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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. 

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Deveron

For readers that have been here before, you’ll know that many of the companies previously profiled are typically (at the time of writing) beaten down. Case in point, the last few posts are consistent with this – Caldwell (price beaten down by COVID), Titan (price beaten down by a weak energy industry, and COVID) and Brattle Street (forgotten and currently reinventing itself). One might think that these are the only kind of companies that are profiled here, which is why this post is different. Deveron (formerly Deveron UAS) had been flying under the radar for a number of years now, both literally and figuratively. However, as of today (October 15 2020), the shares of Deveron are seeing a distinct lift in their price, so the review of this company is somewhat different. Like prior posts, I use a green, amber or red format to highlight areas that I believe are bullish, neutral, or bearish.

Who is Deveron ? Deveron was at one point a subsidiary of Greencastle Resources, a small resource company trading on the TSX Venture exchange. For those of you that are familiar with the Canadian small cap market, a “small resource company” encompasses an enormous amount of companies on the Venture exchange. Essentially, this would be the same as walking down the street and “passing a guy with two arms and two legs” – not exactly attention grabbing. Without much fanfare, Greencastle announced Deveron’s acquisition of a drone company in Q4 of 2015 (see below), and Deveron as a “drone company” was launched.

Not long after that, Deveron UAS applied for and received a listing on the CSE, and began trading as a “stand alone” entity. Greencastle retained a significant ownership interest, but Deveron operated independently in the area of “Agri-Tech”.

What does Deveron do ? Deveron uses data to improve agricultural crop yields. To quote their website, they:

“Provide farmers or growers with both on demand drone, soil sampling and tissue sampling services along with analytics to help you increase yields through our subsidiary Veritas Farm Management.“

In essence, Deveron is a seller of information (agricultural data) which it provides to farmers and the agricultural sector for a fee. The idea is that the commercial or independent farmer gains insight from the data that Deveron provides, which in turn helps them improve their crop yield or reduce costs, thereby improving overall profit margins.

What is the chart telling me ? That is a bit of a loaded question, as I (unfortunately) cannot defer to my favorite chart provider (Yahoo), given that Deveron very recently moved from the CSE to the TSX Venture. Therefore, Yahoo only captures the most recent activity on the Venture, without any of the historical information from the CSE. That being the case, a 5 year chart (up to September 2020) of Deveron trading was sourced directly from the CSE website.

What is immediately apparent is that as of today (October 15 2020), Deveron is trading well above the “exit” price on the CSE, which was $0.27. What is problematic here is that because of the recent move to the TSX Venture, one cannot see the 20 and 50 week moving averages. That being said, the recent strength in price suggests that if it hasn’t happened already, the 20 week moving average will be leading the 50 week moving average soon, which is typically a harbinger of good news. So, on a technical level, this chart is suggesting that Deveron is poised to exit what I call a “saucer bottom”, as it traded sideways since mid-2017. The chart is therefore green, but the obvious concern is that the “ticket price” to acquire shares Deveron is getting more expensive.

The company has moved to the TSX Venture – and changed the symbol. While the move to the Venture has caused issues with the chartist within me, I’m more than willing to give up a good chart for the increased exposure Deveron will get. The move to the Venture exchange can be viewed as a “graduation” of sorts. The CSE is a good starting point for a small public company, as it is less expensive, and generally poses less barriers in both filing requirements and costs. That being said, the TSX Venture has far more visibility than the CSE, which means that Deveron will end up on the radar of larger investors (and larger pools of money), which means more liquidity. In addition to this, the change of the symbol from “DVR” to “FARM” serves the same purpose. While it might be viewed as cosmetic by some, the truth is that a symbol that clearly communicates what the company does (or the sector it works within) only helps sell the story. These two changes are very positive, and it would not be surprising if Deveron attracted more eyeballs at some of the smaller investment firms.

The balance sheet is good – but not great. The balance sheet is typical of a reasonably capitalized young company. On the plus side, there is a decent amount of cash on the balance sheet, overall liabilities have remained fairly static, and there is no long term debt. On the other hand, there is also a very significant amount of Goodwill, which is almost always related to acquisitions. The takeaway is that there are no landmines hidden in this balance sheet. The only concern that one might have is the fact that if business takes a turn for the worse, then it could require an additional financing, which would mean dilution for an existing shareholder. However, all things considered, we are neutral when it comes to the current balance sheet.

The income statement is improving – a lot. Year over year, revenues as compared to the prior 6 and 3 months have increased by 70% and 54% respectively, and gross margins during those same periods have improved by 91% and 82%. To be blunt, these are numbers that make investors salivate. During that same period, costs have also increased, but not nearly at the same clip. So while Deveron is seeing growth in a high margin top line, they have managed to control their cost base, which is often the killer for smaller companies. If they can continue to grow their top line and maintain margins and G&A costs, more and more of the market will notice.

Cash flow from operations is still negative – but it is improving. At first glance, cash flow from operations seems to be almost identical to that of the prior year, as they both come in at approximately -$800,000. But if one views cash flow before changes in working capital, it’s actually much better year over year, as the six months of 2020 comes in at -$250,000 versus the prior year at -$560,000 – a more than 100% improvement. Viewed in another context, the current cash burn rate ($250,000 over 6 months, or $41,666/month) suggests that the company would consume their entire cash position in just over 3 years. Previously, the cash burn rate was twice as fast, at $93,333/month ($560,000 over 6 months), meaning that if nothing else, they have more time to execute their business plan.

Insiders continue to hold a significant position. Currently, insiders hold almost 15 MM of the total 50 MM shares outstanding, almost 30%. Of those 15 MM shares, 13.8 MM are controlled by 3 significant shareholders, all of whom have continued to hold as of October 15 2020.

  • Greencastle Resources (controlling shareholder) – owns 10.5 MM shares (21%). Also acquired shares in the range of $0.25 – $0.30.
  • William Linton (Director) – owns 2.2 MM shares (4.4%). Has a significant history serving on the boards of various TSX listed Canadian companies.
  • Roger Dent (Director) – Owns 1.1 MM shares (2.2%). Is the CEO of Quinsam Capital, and was formerly a small cap portfolio manager.

There has been no selling by insiders, which suggests that they are in it for the longer haul, and means that the public float is that much tighter.

No analyst coverage. As mentioned previously, there is no analyst coverage to be found on Deveron. Assuming that the company keeps executing at the same level (or better), there is the very strong possibility this will change, which will have a further positive impact on the share price.

The company has engaged in a reasonable amount of self promotion. Some companies are overly promotional and issue breathless press releases whenever possible, others toil in obscurity and only issue the bare minimum. Deveron has found the middle ground, and has issued a reasonable number of press releases in the past, but has not gone overboard in doing so. Past press releases tended to be events that were significant to the company, and were clear and succinct. This being the case, we view their news releases as neutral. While Deveron has not been “quiet”, it has also not unduly inflated expectations via over hyped communication.

Share outstanding have been increasing. Its preferable when shares outstanding stay flat, or the company engages in a share buyback. However, as mentioned previously, Deveron is different than some of the other companies previously profiled, as it is positioning itself for “growth mode” rather than “recovery mode” (Caldwell and Titan). So, while we view an expanding share count as bearish, we understand why it is happening. If management has a good handle on things, the growth in shares outstanding will be outpaced by the growth in revenues and gross margins, in which case this will become a non-issue.

The technology is potentially disruptive. Technology and agriculture don’t intuitively end up in the same sentence, but nonetheless, here they are. While I don’t know if farmers are traditionally a tech savvy bunch, I believe that farmers are cost conscious, and will adopt technology if the value proposition is clear. Assuming that Deveron can continue to communicate its story to the end users, adoption rates of the Deveron offering should increase, which has the potential to significantly change the farming landscape.

Valuation is stretched at the current price. At the current price, one is not purchasing Deveron because it represents compelling value in the traditional sense. None of the metrics that I might usually mention (Book value, PE multiple, EV/EBITDA, or Cash flow yield) can be used here to make the typical argument that the company is cheap. To be clear, given the current information we have, it is not cheap, and is clearly trading with the future in mind.

This does not mean that the future for Deveron is not bright. Given the recent revenue and gross margin growth rates, the future could be very bright indeed. Investors simply need to understand that if they invest in Deveron, they are doing so on the technical strength of the shares, not the current fundamentals. Despite the fundamentals, it appears that Deveron could experience a significant run upwards. For proof, one needs look no further than a company like Pyrogenesis, which has appreciated from around $0.50 to as high at $6.00 in less than a year. However, if Deveron fails to meet expectations, the shares could find themselves back in the $0.20 – $0.25 range, handing a potential investor (at the current price) a loss of up to 40%.

The final verdict. The Deveron opportunity can be summed up in the following:

  • The move to the TSX should keep drawing new investors : New investors will continue to be introduced to the Deveron story, and assuming Deveron maintains the same growth it recently demonstrated, these new investors will continue to drive the price in the short term.
  • November results will be crucial: Deveron will report Q3 results in late November. Current trading suggests that investors are bullish on pending results, so failure to come through with solid results will likely cause selling pressure.
  • There is strength from a technical perspective: Those that favor technical indicators over fundamentals will take comfort in the Deveron chart, as it appears Deveron may break out to new highs.
  • Those that go long now should have a clear exit strategy: Given the recent strength in price, those going long now should do so with a clear exit strategy. Price moves both up and down can occur quickly, so having a clear idea how to react before a major swing in price will save ones sanity.
  • Bankruptcy is a non-issue, but dilution might be: Deveron has managed to make it this far without having to worry about insolvency. If cash burn increases, the risk here will be dilution, not bankruptcy.
  • Liquidity has improved, but try & bid at the lower end: Trading volume has picked up, but pricing will likely be volatile. Given this situation, one can bid at the lower end of the bid/ask spread rather than hitting the ask right away.

I am long on Deveron, with an average purchase price of ~ $0.25 CAD. While it is correct to say that I am already in the money, one should bear in mind that I purchased Deveron some time ago (and suffered through the “dead money” phase), whereas a purchaser today is likely to see more immediate price movement. Each situation imposes its own particular risks – as they say, there is no free lunch.

As always, these are only my thoughts & opinions. If you have questions or comments, I can always be reached at mark@grey-swan.com.