exchange agreement (“Agreement”) with S&A Christian Investments L.L.C. (“S&A”) pursuant to which the Company transferred all of the membership interests of MG (“MG Interests”) to S&A in exchange for Stephen Christian, the control person of S&A, returning 1,408,276 shares of the Company’s common stock, par value $.001 per share (“Exchanged Shares”) to the Company for cancellation, additional consideration received by the Company in connection with the transaction included the removal of the Company as a guarantor of certain MG debt. All 750,000 unvested incentive stock options previously granted to Mr. Christian expired at the time of the transaction. Mr. Stephen Christian, the Company’s former Executive Vice President and Secretary, is the control person of S&A. As a result of the terms of the transaction, S&A became the owner of all of the MG Interests. In connection with the sale of MG, Mr. Christian resigned as Executive Vice President and Secretary of the Company. The Company also agreed to pay $150,000 in cash to MG Cleaners, with $75,000 paid in December 2020. The remaining $75,000 was satisfied with a $40,000 sale of equipment and payment of $35,000 to MG Cleaners in February 2021.

The Company’s Consolidated Statements of Operations reflect in discontinued operations MG’s revenues and net loss from discontinued operations for the quarter ended March 31, 2021 of $0 and $2,275, respectively, compared to the first quarter ended March 31, 2020 of $770,123 and $33,912, respectively. The net losses exclude general corporate allocations.

The decision to sell Trinity assets and the MG sale agreement qualify as discontinued operations in accordance with U.S. GAAP, as each represents a significant strategic shift of the Company’s operations that will have a major effect on the Company’s operations. As a result, the Consolidated Balance Sheets as of March 31, 2021 and December 31, 2020 present the assets and liabilities of MG and Trinity as assets and liabilities of discontinued operations. The Consolidated Statements of Operations for the three months end March 31, 2021 and 2020 present the results of MG and Trinity as Loss from discontinued operations. The Consolidated Statements of Cash Flows for the three months end March 31, 2021 and 2020 present operating, investing, and financing activities of MG and Trinity as cash flows from or used in discontinued operations.

The balance sheets of Trinity and MG combined are summarized below:

The statements of operations of Trinity and MG combined are summarized below:

NOTE 11 – COMMITMENTS AND CONTINGENCIES

As of March 31, 2021, the Company has an open letter of credit in the amount of $323,516 as collateral for its insurance policy.

Employment Agreements

Litigation

From time to time, SMG may be subject to routine litigation, claims, or disputes in the ordinary course of business. In the opinion of management no 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 12 – 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 leases for the three months ended March 31, 2021 and 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, 2021:

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, 2021:

During the period ended March 31, 2021, the Company did not enter into new leases. 

NOTE 13 – RELATED PARTY TRANSACTIONS

Newton Dorsett, who received $2 million Series A Convertible Preferred Stock in connection with the sale of Trinity Services to us also owns or has control over Dorsett Properties LLC, an entity that is the lessor to a lease with the Company. The lease is for $2,000 per month from July 1, 2019 until June 1, 2024.

James Frye, who currently serves as a director on our Board and President of our 5J subsidiary and received 6,000 shares of Series B Convertible Preferred Stock in connection with the sale of 5J to us, 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.

On June 15, 2020, the Company entered into an Interim Management Services Agreement with Apex Heritage Group, Inc. (the “Consultant”), of which Steven H. Madden, a related party, has sole voting and investment control over. The Consultant will provide Jeffrey Martini to serve as the Company’s Chief Financial Officer, reporting to both the Company’s Chief Executive Officer and its Board of Directors. The Company shall pay to Consultant an amount and in a form to be mutually agreed by both parties. In December 2020, Mr. Martini was also appointed as Chief Executive officer.

During the year ended December 31, 2020 and the three months ended March 31, 2021, the Company entered into new convertible notes payable with related parties totaling $1,931,071 in principal as of March 31, 2021. See Note 7.

Mr. Martini serves as our Chief Executive Officer and Chief Financial Officer, however, we are not party to an employment agreement with Mr. Martini. Instead, APEX Heritage Group, Inc. (“Apex”) has contracted directly with Mr. Martini for such management services and is routinely compensated in turn via the provision of debt and/or equity instruments under the terms of an interim management services agreement, among other arrangements. During 2020, Apex was reimbursed via convertible debt valued at $225,000, which was in part compensation for such employment, and during the three months ended March 31, 2021, $112,071 was reimbursed through convertible debt. The Company expects to continue such arrangement throughout 2021.