Sky Quarry Inc.: Form 10-Q for the period ended Sep 30, 2024

You should read the following discussion and analysis together with our unaudited condensed consolidated financial statements and the notes to our unaudited condensed consolidated financial statements, which appear elsewhere in this report, as well as our Annual Report on Form 1-K for the year ended December 31, 2023, filed with the Securities and Exchange Commission (the “SEC”) on May 7, 2024.

Our Management’s Discussion and Analysis contains not only statements that are historical facts, but also statements that are forward-looking (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934). Forward-looking statements are, by their very nature, uncertain and risky. These risks and uncertainties include international, national and local general economic and market conditions; demographic changes; our ability to sustain, manage, or forecast growth; our ability to successfully make and integrate acquisitions; raw material costs and availability; new product development and introduction; existing government regulations and changes in, or the failure to comply with, government regulations; adverse publicity; competition; the loss of significant customers or suppliers; fluctuations and difficulty in forecasting operating results; changes in business strategy or development plans; business disruptions; the ability to attract and retain qualified personnel; the ability to protect technology; and other risks that might be detailed from time to time in our filings with the Securities and Exchange Commission.

Although the forward-looking statements in this Quarterly Statement reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by them. Consequently, and because forward-looking statements are inherently subject to risks and uncertainties, the actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements. You are urged to carefully review and consider the various disclosures made by us in this report and in our other reports as we attempt to advise interested parties of the risks and factors that may affect our business, financial condition, and results of operations and prospects.

The following discussion and analysis of financial condition and results of operations of the Company is based upon, and should be read in conjunction with, its unaudited financial statements and related notes elsewhere in this Form 10-Q, which have been prepared in accordance with accounting principles generally accepted in the United States.

Reverse Stock Split

We filed a Certificate of Amendment to our Certificate of Incorporation with the State of Delaware on April 9, 2024 (the “Effective Split Date”) to effect a one-for-three (1-for-3) (the “Split Ratio”) reverse stock split of our shares of common stock (the “Reverse Stock Split”), without changing the par value, rights, terms, conditions, and limitations of such shares of common stock. No fractional shares were issued in connection with the Reverse Stock Split, and any of our stockholders that were entitled to receive a fractional share as a result of the Reverse Stock Split instead received one additional share of our common stock in lieu of the fractional share. The Reverse Stock Split did not in itself affect any stockholder’s ownership percentage of our common stock, except to the extent that any fractional share was rounded up to the nearest whole share. The number of shares of common stock subject to the exercise of outstanding options, warrants and convertible securities was also reduced by the Split Ratio as of the Effective Split Date and their respective exercise prices were increased by the Split Ratio. Neither the authorized shares of capital stock nor the par value per share of our common stock was affected by the Reverse Stock Split.

All historical share and per-share amounts reflected throughout the consolidated financial statements have been adjusted to reflect the Reverse Stock Split.

Overview

We are an oil production, refining, and a development-stage environmental remediation company formed to deploy technologies to facilitate the recycling of waste asphalt shingles and remediation of oil-saturated sands and soils. The recycling of asphalt shingles is expected to reduce the dependence on landfills for the removal of waste and to also reduce dependence on foreign and domestic virgin crude oil extraction for industrial uses.

We have developed a process for separating oil from oily sands and other oil-bearing solids utilizing a proprietary solvent which we refer to as our ECOSolv technology or the ECOSolv process. The solvent is used in a closed-loop distillation and evaporation circuit which results in over 99% of the solvent being recoverable for continuous reuse and requires no water. The solvent has demonstrated oil separation rates of over 95% in bench testing using samples of both mined crushed ore and ground asphalt shingles.

We intend to retrofit the PR Spring Facility, located in southeast Utah (as defined below) to recycle waste asphalt shingles using our ECOSolv technology, to produce and sell oil as well as asphalt paving aggregate mined from our bitumen deposit.

We also plan to develop a modular asphalt shingle recycling facility (the “ASR Facility”) which can be deployed in cities with high concentrations of waste asphalt shingles and near asphalt shingle manufacturing centers.

Corporate History

We were incorporated in Delaware on June 4, 2019, as “Recoteq, Inc.” On April 22, 2020, we changed our name to “Sky Quarry Inc.” Sky Quarry is a holding company and has no operations. The purpose of the holding company is to maintain ownership over our subsidiaries, create management efficiencies and establish an organizational structure to facilitate the potential acquisition of other businesses within or complementary to our industry.

On September 16, 2020, we acquired 2020 Resources LLC. The assets of 2020 Resources include an oil sands remediation facility (the “PR Spring facility”) and a 100% interest in asphalt bitumen leases covering approximately 5,930 acres in the PR Spring region in Utah. On September 16, 2020, we also acquired 2020 Resources (Canada) Ltd, an entity which is currently inactive.

On September 30, 2022, we acquired Foreland Refining Corporation, which is engaged in the refining of heavy crude oil into diesel and other petroleum products (naphtha, vacuum gas oil, and paving asphalt liquids) at its Eagle Springs Refinery located near Ely, Nevada. The acquisition of Foreland was immediately accretive to our revenues and cash flow and provides a strong base for growth. We believe the acquisition is a strategic fit and will form an important role in the future enabling us to vertically integrate the production and refining of oil from waste materials to energy in a sustainable and efficient manner.

Our Financial Condition and Going Concern Issues

As a result of our financial condition, we have included in our condensed consolidated financial statements as of September 30, 2024 and December 31, 2023, and for the three and nine months ended September 30, 2024 and 2023, a note indicating that there is significant doubt about the Company’s ability to continue as a going concern. The opinion on the December 31, 2023 audited financial statements from our independent registered public accounting firm for those statements also includes an explanatory paragraph describing the uncertainty as to our ability to continue as a going concern. From inception (June 4, 2019) through September 30, 2024, we have incurred accumulated net losses of $19,764,072. To address our going concern, we aim to increase revenues by securing greater volumes of crude oil for our Foreland refinery, which should enhance our contribution margin. Additionally, we are pursuing opportunities to reduce debt service through refinancing or repayment of existing obligations, establish strategic partnerships, and raise capital through equity or debt offerings, or a combination of these actions. Given our current revenue and cash usage levels, we have pressing working capital needs that necessitate raising funds through equity or debt issuance, coupled with efforts to boost revenue and control operating expenses. However, there is no guarantee that we will be able to raise sufficient capital, grow revenues, and generate the cash flow needed to meet our operating expenses and capital requirements effectively.

Special Notes Regarding Smaller Reporting Company Status

We are filing this report as a “smaller reporting company” (as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended). As a result of being a smaller reporting company, we are allowed and have elected to omit certain information from this Management’s Discussion and Analysis of Financial Condition and Results of Operations; however, we have provided all information for the periods presented that we believe to be appropriate.

Results of Operations for the Three and Nine Months Ended September 30, 2024 and 2023

Introduction

This section includes a summary of our historical results of operations, followed by detailed comparisons of our results for the nine months ended September 30, 2024 and 2023, respectively. We have derived this data from our unaudited interim condensed consolidated financial statements included in this Quarterly Report.

We had net sales of $4,846,795 and $19,174,369 for the three and nine months ended September 30, 2024, compared to $14,397,648 and $39,140,246 for the three and nine months ended September 30, 2023. Our cost of goods sold for the three and nine months ended September 30, 2024 were $4,532,565 and $18,409,703, compared to $11,647,135 and $33,406,211 for the three and nine months ended September 30, 2023. The significant decrease in our sales were the direct result of a combination of reduction in WTI pricing and refurbishment of the Foreland refinery. WTI pricing fell from $87 per barrel on April 5, 2024, to $67 per barrel on September 10, 2024, which corresponded with reduced pricing in the end products. The refurbishment at Foreland refinery occurred over the period of May to July 15, 2024, covering an overhaul of the primary and secondary boilers, and completion of 24 work packages. This significant project, conducted once every decade, not only aims to enhance air quality and water recycling but also establishes the foundation for increased operational efficiency and the potential to raise production levels moving forward. During the nine months ended September 30, 2024 the Company incurred one-time cost of goods sold items related to maintaining the refinery during its refurbishment. These expenses totaling approximately $770,915, were necessary to ensure continued operations and safety while refurbishments were underway. These costs are non-recurring and are not expected to impact future periods.

Our operating expenses were $1,499,381 and $4,446,685 for the three and nine months ended September 30, 2024, compared to $1,433,634 and $3,821,476 for the three and nine months ended September 30, 2023. Our operating expenses consisted of General and Administrative, Share-Based Payment, Depreciation and Amortization, and Foreign Exchange.

Our net income (loss) was ($4,445,206) and ($10,524,493) for the three and nine months ended September 30, 2024, compared to ($597,527) and $450,476 for the three and nine months ended September 30, 2023.

Net Sales and Net Income (Loss)

Our net sales, costs of good sold, gross profit, operating expenses, other income (expense) and net income (loss) for the three and nine months ended September 30, 2024 and 2023 were as follows:

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Net Sales

We had net sales of $4,846,795 and $19,174,369 for the three and nine months ended September 30, 2024, compared to $14,397,648 and $39,140,246 for the three and nine months ended September 30, 2023, a decrease of ($9,550,853), and ($19,965,877), respectively. The decline in net sales for each period present compared to the prior period was primarily due to a combination of reduction in WTI pricing and refurbishment of the Foreland refinery. WTI pricing fell from $87 per barrel on April 5, 2024, to $67 per barrel on September 10, 2024, which corresponded with reduced pricing in the end products. The refurbishment at Foreland refinery occurred over the period of May to July 15, 2024, covering an overhaul of the primary and secondary boilers, and completion of 24 work packages. This significant project, conducted once every decade, not only aims to enhance air quality and water recycling but also establishes the foundation for increased operational efficiency and the potential to raise production levels moving forward. We expect strong growth as our refinery asset improvements increase production, and our direct consumer sales and marketing efforts continue to perform.

Cost of Goods Sold

Our cost of goods sold for the three and nine months ended September 30, 2024 were $4,532,565 and $18,409,703, compared to $11,647,135 and $33,406,211 for the three and nine months ended September 30, 2023, a decrease of $7,114,570, and $14,996,508, respectively. Gross profit for the three and nine months ended September 30, 2024 was $314,230 and $764,666, compared to $2,750,513 and $5,734,035 for the three and nine months ended September 30, 2023, a decrease of $2,436,283, and $4,969,369, respectively. The decline in cost of sales for the periods presented compared to the prior periods was primarily due to the decline in net sales described above. During the nine months ended September 30, 2024 the Company incurred one-time cost of goods sold items related to maintaining the refinery during its refurbishment. These expenses totaling approximately $770,915, representing 4% of costs of goods sold during the period, which we believe were necessary to ensure continued operations and safety during the refurbishment phase. These costs are non-recurring and are not expected to impact future periods. With the refurbishments now complete, we anticipate a return to historical cost structures and gross margin levels in the upcoming periods.

Cost of goods sold as a percentage of net sales was 94% and 96% for the three and nine months ended September 30, 2024, compared to 81% and 85% for the three and nine months ended September 30, 2023. The expenses related to non-recurring items represented 4% of costs of goods sold. The increased cost as a percentage of revenues for the third quarter was due to the reduction in operating production volumes as the refinery ramps up post refurbishment activities.

General and Administrative

Our general and administrative expenses were $1,205,032 and $3,322,846 for the three and nine months ended September 30, 2024, compared to $1,173,593 and $3,195,049 for the three and nine months ended September 30, 2023, an increase of $31,439, and $127,797, respectively. In the nine months ended September 30, 2024, general and administrative expenses consisted mainly of executive compensation of $1,157,697, professional fees of $920,378, insurance of $479,600, lease and utilities of $200,090, bank charges of $136,477, travel expenses of $158,748, automobile of $79,544, licenses of $36,068 and other of $154,245. In the three months ended September 30, 2024, general and administrative expenses consisted mainly of executive compensation of $474,457, professional fees of $382,688, insurance of $150,516, lease and utilities $113,590, bank charges of $11,840, travel of $27,252, automobile of $24,510, licenses of $13,384 and other expense of $6,795. In the nine months ended September 30, 2023, general and administrative expenses consisted mainly of executive compensation of $1,838,402, professional fees of $858,656, rent of $146,699, travel expenses of $134,175, insurance of $133,237, licenses of $51,073, and bank charges of $9,488. In the nine months ended September 30, 2024, increase over the nine months ended September 30, 2023 is due to realizing a full 9 months of rent expense. Additionally, some of the incremental costs of the Company’s RegA Offering and listing on the Nasdaq Capital Market increased our professional, consulting and marketing expenses in the current periods.

Other Income (Expense)

Other expense was $3,260,108 and $6,842,474 for the three and nine months ended September 30, 2024, respectively, compared to $1,914,406 and $1,459,756 for the three and nine months ended September 30, 2023, respectively, an increase of $1,345,702, and $5,382,718, respectively. In the nine months ended September 30, 2024, other income (expense) consisted of interest expense, net of interest income $4,773,663, loss on issuance of warrants of $1,935,934, loss on extinguishment of debt $108,887, loss on sale of assets $25,075 and other income $1,085. In the three months ended September 30, 2024, other income (expense) consisted of interest expense, net of interest income of $1,320,115, loss on issuance of warrants of $1,935,934 and other expense of $4,059. During the quarter ended September 30, 2024 the Company recorded a one-time expense related to the initial measurement of its warrant liability, totaling $1,935,934. The warrant liability is revalued at each reporting date based on changes in the underlying factors influencing the fair value of the warrants, such as the Company’s stock price, volatility, and other market conditions. The Company’s management believes that this one-time loss related to the warrant liability measurement should be evaluated separately from ongoing operations when assessing the Company’s financial performance. During the period, the Company incurred significant interest expense related to its term debt. This interest expense is primarily due to the high financing costs associated with the term notes, which were utilized to support ongoing working capital needs and operational expenses. These notes terms, characterized by higher interest rates relative to traditional debt instruments, have resulted in a notable impact on our financial performance for the quarter. This increase in interest expense reflects the financial obligations of maintaining liquidity and funding operations, particularly during a phase of substantial investment in refinery refurbishment and related activities. The Company continues to evaluate its capital structure to optimize costs and enhance financial stability, considering refinancing options and alternative capital sources where feasible.

Net Income (Loss)

Net loss was $4,445,260 and $10,524,493, or a loss of $0.25 and $0.59 per share, for the three and nine months ended September 30, 2024, respectively compared to net loss of $597,781 and net income of $466,646, or $0.04 and $0.03 per share, for the three and nine months ended September 30, 2023, respectively.

Our net loss compared to the previous periods net income was primarily driven by reduced net sales from refurbishment of the Foreland refinery during the period of May to July 2024, higher interest expense on increased term debt and the loss on issuance of private placement warrants.

Liquidity and Capital Resources

Introduction

We had negative operating cash flows for the three and nine months ended September 30, 2024. Our cash on hand as of September 30, 2024, was $292,290. While we had negative net cash from operations for the three and nine months ended September 30, 2024, our monthly cash flow burn rate for the nine months ended September 30, 2024 was $512,364. Although we have strong short-term cash flow, as we integrate our Foreland acquisition we will face strong medium to long term cash needs. We anticipate that these needs will be satisfied through the issuance of debt or the sale of our securities until such time as our cash flows from operations will satisfy our cash flow needs.

Our cash, current assets, total assets, current liabilities, and total liabilities as of September 30, 2024 and December 31, 2023, respectively, are as follows:

Our cash decreased by $33,901 as of September 30, 2024 as compared to December 31, 2023. Our total current assets decreased by $1,593,916 primarily because of a decrease in accounts receivable of $1,988,215 offset by an increase of prepaid expenses of $179,439 and inventory of $248,762. Our total assets decreased by $1,827,929 due to the changes in current assets as well as an increase in property, plant and equipment of $594,876, oil and gas properties of $689,992 offset by a decrease in restricted cash $1,466,426 and operating right-of-use asset of $52,455.

Our current liabilities as of September 30, 2024 as compared to December 31, 2023 increased by $2,720,082 and our total liabilities increased by $2,638,344, both primarily as a result of an increase in current maturities of notes payable of $3,914,152, and warrant liability of $1,936,937, offset by decreases in accounts payable and accrued expenses of $1,784,476, current portion of operating lease of $12,971, lines of credit of $1,333,560, note payable of 43,316, and operating lease liability of $38,422.

In order to repay our obligations in full or in part when due, we will be required to raise significant capital from other sources. There is no assurance, however, that we will be successful in these efforts.

Cash Requirements

Our cash on hand as of September 30, 2024 was $292,920. The Company will continue to require additional cash to meet ongoing operational and capital needs. Despite the company’s efforts to increase production capacity at the refinery, as well as ongoing maintenance and refurbishment activities, and the high debt payments, we are not yet generating sufficient cash flow to cover operational costs. The need for cash is driven by both regular operating expenses, and financial loan. We anticipate that these needs will be satisfied through the issuance of debt or the sale of our equity securities, or a combination thereof, until such time as our cash flows from operations will satisfy our cash flow needs. Management remains committed to securing the necessary resources to ensure the company can meet its financial obligations and continue executing its long-term objectives.

Sources and Uses of Cash

Operating Activities

Our net cash used in operating activities for the nine months ended September 30, 2024, were $4,616,746, as compared to cash generated of $2,529,554 at September 30, 2023. Our net cash used in operating activities for the nine months ended September 30, 2024 consisted of a net loss of $10,524,493, decrease in working capital of $270,380, less share based compensation of $534,572, depreciation and amortization of $589,267, amortization of debt issuance costs of $2,936,408, amortization of right-of-use asset of $52,455, loss on issuance of warrants of $1,936,937, loss on extinguishment of debt of $108,887 and loss on sale of assets of $25,075.

Investing Activities

Our cash flow used in investing activities for the nine months ended September 30, 2024 and 2023 was $1,899,211 and $1,307,265, respectively, an increase of $591,945. Our investing activities in 2024 and 2023 consisted of a net increase from proceeds of sale of assets of $200,000, payments for exploration and evaluation assets of $117,547, and payments for property, plant and equipment of $274,398.

Financing Activities

Our net cash provided by financing activities for the nine months ended [September 30, 2024 and 2023 was $5,023,763 and $2,779,347, respectively, a decrease of $2,244,416. Our cash flows from financing activities in 2024 consisted of proceeds of lines of credit of $33,556,317, proceeds from notes payable of $16,767,738, issuance of preferred stock of $308,000, exercise of warrants of $4,790,597, and issuance of common stock of $34,025, offset by payments on lines of credit of $34,889,877, payments on notes payable of $12,216,266, debt discount on notes payable of $1,565,277, preferred stock offering costs of $40,874, and common stock offering costs of $1,720,619. Our cash flows from financing activities in 2023 consisted of proceeds of lines of credit of $20,501,839, proceeds from notes payable of $2,935,860, and issuance of common stock of $28,741, offset by payments on lines of credit of $17,828,495, payments on notes payable of $41,854 and deb discount on note payable of $2,816,744.

Evaluation of Disclosure Controls and Procedures

Our management conducted an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) as of September 30, 2024, pursuant to Exchange Act Rule 13a-15. Such disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company is accumulated and communicated to the appropriate management on a basis that permits timely decisions regarding disclosure. Based upon that evaluation, our management concluded that the Company's disclosure controls and procedures as of September 30, 2024, were not effective to provide reasonable assurance that information required to be disclosed in the Company’s periodic filings under the Exchange Act is accumulated and communicated to our management to allow timely decisions regarding required disclosure. Management is actively developing and implementing a plan to address and resolve any material deficiencies identified in the company’s disclosure controls and procedures.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal controls over financial reporting during the quarter ended September 30, 2024, that have materially affected or are reasonably likely to materially affect our internal controls over financial reporting.

Limitations on the Effectiveness of Controls

Our disclosure controls and procedures provide our management with reasonable assurances that our disclosure controls and procedures will achieve their objectives. However, our management does not expect that our disclosure controls and procedures or our internal control over financial reporting can or will prevent all human error. A control system, no matter how well designed and implemented, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Furthermore, the design of a control system must reflect the fact that there are internal resource constraints, and the benefit of controls must be weighed relative to their corresponding costs. Because of the limitations in all control systems, no evaluation of controls can provide complete assurance that all control issues and instances of error, if any, within our company are detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur due to human error or mistake. Additionally, controls, no matter how well designed, could be circumvented by the individual acts of specific persons within the organization. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated objectives under all potential future conditions.