Deveron – update at Q3 2020

On November 18th 2020, Deveron released Q3 results. The numbers were a mixed bag – not bad & not great. Generally speaking, because market expectations weren’t overly inflated, it would appear that results have been viewed in a positive light. However, there is always the risk that enthusiasm (for shorter term investors) might be waning, which brings us to our usual first stop – the Deveron chart.

The Deveron chart is still looking “up”. For those who read my last Deveron post, you will recall that I originally had trouble sourcing the Deveron chart on Yahoo. It would seem that the recent move from the CSE to the TSX Venture caused issues for Yahoo, as the chart below shows three years of Deveron price and volume, but one can see that the current price that is displayed ($0.23 as of August 27th), the symbol (DVR), and the exchange (CN) are incorrect. Despite these errors, the chart displays correct historical and current pricing, and one can see that from a chartist’s perspective, things still look positive as of November 23rd. While there was some selling pressure on the 18th, other investors with a longer view have picked up the shares.

The balance sheet is still OK. Since the end of Q2 (June 30th 2020), Deveron has burned some cash ($618,000), and overall current assets are down by $489,000 to just over $2.0 MM. When compared with the prior quarter, longer term assets are essentially the same, with no significant changes. So, in the “big picture” context, total assets have fallen entirely as a result of cash burn, and now come in at $4.33 MM vs $4.79 MM at Q2. If one goes further back (to December of 2019) it’s clear that total assets have increased by $480,000 (+12%) since December of 2019 – but in this case, this is all growth in Goodwill, which is the result of acquisitions.

On the liability side of things, total liabilities at $779,000 are up as compared to both the prior quarter ($777,000) and December 2019 ($736,000). The bulk of that change is found in the current liabilities section, in overall growth in Accounts Payable. However, while total liabilities are up, they are not up so much as to be a major concern. So, the balance sheet, while it’s a bit worse off, still falls into “ok” territory. Of all the balance sheet items that are worth discussing, it’s the very first one – cash burn – that leads right into the income statement.

Revenues are up – but so are costs. Revenues are up by $647,000 (+44%) over this period last year, at $2.117 MM vs $1.470 last year. When compared to the prior quarter, the change is not quite so dramatic, with only a 10% increase, but it’s still up. Additionally, gross margins for the full 9 months are healthy, at $1.628 MM vs $1.033 MM last year, an increase of +58%. All things being equal, this section should look a lot “greener” – but it’s not.

When looking at “why” earnings are good (or bad), I prefer to look at cash expenses in isolation. The truth is that non-cash expenses are sometimes subject to more discretionary measures, which can obscure what actually happened. So, in this case, for the nine months ended September 2020, we have taken all the non-cash expenses that appear on the cash flow statement ($307,000) and subtracted them from the total expenses ($2.963 MM) on the income statement. This process tells us that the actual cash expense for this period was $2.656 MM, or about $295,000/month. If we complete this same exercise for the 9 month period in 2019, we come up with non-cash expense of $625,000, which is backed out of total expenses of $2.429 MM, to come up with actual cash expenses of $1.804 MM, almost exactly $200,000/month. All in all, cash expenses were up 47% YoY, which unfortunately outstrips any gains in revenues.

So with costs growing faster than revenues, why is this section not red ? Well, the silver lining in this cloud can be found in the press release following the earnings announcement, from which we have taken the following excerpt:

Data collection revenue lagged in Q3 due to late harvesting across North America with most bookings rescheduled for Q4. Gross margin decreased 13% largely due to the company expanding its collection capabilities in the United States. Deveron relies on third party contractors to drive new network node expansion and expects margin improvement as the Company fills these positions with employees.

So, the short and sweet summary is that revenues normally would have been larger, and future costs should fall as the company transitions from more expensive 3rd party contractors to (hopefully) less expensive employees. Additionally, if most bookings are going to happen in Q4, then we should see a particularly good Q4. So, this tidbit keeps the income statement story amber for now, as we wait to see what Q4 brings.

Along with increased costs, increased cash burn. Yes, that heading is correct – it is showing two colors – amber for the fact that cash burn is essentially the same, red because it hasn’t improved. Not surprisingly, increased costs also means that cash burn hasn’t slowed down. While it isn’t out of control, cash flow (before changes in working capital) for the current 9 month period came in at -$757,000 vs -$771,000 during the 9 months of 2019, virtually unchanged. After changes in working capital, the story is the same, as operating cash flow came in at -$1.294 MM, slightly higher than the 9 months of 2019 at -$1.190 MM. So operating cash flow hasn’t come off the rails, but it hasn’t improved either, regardless of how one looks at it. Again, given that a significant amount of revenue has been pushed into Q4, we will have to wait to see if this situation turns around. In the meantime, if operating cash flow doesn’t improve, Deveron has a little more (or a little less) than a year’s worth of cash left before it will have to raise capital or seek other financing.

Insiders continue to hold. Not surprisingly, not much has changed since the prior Deveron post in mid-October. There is no indication of insider selling, and the three largest shareholders (Greencastle, William Linton and Roger Dent) still hold 13.8 MM shares, or about 27% of the total shares outstanding.

Deveron remains relatively unknown. Deveron remains unknown in the general market, and has not engaged in “excessive” PR. So, while expectations are higher (for those that are familiar with Deveron), there remains a much larger segment of investors that have never heard of the company. If one searches for something like “Deveron analyst coverage”, the end result is usually something like this:

Suffice to say that the company hasn’t engaged the typical “press cycle” yet, which in turn means that upside from such engagement is yet to come.

The share count may increase again. Usually, a heading such as this is red, as it was in the prior post. However, as mentioned above, Deveron has virtually no following – yet. If Deveron decides to leverage the improving share price and raise incremental capital, it may happen with coverage from whatever investment bank or wealth management firm that leads the charge. So, the question becomes: is the potential dilutive effect less (or more) impactful than the increased number of investors chasing the story? Ultimately, the answer is unknown, but with Deveron executing reasonably well, and demonstrating top line growth, it would not be a huge leap to see a capital raise that would attract a larger investment following, which in turn drives the share price. With this in mind, we recognize that this issue has both good and bad impacts, hence the amber heading.

So, while Q3 wasn’t great, Deveron isn’t a write off. We continue to hold our Deveron position, as we believe that over the longer term, it has promise. In the meantime, most of the key points from the October 16th post still hold true, plus a few new ones:

• The move to the TSX should keep drawing new investors: Given that Deveron is still relatively unknown, this should still be the case. Additionally, any capital raise will likely draw new eyeballs.
• There is expectation around Q4 results: Deveron clearly indicated that Q4 results will include business that usually would have fallen into Q3, thereby “kicking” expectations down the road.
• There is still strength from a technical perspective: As of the date of writing this (November 23rd 2020), the Deveron share price is still trading around $0.35-$0.37. We believe the share price would have suffered more (around the 18th – 19th of November) if current investors were “giving up” on Deveron.
• Investors should maintain a clear exit strategy: Depending on one’s stomach for volatility, have a plan before going long, which is even more important for those that consider themselves short term traders. If one thinks of investment horizons in years, then you probably will sleep well despite volatility. If your investment time frame is shorter, be aware that the share price has the ability to move quickly – either way.
• Bankruptcy remains a non-issue, but dilution still might be: Insolvency is unlikely, but any future capital raises will obviously create dilution. If a capital raise does occur, hopefully Deveron can do so above the current $0.35 – 0.37 range to minimize dilution.
• Liquidity is still good, so pricing is less choppy: Trading volume & liquidity are still solid, so the bid/ask spread is better than it was when Deveron traded on the CSE. With this in mind, one is better able to potentially fill bids at the lower end of the spread rather than having to hit the ask right away.

I continue to be long on Deveron, with an average purchase price of ~ $0.25 CAD. As always, these are only my thoughts & opinions. If you have questions or comments, I can always be reached at mark@grey-swan.com.