Extractors have been looked at more intensely by the market in recent months. Rapid expansion of sales and the crisp margins reported in the latter half of 2019 have been replaced by earnings declines and inventory write-downs. Not only has this been seen in several of the smaller companies, but Medipharm’s ($LABS) most recent financials appear to confirm this trend, which can easily be looked at as a dark cloud on the extraction horizon.

The Valens Company ($VLNS) has not been untouched by the challenges faced by others as we see inventory growth and receivable expansion….the latter of which exceeded quarterly sales, just like $LABS. This is most definitely a dark cloud, reflective of the glut formed and growing in refined cannabinoid markets.

GoBlue’s stellar identification of an industry ‘feature’ in biomass boomerangs will have served readers well. The resulting debris that comes from it isn’t rocket science, and the practice itself is simply an act of inflating revenues. Most analysts and the industry itself has taken to hushed tones regarding the practice…..driven by the ‘relationship tending’ that the financial firms are wont to do (hey, wouldn’t want to queer potential future business), or, by the ‘Omerta’ of the sector (who doesn’t want to air dirty laundry in public). The extent to which $VLNS has engaged in the practice of forward product swaps is less clear than $LABS, but several of the indications that it has are present.

$VLNS has got an all new shiny design for their financials (they look slick), but let’s look past the polish and see if there’s any rust under that shine.

To the financials!

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• And sales…..down more than 40%. Declining margin too, at 36%. Ugly. And that margin number….includes a $1.4MM inventory write-down from it too. Last Q, the write-down was $2.5MM. At least something is improving.
• The driver of the write-down this time continues, with a little more detail than last: “as a result of the continued compression in pricing of bulk winterized and distillate oil”. Last quarter it was limited to being described as ‘cost exceeding net realizable value’.
• Cash position is good, the only thing that looks that way so far.
• Inventory relatively flat. Receivables dropped by $15MM to $35MM. Looks like they got a cheque.
• $VLNS doesn’t provide an aging schedule on A/R, and one has to go pretty deep to find out information on them. They have $14.6MM over 60 days, same 5 customers as before. What is novel about it is under ‘Credit Risk’ in Note 20 – which describes how o/s receivables and the risk associated is notionally set-off against payables with same/same counter-parties, with a net attribution to credit provisions. It’s another way to validate a ‘boomerang’.
• In this case, it reflects the defined forward product swap with $APHA, which was disclosed. Disclosure helps so much with this, and the sector would do themselves a world of good doing so.
• G&A has almost doubled from previous quarter to $750k. It isn’t a lot, but noticeable for the increase. Identical delta with Professional Fees. Travel and BD tanked (in lieu of COVID), but most noticeable was wages and salaries, which dropped from $2.3MM to $1.4MM.
• Note that this was done is a single quarter, and for an outfit to shed more than 30% in wages means there were either layoffs, or they have an extremely flexible workforce. Or….as I just spotted, $VLNS rec’d gov’t COVID assistance, and offset wages for the quarter.
• SBC is largely flat at $2MM, that’s a run rate of $8MM for this fiscal year. More below.
• And…..what they didn’t tout (too loudly) here is that there is RECORD(!) biomass throughput. Woot!. Except….more went through, less money came out. This is what we predicted in our piece from last fall (Extracting the Numbers). Note that inventory only accreted by $2MM, despite this being the largest single quarter of operations in the company’s history. This is the dark cloud for bulk extractors: more work, less revenue:

Ok. I like Q2 statements because they’re relatively clean to do comparatives. That, and extractor’s financials are *typically* much easier to approach than many LP’s.

There’s not a ton of stuff to see here incrementally, aside from sales cratering.

Their term-loan (of $20MM) is serviceable, with some forward looking loading having been negotiated in:

Share Based Compensation is brisk, given performance. It’s not necessarily fair to pick off one particular quarter (good or bad) to gage reasonableness. It looks like management locked in renumeration which will track with share price. So, more SBC to come, but at least it’s known and disclosed. I’m watching for incremental issues and related party deals (the latter being relatively stable and w/o red flags at the moment):

I mentioned ‘Pommies’ in the last 2 structures, but I wanted to include the following – it’s a heck of a picture. ‘Pommies” is a brewery that makes cider, and $VLNS has intent to produce their own infused beverages at some point. TheCannalysts are deeply skeptical about the beverage market – and even disregarding that – think about purchasing a money losing company and it’s assets, with absolutely nothing tangible (in totality) coming onto a balance sheet. Sure, ‘future potential’ and all. But if this was some sort of *seriously* speculative venture, into a world of a completely new product, I can take the leap. But cannabis beverages have borne out in mature markets to be ~=3% market share….and anything I’ve seen around the hype remains the purview of ‘forecasted demand’. Yep, I’m a cynic. Time will tell, and I can most certainly be utterly wrong. I’ll be the first to say it. But, I think this is a $FIRE level asset-acquisition boner $VLNS has pulled with ‘Pommies’:

So, what’s next? The high level is that these financials represent $VLNS in a period of post-2.0 product loading. This could/should represent some form of actual operational run rate of ~=$80MM/yr near term. As is, that means about ~=$10MM/yr in net income, for a company with a $250MM market cap, or about $0.08/share. A quick and dirty calc would suggest a share price of around $0.40, cet par.

And to absolutely no one’s surprise, there’s still a ton of forward potential baked into this share price. The good news is that the market is expanding, and 2.0 has only just begun. Another positive is in their segmentation, which in a ‘post-tolling world’ (where conventional thinking now lays around bulk extractors), is showing signs of life that has eluded $LABS so far.

Via segmentation, we find out that Testing revenue (immaterial) has tanked, throughput has fallen off a cliff, and that corporate is bloated (see below). Note 14 is the one to watch, as both of their primary segments are in a nosedive. These need to stabilize, and I don’t believe they’ve hit actual run rates yet. I’ll step out on a limb here and suggest another 10-15% decline below these levels next quarter. I wouldn’t be surprised if it’s more. I would be surprised if they do maintain:

The disclosure is very good overall. This one has been time consuming, because there is much to chew on. I do appreciate the breadth of information.

A criticism I’ll lay on $VLNS – and I’ll lay it hard – is in their compensation. Bloated, and waaaaay overpriced. The CEO is pulling in $2MM/yr, and the rest of the executive is a shiny pony enjoying compensation levels that appear to be based upon a one off ramp. This does happen in business. After the quarter ended, they approved the use of a range of compensation instruments (DSUs/RSUs/PSUs), as well as bringing forward legacy options.

If $VLNS keeps putting out numbers like in these financials – compensations levels won’t simply become stale, it will become a bad joke. Fast. $FIRE burns bright in my mind for being a loot-box, and this one – in the absence of performance – is taking the same tack on a similar timeline on a similar trajectory.

The positives are they have expanded to 36 SKUs (without a blowout in G&A), they’re first to hydrocarbons (likely the only for awhile), and relatively speaking, have a decent reputation and financial statements relative to peers. Note, I said ‘relative’.

The extraction space is a mess right now, and in flux. Looking from the perspective of investing, one might think it’s good to pick the ‘best’ of what’s out there when confronted with an uncertain future. That this sort of decision will at least inure oneself from the risk inherent within marginal others. In some situations, that is the case. In terms of extraction, LP’s are going in-house, distributed extraction for micros/mids will emerge, the industry is awash in product, and to call this segment ‘in-flux’ is gross understatement. I can’t see the price where it is with these financials.

I do know that the executive does, and they will enjoy it. They’re gonna make out fine for awhile.

The preceding is the opinion of the author, and is in no way intended to be a recommendation to buy or sell any security or derivative. The author holds no position in $VLNS