In our last look at Valens ($VLNS) we noted how the extraction space is somewhat relatively ‘unsettled’ – in that the days of mass bulk extraction (and bulk revenue) is probably behind us excluding hemp.

Other extraction outfits have seen share prices wane for several quarters now ($OILS/$PUMP/$LABS/$CANN), and I’ve been trying to get to what a ‘normal’ run rate of an extractor will eventually settle into. The next few quarters from these companies should firm up who’s growing and who’s not.

$VLNS ran up to $1.90 from $1.50 in anticipation of these, only to retrace after reporting. Let’s get on it……

To the financials!

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• Cash at $30MM, $34MM in receivables, $22MM in current liabilities.
• They’ve burned $20MM so far this year ($6MM in this quarter). Additional sales need to incite.
• $VLNS is kind enough to split out excise tax remissions, reported at $389k this Q (versus $3k quarter prior). To me, this reveals that last this quarter was the first of significant internal product provision. Good, now we have a starting point.
• And….this implies that $VLNS own products (not white-label nor tolling) is at $1.5MM, or 10% of total products sold. This is what we want to know and look for in the future.

• Inventory slightly down, and appears that some $2MM in extract was converted into products.
• Beverages are a major focal point in their future (Pommies/SoRSE), they held $80k in finished good in beverages, and $20k this one. Presumably they completed and finished a production run in there, and shipped product. If so, that means their proprietary vapes and beverages shipped $500k/month of product.

• Insurance expenses over $100k/month, revealing that owning a certified explosion-proof hydrocarbon bunker ain’t for the faint of heart.
• BRNT’s order of some 2MM vape pens (!) has probably initiated, and helped with sales. And they shipped, but not before the royalty agreement was amended to ‘support high volume sales in a dynamic environment’. Read: too expensive. More on this at the very bottom.
• Corporate expense at $4MM/q. If these guys are serious about knuckling down expenses, one doesn’t have to look any farther when figuring out where to start. More below.
• $VLNS initiated a share buyback program back in February, although it has not been flexed. Only 43k shares have been bought and cancelled, although the program runs until December 1st.

Ok. Again, disclosure is pretty good on most parts, but there are exceptions.

Subsequent to quarter end, they bought $1MM in an LP’s private placement. It appears somewhat linked to a $3.3MM receivable, of which $2MM was paid, and $VLNS extended payment for the remaining $1.3MM by converting it to a note receivable at 15%, due in January 2021. An illustration of how extractors have needed to be ‘flexible’ in providing bridge financing to counterparts. The LP? Speakeasy, which you might recall from our recent article.

I’ve been near inter-industry credit provision before, at a low heat, it works fine with risk being isolated and dispersed. If it becomes endemic, it has to potential to salt a sector’s earth. Here’s hoping this sort of thing remains low-heat, HEXO’s already shown where this could go. ‘Dominos’ is the image that come to mind.

I stepped out last structure, and predicted there might be some more attrition in sales run rates:

How did that prediction turn out? I’d say it’s a mixed result, with tolling services continuing a sharp decline, with their own product sales showing a return to Q1 levels:

$15MM in throughput of proprietary product is very good relatively speaking, and a decent increase over prior quarter’s sales is a positive. Presumeably, margins are better on in-house products. $VLNS doesn’t provide a split between tolling and product contribution margin, and instead merges the two segments. Let’s have a look at gross margin this fiscal year:

A slight improvement in gross margin, one suspects driven by a shift from tolling services to product creation.

Another item of note from last time – a record volume of biomass extracted – has been swapped out for the lowest volume seen in 6 quarters:

It’s a great illustration of the challenges in running a business based upon utilization rates. Twenty-two tons of throughput vanished over the quarter. While it can be said that logistics quality and production planning are requisite for any successful company – in extraction – it is the business.

We haven’t mentioned SoRSE since back in Q4 of 2019. They provide emulsion technology for beverages and topicals and such. It’s become more expensive since, with the initial deal being re-negotiated to provide exclusivity to $VLNS in 3 more countries (previously, it was Canada only). There is minimum royalty payments, but notably, to enable ‘Pommies’ to produce product, one needs emulsifiers. While the brewery was some $10MM (with no tangible assets), of the $33MM carrying value in goodwill/intangibles $VLNS reports, $30MM comes straight from SoRSE. It’s the nature of purchasing IP, and completely in the hands of management to crystallize.

Realistically, $VLNS is a company who’s on track for some $80MM in sales this year, is operating ostensibly at break-even, and is packing notable volatility across revenue streams. This latter point reflecting (to myself) the state of flux extractors are living within right now. In general, extractors got an easy ride early on as most assumed the same in build that ‘if you build it you’ll print money’. At this point for $VLNS…..assuming a gross margin of some 40% – that’s $32MM/yr to support $42MM/yr of operating expenses.

In many ways, these financials reflect the unknowns of the larger sector: where are we heading? What will a functioning and efficient outfit look like in 1 year? 5 years?

The best things in these financials is how well their own product launch has appeared to have gone. Increasing by $6MM in the quarter is good, yet a caveat might be that this reflects channel pressurization and white-label services included under ‘product sales’, which, leaves the reader wondering how their own product is actually moving. From the data we access, the previous 2 quarters saw their ‘Wayfarer’ vape line shipping about ~=$45k/week on average. This has dropped since early August to some ~=$30k/week. Perhaps a reflection of increasing competition and/or price drops, until and unless $VLNS discloses product lines, we don’t have much visibility.

Their debt/capital structure is orderly, and it’s great to see a company use a realistic number for volatility to calculate optionality ($VLNS expects 150% vol in share price over the next year).

That’s about it.

$VLNS is currently a break even-business moving towards both in-house and white-label production and sales….and has based a good part of their most recent capital spends on a beverage market that’s 3.6% of total cannabis sales in the country (that’s about $6MM/mo, or $70MM annually, as of May 2020). It isn’t immaterial, but $WEED and $HEXO have products landed or incoming, along with several other smaller outfits. $VLNS from here looks to be rolling out anything and everything product-wise go, and to myself, it likely signals they expect an 80/20 revenue split between tolling and proprietary in the future.

To myself, despite moving dollars and product and volumes, the company remains high risk and their business model unproven. It’s nice to see some expansion in sales despite being offset by reductions in tolling. Look to see if either is held (or expanded) next quarter.

I’ll repeat it as well, the main thing about extractors is to discover what their longer-term sales rate will be. Lumpiness in sales and product/service mix that $VLNS and $LABS are showing isn’t helpful to spot trends, yet. It might even be a permanent feature of the extraction space. My last prediction of a reduction in sales wasn’t a complete bullseye. While not a glutton for punishment, I’ll make another prediction: Should sales generally remain at these levels…….look for a restructure or re-org in the next quarter or two. They need to address corporate bloat and OPEX. In terms of a being a viable, functioning business model – they’re not showing it in these statements at this moment.

They’re positioned better than almost any other company I’ve looked at, and like others, will benefit from continued expansion in the legal market. That expansion can’t happen soon enough for so many in-sector.

On a final note, I’d like to point out regional price disparities the State Monopolies are installing across the country. Vapes have been updated on the BC State Monopoly website with permanent price drops (.3’s and .5’s), and there is currently 12 vape products under $30, and even one under $20. Ontario’s low end is now around $33. For anyone making a vape out there….they’ll need to be running lean:

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.