OrganiGram - Q1 2021

Transcript

Operator (participant)

Good morning. My name is Casey, and I will be your operator today. At this time, I would like to welcome everyone to the Organigram Holdings Inc.'s Q1 fiscal 2021 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. We ask that you please limit yourself to one question and one follow-up question. You may re-queue if you have any further questions.

As a reminder, this conference call is being recorded and a replay will be available on our Organigram's website. At this time, I would like to introduce Amy Schwalm, Vice President, Investor Relations. Please go ahead.

Amy Schwalm (VP of Investor Relations)

Thank you, Casey. Joining me today are Organigram's Chief Executive Officer, Greg Engel, Chief Financial Officer, Derrick West, and our Chief Strategy Officer, Paolo De Luca. Before we begin, I'd like to remind you that today's call will include estimates and other forward-looking information from which our actual results could differ. Please review the cautionary language in today's press release regarding various factors, assumptions, and risks that could cause our actual results to differ.

Furthermore, during this call, we will refer to certain non-IFRS financial measures, including adjusted EBITDA and adjusted gross margin. These measures do not have any standardized meaning under IFRS, and our approach in calculating these measures may differ from that of other issuers and so are not directly comparable. Please see today's earnings report for more information about them. I will now hand the call over to Greg.

Greg Engel (CEO)

Thanks, Amy. Good morning, and thank you for joining us today. This morning, we reported our fiscal quarter, our Q1 fiscal 2021 results for the period ended 13 November, 2020. We're pleased with meaningful growth in our adult rec sales sequentially from last quarter. Strong evidence that our new products, as part of our portfolio revitalization, are resonating well with consumers.

We're excited about the recent launch of another three strains under our Edison brand, and we have more to come in the next few quarters as we continue to reinvigorate this brand. Encouragingly, Edison was recognized as one of the most searched brands on the Ontario Cannabis Store website for the month of November.

We've started to ramp up cultivation and staffing such that we can meet overall increased demand in the industry and for many of our new products, and we have the assets and financial strength to support our plans. In contrast to many of our peers, we generated positive cash flow from operations in Q1, the Q2 of the last three quarters with positive cash flow from ops.

Since the second half of fiscal 2020, we've been extremely active introducing new products and improving many of our existing ones. Since July, we have launched 53 new SKUs, with up to fourteen more in the pipeline expected to launch before the end of February.

We continue to see dry flower and pre-rolls as the two largest categories in the Canadian rec market, and based on US legal state data, we believe they will continue to dominate the foreseeable future, even as alternative product forms gain traction. We've successfully launched a number of value segment dry flower offerings in the first half of fiscal 2020, particularly in larger format sizes, in response to increased demand in that category. I'll talk more about our success there in a moment.

We're also very focused on our higher-margin Edison flower portfolio by introducing new unique strains and higher potency THC products, where we think there's a good opportunity for us to differentiate. Subsequent to quarter end, we launched three new indica strains, Black Cherry Punch and Ice Cream Cake, or ICC, both with THC ranges of 20%-26%, and Slurricane with 17%+ THC.

We expect to launch at least three more high THC strains under the Edison brand over the next few quarters as a result of our continuous investment in new genetics. We run trial cultivation cycles to ultimately identify the winners, the ones we decide to move forward with, because we expect them to attract the strongest consumer response. We continue to leverage our indoor facility and our unique three-tiered cultivation rooms.

Every Edison strain benefits from being grown in one of these data-backed, strain-specific grow rooms with bespoke microclimates, designed to offer a distinct flavor and aroma profile and to ensure consistent quality. Variables such as humidity, temperature, and light are customized to optimize the growth, cannabinoid and terpene profile of each strain.

Opportunity to scale up new genetics require patient and deliberate process, where cultivation protocols are trialed for each cultivar and adjusted through multiple grow rooms before full rollout to multiple rooms in our facility. We've launched a number of new genetics over the past eighteen months, including our high THC Edison Limelight or Ultra Sour, which is now the company's best-selling strain. Our newest cultivars were developed from genetics that were originally sourced from a premium cannabis nursery.

The nursery's processes and technology help ensure robust, healthy, high-quality plants. Our focus on both genetics and the environment in which they are grown results in a unique phenotype expression. This means even plants grown from the same genetics can be markedly different in terms of physical properties, potency, terpenes, and aromas based on their growing conditions. We believe this product development process is a differentiator for us.

Revisiting our more recent launches in the value dried flower category, we believe our value products are differentiated and do not have to compete on price alone. Particularly since the onset of the COVID-19 pandemic, value and large format sizes have become an increasing focus of consumers. In the spring of 2020, we responded with the introduction of Buds, which is indoor-grown, whole dried flower and strain-specific.

The company's value segment strategy also includes dried flower offerings that were launched in larger format sizes of 7-gram and 15-gram under the Trailblazer brand in July 2020. The Trailblazer value brand continues to offer increasingly higher THC levels versus what was offered when originally launched near the start of adult use cannabis legalization, and at a competitive price point.

At the beginning of Q1, we expanded our value portfolio with the launch of SHRED, a high quality, high potency dry flower that is pre-shredded for consumer convenience. SHRED offers three pre-milled varieties, all with THC levels of 18% or more, and combines specific strains to provide unique flavor profiles for each of the three product offerings. It is made from whole flower, does not contain any shake or trim, and is milled to the same specifications as our existing pre-rolled products.

SHRED is currently Organigram's most affordable option on a per gram basis. Sales of SHRED contributed significantly to our growth in rec revenue in Q1, and was the number one most searched brand on the Ontario Cannabis Store website for both November and December. The product has exceeded our expectation and continues to sell out.

One of the reasons we are ramping up cultivation and staffing, which I will talk about more shortly. At the end of the quarter, we also launched limited edition seasonal offerings, including Trailblazer Christmas Sticks, an affordable 0.5 gram pre-roll, which continues to do well in retail stores. In addition to new Rec 1.0 products, we've launched a number of innovative Rec 2.0 offerings in vape, edible, and beverage categories.

Just after quarter end, we launched Trailblazer Spark, Flicker and Glow 510 thread Torch vape cartridges in a new 1 gram format. This extended our lineup to a suite of trial size 0.5 gram and full-size 1 gram cartridges for the 510 vaporizer. Trailblazer Torch offers consumers 510 cartridges, high quality CO2 extract in three unique terpene-infused flavors. Our vape portfolio also includes products for the mainstream and the premium segments.

Edison plus Feather ready to go distillate pens and Edison + PAX Era distillate cartridges. We're focused on increasing THC concentrations in many of our vape products to meet consumer demand, so stay tuned for changes to come in this category. Our chocolate portfolio includes Trailblazer Snax, a value-priced, cannabis-infused chocolate bar available in both mint and mocha flavors, and we expect to launch a new flavor this quarter.

Our state-of-the-art chocolate equipment allows for each of the five sections of the bar to be filled separately, allowing for higher accuracy of infusion. We also offer Edison Bytes truffles, available in both milk and dark chocolate formulations, as well as a gingerbread flavor for a limited time. At the end of the quarter, we launched Edison Remix dissolvable cannabis powder. This product's distribution has expanded listings to eight provinces, and we expect to secure listings for the remaining two provinces in the near future.

We believe the beverage segment could have greater potential than we've seen in the U.S., than what we have seen to date in the U.S. As mentioned on our last earnings call, but worth repeating, estimates suggest that recreational cannabis beverage market represents a CAD 467 million dollar opportunity in Canada, and results of a recent Organigram survey indicate a significant majority of current consumers, 74%, would prefer to add cannabis to their beverages versus consuming a pre-mixed one.

This is also supported by sales data in Colorado, where cannabinoid-infused powders have rapidly risen to the top of the beverage category in popularity, representing 55% of the state's beverage market sales. This is from Headset data in Colorado Market Insights from July of 2020, of last year. We believe Edison Remix offers a unique experience for consumers, made possible by our R&D department. They developed a proprietary nano-emulsion technology that generates nano-droplets, which are very small and uniform.

This provides improved absorption compared to traditional solid edibles and beverages, potentially allowing for a more reliable and controlled experience. The nano-emulsion technology is also anticipated to have increased ability to temperature variations, mechanical disturbance, salinity, pH, and sweeteners, and the dried powder formulation offers discretion, portability, and a potentially extended shelf life compared to a liquid.

It's available in three formats: two sachets with five milligrams of THC each, two sachets with five to five milligrams of THC to CBD, and five sachets with ten milligrams of CBD each.

As we've said, we're encouraged by the consumer response to date for many of our new products. However, we understand the frustration consumers have when they can't get what they want because of inventory stockouts. We've already begun to ramp up staffing with plans to hire a hundred staff, mostly in cultivation, with up to another thirty staff in packaging by early in our third quarter. We know we have missed out on significant sales opportunities and remain focused on improving supply chain processes and order fulfillment rates.

For example, internally, we've identified a list of core SKUs for which we aim to ensure never go out of stock in an effort to drive maximum distribution and continue to build brand equity. Increased production and staffing should result in efficiencies from greater economies of scale. Benefits to revenue and margins are not expected to be recognized in Q2 as we take this quarter to hire staff. Further, we do note that the industry demand may be dampened and negatively impacted Q2 sales due to lockdowns related to COVID-19.

For example, since November 23, cannabis retail stores in the densely populated regions of Toronto and Peel in the province of Ontario have been closed to physical retail traffic. And since December 26, the remainder of stores in Ontario have been closed to in-store purchases. The stores have still been able to offer click and collect and limited delivery services. In the near future, we expect to resume shipments to Canndoc in Israel.

We're seeking good agricultural practice certification by the Control Union Medical Cannabis Standard to comply with Israel's updated standards for imported cannabis. We're making good progress, and subject to successful completion of a required inspection, likely to be conducted remotely, we anticipate being certified as early as our third quarter. Shipments will also depend on the availability of the desired product mix as we work on ramping up staffing and production to accommodate demand.

In addition to revenue upside beyond fiscal Q2, we've identified a number of opportunities which have the potential to greatly enhance gross margins. We expect to gain economies of scale and efficiencies as we scale up cultivation and packaging, including the decline in charges for unabsorbed fixed overhead costs.

The recent launches of higher-margin Edison strains, with more launches on the horizon, have the potential to positively impact gross margins over time as these products gain traction in the market and comprise more of our total revenue. A greater proportion of our portfolio is being dedicated to higher volume SKUs, such as multi-pack pre-rolls and one-gram vape cartridges, which attract higher margins.

We continue to invest in automation to drive cost efficiencies and reduce dependence on manual labor. For example, a new pre-roll machine is expected to be fully commissioned and operational by the end of fiscal Q2 2021, and as a result of a packaging task force project, a number of cost reduction opportunities have been identified with the potential to benefit margins starting in Q4 2021. I'll now pass the call over to Derrick to go through our financial position and results in more detail before I wrap up.

Derrick West (CFO)

Thanks, Greg. Starting with our financial position, we ended the quarter with CAD 134 million of cash and short-term investments. On December first, we used CAD 55 million to pay down our term loan to CAD 60 million, which left us with a pro forma cash and short-term investment balance of CAD 79 million. The repayment on our term loan was agreed as part of the amendment and restatement of our credit facility completed during the quarter.

As we discussed last quarter, we raised CAD 69 million in gross proceeds in Q1 from an underwritten public offering with strong institutional support. As Greg mentioned, this past quarter represented the Q2 of the last three, which generated positive cash flow from operations. In Q1, net cash provided by operations of 0.3 million, compared to net cash used by operations of 26.9 million in the prior year period.

The improvement was largely due to the prior period's increase in working capital assets as we scaled operations ahead of Rec 2.0 legalization. Turning to our results for Q1. Canadian adult use rec net revenue grew 30% to CAD 16.8 million, from CAD 12.9 million in the prior year quarter, and gross rec revenue grew 42% to CAD 22.5 million, from 15.9 million in Q1 2020.

The year-over-year increase was mainly driven by the legalization of Rec 2.0 products. Despite overall revenue being down sequentially due to the temporary pause in sales to Canndoc, gross and net adult use rec revenue grew 14% and 11%, respectively, from Q4 2020.

Q1 total net revenue of CAD 19.3 million declined from CAD 25.2 million in the prior, prior year quarter, largely due to significantly lower wholesale revenue and a lower average selling price in Q1 2021. The higher wholesale revenue in the prior year period reflected opportunistic sales to a single licensed producer and was not necessarily expected to recur each quarter at those levels or at all.

Total gross revenue of CAD 25.3 million, compared to CAD 28.4 million in Q1 2020, largely due to similar factors impacting net revenue and reflected the increase in excise taxes as a percentage of gross revenue in Q1 2021. Q1 2021 cost of sales of CAD 23.2 million increased from Q1 2020 cost of sales of CAD 15.8 million.

Higher cost of sales this past quarter was largely due to higher production costs, a greater inventory provision, and a charge related to unabsorbed fixed overhead as a result of lower production volumes in Q1 2021. Adjusted gross margin decreased to CAD 1.9 million from CAD 10.2 million in the prior year's quarter, primarily due to lower net revenue and value segment offerings comprising a larger proportion of total revenue in Q1 2021.

Negative IFRS gross margin of CAD 16.7 million declined from positive gross margin of CAD 11.2 million in Q1 2020, largely due to net non-cash negative fair value changes to bioassets and inventory sold in Q1 2021 versus positive changes in Q1 2020. SG&A of CAD 11.1 million increased from the prior year's amount of CAD 9.4 million as a result of higher insurance costs and general wage increases.

Q1 2021 negative adjusted EBITDA of CAD 6.8 million declined from a positive adjusted EBITDA of CAD 5.7 million in Q1 2020, mostly due to lower adjusted gross margin this past quarter. The net loss of CAD 34.3 million, or 17 cents per share on a diluted basis in Q1 2021, compared to a net loss of CAD 0.9 million, or 1 cent per share in the prior year quarter, primarily due to greater negative gross margin in Q1 2021. That concludes my remarks, so I'll pass the call back to Greg.

Greg Engel (CEO)

Thanks, Derrick. The industry continues to make progress, with the latest run rate estimated at CAD 3.2 billion for the rec market based on Stats Canada data for October 2020. A large driver of the growth is coming from the increase in the number of retail stores, mostly in the province of Ontario. Since July, the store count in the province has grew by approximately 47% to 1,414 stores as of last week, driven by Ontario's cannabis retail stores more than tripling to 330 stores.

In early December, Ontario announced it was doubling the number of store authorizations again to 80 per month. Outside of Canada, we continue to serve international markets, including Israel and Australia, via export permits and look to expand international sales channel.

Finally, I'd like to make a few comments about the United States, because recent developments are significant for cannabis. As everyone's likely aware, the U.S. election results, in particular, the Georgia runoff elections that tipped Senate control to the Democrats, is positive for pro-cannabis initiatives. While we believe the timing of full legalization is unclear and will likely still take considerable time to happen, it is clear the political landscape has changed.

We've patiently followed the market and in particular, exploring paths to enter the CBD market. To date, we have not found opportunities that meet our risk-reward criteria, but we continue to monitor closely. Many of the R&D initiatives and new products that we work on, we believe, will ultimately be commercialized in U.S. CBD markets and ultimately THC markets, when federally legal.

For example, our Edison Remix is an innovative product that we believe will translate well in the U.S. In preparation for U.S. activities, Christie-Jo, our Vice President of Legal and Regulatory Affairs, is now an active member of the board of directors of the American Trade Association for Cannabis and Hemp. This is a trade organization registered in Washington, D.C., founded to promote the expansion, protection, and preservation of businesses engaged in legal trade of industrial, medical, and recreational cannabis and hemp-based products.

The organization is ushering in the next phase of marketplace expansion by providing the bridge from the cannabis industry to mainstream name brand businesses, who will be partners in advancing the industry and ending prohibition. And we are pleased to welcome Marni Wieshofer to the company's board of directors. Ms. Wieshofer is based in California and represents our first U.S. domiciled board member.

We believe she will be a tremendous asset, given her deep U.S. and international M&A and finance experience, combined with her board experience. Notably, she was recognized by Variety Magazine in the 2018 Dealmakers Impact Report. Her former roles include Chief Finance Officer and Executive VP of corporate development at Lionsgate Entertainment, a multi-billion dollar global entertainment company. She oversaw M&A, including the acquisitions and integration of Trimark Pictures, Artisan Entertainment, and Redbus Films Distribution UK.

We look forward to Ms. Wieshofer's contributions and insight as we continue to chart an ambitious path for the company, nationally and internationally. In closing, we are well through the revitalization of our product portfolio and are starting to see it come through in top line growth. This will only be aided by the additional resources we are now bringing on.

We remain focused on cost management and have identified meaningful upside potential for gross margins to drive profitability and sustained attractive returns on investment for shareholders. So that concludes my prepared remarks. Operator, if you could go ahead and open up the line for questions?

Operator (participant)

Great, thank you. At this time, if you would like to ask a question, please press star followed by the number one on your touchtone phone. To withdraw your question, press the pound or hash sign. Once again, please limit yourself to one question and one follow-up question. You may re-queue if you have any further questions from there. Thank you. And your first question here comes from the line of David Kideckel from ATB Capital Markets. Please go ahead. Your line is now open.

David Kideckel (Managing Director and Senior Institutional Equity Research Analyst)

Oh, hi, good morning. Congrats on the quarter, and thanks for taking my question. So just looking at your gross margin profile here, Greg, I'm wondering, if you can comment just over the next several quarters, and knowing that, you know, that you won't be providing a formal guidance here, just with respect to product mix, whether it's value or in your premium segment, two point zero versus one point zero products, how should we think about the overall, splits in revenue and just so we can get a better grip here on gross margin? Thanks.

Greg Engel (CEO)

Yeah. No, thanks, Dave. It's a great question. So, I mean, certainly, as we indicated, dried flower makes up the greatest proportion of our revenue. And over the last couple of quarters, the value segment has been a higher proportion over those two quarters than we'd seen in the past. You know, as I alluded to earlier, you know, one of our keys is our genetics program and introducing new cultivars.

So we did introduce three new cultivars in late December, Black Cherry Punch, ICC, and Slurricane, as I mentioned, and we have plans to introduce additional new products under Edison coming forward. So those new higher THC new genetics in the Edison banner are of higher margin because they have a higher average selling price. So that's been a big shift for us.

You know, it's important to note as well, you know, while in a couple of quarters previously, we have reduced pre-roll production due to COVID, we were able to start ramping pre-roll production up, but those do also have a lower margin than Edison, for example. One big advantage for us, as I mentioned earlier as well going forward, is that, you know, we have new automation equipment we expect to be fully commissioned and operational by the end of this quarter or early Q3.

Which again, will reduce the cost of goods on pre-rolls and allow us to not only, you know, be efficient in the pre-roll production, but as our plan evolves, you know, what we're looking to do is continue to increase, you know, SKU size and efficiency and margin by going to higher volume.

I talked earlier about, you know, on our Trailblazer vape carts going to a one gram. On the pre-rolls, we're going to multi-packs as well, which we've seen very good consumer response from. And you know, I think, when you look at our overall picture, one of the things that's impacted us certainly is, you know, part of the good news on the genetics program is that, you know, we've really been able to sort through and come up with these new products.

But it does have an impact in the near term as you're working on a number of different new genetics and getting through that genetic mix until you optimize the conditions takes time. So, you know, we're confident that we're going to be able to continue to improve that on a go-forward basis.

You know, I think one of the other things that's really impacted us, you know, as we said, we're in the process of staffing up, because we were producing less than the market demand for our products, which is good news in terms of on a go-forward basis. So, you know, increasing that will reduce, you know, this is in gross margin specifically, but will reduce some of the unabsorbed overhead and affect, you know, Adjusted EBITDA, and really optimize and continue to improve efficiencies.

And that's one of the keys for us as an organization. We've proven in the past that we can run very efficiently, and now with kind of scaling back up, we, you know, we believe that will be the case, going forward.

And the last thing I'd say, David, is just that, you know, we also have a packaging task force that's been working over the last two quarters to look at other opportunities for cost reductions. And I think one of the key areas, you know, we identified a number of key areas. Is to bring by Q4 some of those initiatives into place to really have an impact on efficiencies and packaging.

So, you know, just I guess in summary, I would say that ultimately, we believe that our, our investments, as I said, in, in these new strains and new genetics to really meet the consumer demand, are going to pay off, but it takes time to get there.

David Kideckel (Managing Director and Senior Institutional Equity Research Analyst)

Okay, thanks, Greg. That's a really great color. My follow-up question has to do with kind of in the month of December and given these unusual times with COVID, but have you noticed any seasonality effects, and in particular, have any particular products within your two point O product portfolio, whether that's chocolates, vapes or beverages, have any of those products kind of stuck out to you just from a consumer overall revenue perspective there during the month of December and even in two weeks of holidays? Thanks.

Greg Engel (CEO)

Yeah, no, it's a good question, David. I mean, certainly, it's too early to tell on our Remix Beverage product because, you know, we've just launched that and we don't have distribution in every province as of yet. You know, we did look to some seasonal offerings, and I think that was one of our approaches, right? With our Christmas Sticks pre-roll 0.5 grams, specific for the Christmas season, as well as Gingerbread Edison Bytes, a milk chocolate truffle that was gingerbread flavored.

And so the response to both of those was very good. You know, the only thing I would say, we have seen an impact during COVID and through the whole period of COVID on areas like disposable vape pens. Revenue in that area has not been as high as expected, and we understand that.

Those are driven, in some cases, more by, you know, tourism and travelers and areas like that, and those are also things that people take to share at events and stuff. So those have been the kind of carriers, but we didn't necessarily see a seasonal. But, you know, again, typically, like anything, you know, people may have been diverting kind of some of their disposable income to other areas.

But, you know, overall, you know, I think you know, part of our way of taking advantage of some seasonality was to offer a couple unique seasonal offerings, which both were very well received in the market.

David Kideckel (Managing Director and Senior Institutional Equity Research Analyst)

Okay, got it. Thanks very much for that color. I'll hop back in the queue, and congrats on the quarter.

Operator (participant)

Your next question comes from the line of Andrew Partheniou from Stifel GMP. Please go ahead. Your line is now open.

Andrew Partheniou (Equity Research Analyst)

Hi, thanks for taking my question. Maybe if we could continue the conversation on gross margin. You know, I think you mentioned, you know, the restaffing activities only benefit gross margin in Q3, but unabsorbed costs could be reduced in Q2. Just wondering if restaffing activities are the main source of the unabsorbed costs and lower production utilization, could you provide a little bit more detail and reconcile these two items?

Greg Engel (CEO)

Yeah, maybe I'll turn that over to Derrick to answer that question.

Derrick West (CFO)

Sure. Thanks, Greg. Yeah, during the quarter, we had unabsorbed overhead fixed costs, essentially depreciation, insurance, and taxes of CAD 2.7 million, and that was, as a consequence of operating, at the capacity level we have, which was approximately 40% during Q1. As we, add to our planning and cultivation and add the staff, we would be utilizing more of the rooms, and as a consequence, as it relates to our overall margin,

a lower dollar amount or of these unabsorbed overheads would impact, Q2 as well as Q3. It would be staggered in terms of the direct benefit, but there would be, some benefit in terms of the overall direct charge to, the cost of sales during the Q2.

But to Greg's point, on an overall basis, the cost in production of grams that go into your inventory really normally impact the subsequent quarters, margins and cost of sales. And that was why he's providing perhaps a comment that the true benefit of operating at a higher level and getting a lower cost per unit starts to impact Q3 and later quarters.

Andrew Partheniou (Equity Research Analyst)

Good. Thanks for that additional color. And, kind of on the same, length, you know, when you... We've noticed that, you know, and you talked in the past that, you know, you're planning on lowering yields to increase quality. So when you combine the lower yields, but also the higher margin, new Edison strains, and obviously taking into context that you won't be providing any kind of formal guidance, around what levels do you think we can see gross margin stabilizing?

Do you have any internal goals in this metric? And maybe as, you know, as part of that, could you also remind us, you know, where your production levels were before restaffing activities and what kind of increase we can expect once you're fully staffed?

Greg Engel (CEO)

Yeah. So maybe I'll start off and answer that, Andrew. I think, you know, again, we, you know, when we commented before, that our, you know, we knew we would, you know, be decreasing yields on a per gram basis. I mean, part of that also, keep in mind, you know, because of COVID and the amount of inventory we had of, extractable product and concentrate, we also stopped harvesting, trim, right, in Q2 of 2020, which made up, 30% of the, you know, product or material from the plant.

So that had an impact on our overall yields to begin with. We knew to optimize THC, we would, you know, have to kind of work to optimize yields. And it, it wasn't necessarily improving THC, as I said, it was that investment in genetics.

You don't have the ideal conditions, you know that impacts the drop, and it takes, you know, a number of different rooms and cycles to really get to the point. We are seeing yields improving over the last quarter, certainly, along with THC levels. So we've been able to continue to see progress in both areas, as you can see by the product launches that we've recently had, you know, in that 23%-27% THC range. And, you know, yields are starting to go back up.

I don't want to give a kind of necessarily a specific target relative to, you know, what yield, you know, where we need to be on a yield per THC basis because, you know, every strain is different, and you have to treat them accordingly.

And there is room, depending on the strain, to have, you know, some differential pricing as well for the product based on the demand. You know, one comment I would make before answering the second part of your question also is that, you know, we returned, or we started using street names, you know, in the marketplace, and it's actually had a very positive impact in terms of response.

People know the strains. You know, we've seen the legal market attract a lot of people from the illicit market, and that's been very, very helpful, for them to identify the products and certainly something that's been a positive move.

I think there, just Al indicated that, you know, in answer to your second part of your question, that, you know, when we look at our facility utilization prior to staffing up, we're at about a 40% utilization rate of the facility. So, you know, by adding these, you know, 100 cultivation and 30 packaging people, again, this will be staggered in over time. And, you know, we, we expect, to continue to progress on that.

You know, it's not only just a Q2 initiative, as we see opportunities not only domestically, but internationally growing, you know, an opportunity to continue to expand and increase cultivation levels going forward.

Andrew Partheniou (Equity Research Analyst)

Thanks for that additional color, and I'll get back in the queue.

Operator (participant)

Your next question comes from the line of Aaron Grey with Alliance Global Partners. Please go ahead. Your line is now open.

Aaron Grey (Managing Director, Equity Research)

Hi, good morning, and thanks for the questions. You know, first of all, for me, just kind of, you know, want to go back to the commentary you made kind of around the U.S. and kind of how you're looking at it, because obviously been, you know, a lot of focus on that given the election results. So you've seen some of your peers kind of get into the U.S. market via CBD, you know, MSOs or other CPG businesses.

So just curious, as you kind of talked about, you know, not liking some of the risk/reward you're seeing right now, could you kind of give some more color in terms of what you believe might be the best way to play it today?

You know, given there's still uncertainty in terms of, you know, whether there will be federal laws passed and how those federal laws will look, and if you're now kind of thinking about play the wait-and-see game to see it all, how it evolves, or if you might be a little bit more aggressive, in terms of making a potential movement to the US. Thanks.

Greg Engel (CEO)

Yeah, no, it's a great question, and thanks for the question, Aaron. And, you know, I think as I alluded to, I mean, one of our focuses has been always our focus and investment in R&D, in developing new and differentiated products. You know, because again, ultimately, we believe in order for the legal market to displace the legal... the illicit market, whether or not that's in Canada, in the U.S., or in other jurisdictions, offering differentiated products that change the whole cannabis consumer experience is going to be important.

So that's why, you know, in products like our Remix, dry powder beverage, you know, that we've developed and invested, we believe, there are opportunities potentially to, you know, to license that to other markets, and to look at, you know, how do you take those platforms and bring them into the markets? You know, as I said earlier, we have spent a lot of time over the last two years really looking at the CBD market and as a potential entry point into the U.S. And I think, you know, ultimately,

to be frank, we just haven't found the right partner on how to do that. You know, I think for us, as we look at, you know, we continue to focus on the US as an opportunity, you know, there isn't a clear path as a, you know, as a Canadian company, that, you know, that is dual listed on the Nasdaq and the TSX with the regulations that exist there currently to enter the US, in the THC market, certainly. You know, we've seen some companies take some option approaches relative to.

You know, our approach is really about developing branded products, developing innovation and technology that we feel will lend itself to the market, and that may be something, you know, we either look to license out or we look to do ourselves in the future as the regulations allow.

Aaron Grey (Managing Director, Equity Research)

All right, great. Thanks a lot for that color. And then second one would be specifically kind of around the province of Ontario. Obviously, you know, everyone's looking for, you know, a lot more stores to come online, you know, in 2021, and we start to see towards the end of 2020. So just curious to, from your perspective in terms of, like, as those incremental stores come online, you know, how are you seeing in terms of, like, saturation within specific geographies, right?

So I know there's some cities in Toronto where there's a lot of, you know, retail stores in one specific area. So do you feel like that might start to impact maybe the incremental, you know, dollar sale we're gonna be seeing, you know, per new store that you're seeing in Ontario?

How do you feel like that might impact kind of the overall, you know, competitive landscape for you guys going forward? Thanks.

Greg Engel (CEO)

No, yeah, it's a great question, Aaron. I think, you know, you're bang on in terms of, you know, not every new store is the same in terms of the ability to generate additional revenue. I think, you know, what you're seeing, for example, you referenced in Toronto, there's a couple key areas in Toronto, along Queen Street, along Yonge Street, the two of the major arteries, where there is an abundance of stores going in, and so that does lead to some level of saturation.

So, it will grow the overall market, but at the same time, the revenue per store will, you know, will not be, at the same level, because of that saturation point.

You know, I think when you look outside of the core of Toronto, there are certainly lots of opportunities, and we are seeing new stores happen in areas that have limited stores or no stores today, and I think that's been one of the keys. You know, and I think that's where the growth opportunity certainly exists, is to kind of... You know, people that have had to rely upon online-only sales, getting access to, you know, a store or multiple stores now, is one of the key facets. So, it's a bit of combination of both, but certainly, you know...

I'll look at Alberta as an example, where, you know, with the number of stores, Alberta has the highest number of stores per capita right now. They probably did reach a saturation point kind of last year, and we've seen where, you know, a small number of stores have closed, or there's been a little bit of consolidation happen and optimization.

So, Ontario is a long way away from that happening because there's still tremendous room for growth and, you know, in terms of, you know, where we see the growth happening, but again, certainly along a couple quarters, you know, there is some saturation happening. The other area I would comment on is, you know, there are still a couple municipalities, especially in and around Toronto, that don't allow cannabis stores.

So if you recall, when legalization happened, the Ontario government allowed each municipality to opt in or opt out. I think certainly smart retailers should be looking to, you know, put stores on the border of kind of those municipalities, and I think that's kind of one of the opportunities that exists right now. Especially kind of north of Toronto, you know, there's a big opportunity where some border stores along Steeles Avenue, for example, would have a huge impact on revenue.

Aaron Grey (Managing Director, Equity Research)

All right, great. Thanks for the call, and I'll pass it along.

Operator (participant)

Your next question comes from the line of Graeme Kreindler with Eight Capital. Please go ahead. Your line is now open.

Graeme Kreindler (Principal and senior equity research analyst)

Hi, good morning, and thank you for taking my question. I wanted to ask a follow-up with respect to the adjusted gross margin, and I appreciate the comments made in the prepared remarks and the discussion earlier about the unabsorbed fixed overhead. I wanted to dig a little deeper. Greg, you mentioned on the call that you're gonna be bringing in a pre-roll machine in the middle of the year, and the packaging task force is expected to complete their work by the end of the year.

Can you give any indication of what those initiatives will do discretely for the gross margin? You know, maybe there's some internal modeling you've done there, and you can compare that to what the baseline is right now. That would be helpful. Thank you.

Greg Engel (CEO)

Yeah, Graeme, I don't wanna give guidance necessarily specifically about the impacts. I mean, the one, you know, I will give a comment on the pre-roll equipment. I mean, that equipment's been on site now. We've been working with it, and we have seen, you know, during test runs, it producing 40-50 pre-rolls per minute, you know, and reducing labor required with pre-roll production from 22 people down to 3.

So, you know, that's an example of, you know, just directionally what we've seen. Now, it's not fully optimized. We're still, you know, on, playing around with the blends, in terms of the appropriate, blend mix of, you know, material for it. But, you know, we expect that to have a significant impact in the near term.

And then, you know, part of our shift for Q4, as I said, is really looking at, you know, some of the shift in some of our packaging types and designs and, you know, trying to be more consistent in terms of utilizing a couple, you know, pouches, for example, for multiple different product lines, which allows us not only efficiency in packaging, but also allows us, in terms of, you know, packaging inventory and always availability.

You know, one of the things I commented on in the prepared remarks was, you know, we know we left revenue on the table in the quarter. We certainly, you know, we did not have sufficient product and/or capacity and staffing to meet the demand for our product, which is why we're staffing up. But, you know, so I can't...

I, you know, I don't wanna give specific direction in terms of what we expect on savings. We have done modeling, but, we're, you know, until we get to the point where, you know, one of the challenges always with automation and equipment is until you get it commissioned and up and running, you don't know what impact it's going to actually have.

Graeme Kreindler (Principal and senior equity research analyst)

Okay, understood, and appreciate the anecdote there. That's helpful. Then perhaps in terms of order of magnitude and what your expectations are between increasing your staffing levels, which are gonna give you higher throughput there, and then, you know, the pre-roll initiatives, the packaging initiatives, can you give any sense directionally in terms of what you're expecting will have the most outsized impact in terms of increasing the gross margin there?

Greg Engel (CEO)

you know, again, directionally, I would say it's definitely a combination of both. You know, I think increasing staffing and increasing output and throughput is going to have the most significant impact because, again, producing more sellable product, especially as we've now optimized conditions around some of these new high THC genetics will create significant opportunities for us. And you know, the initiatives on packaging are more of a longer term impact and will have an improvement in margin.

But at the end of the day, you know, increasing revenue on a high THC product, which has a higher margin, is going to have more impact.

Graeme Kreindler (Principal and senior equity research analyst)

That's very helpful. Thank you very much, Greg.

Greg Engel (CEO)

Thanks.

Operator (participant)

Your next question comes from the line of Adam Buckham with Scotiabank. Please go ahead. Your line is now open.

Adam Buckham (Associate Director of Equity Research)

Good morning, and thanks for taking my questions. So first, in some sort of capacity, is it possible to speak to the potential size of missed revenue opportunities in fiscal Q1 as a result of production constraints, maybe in terms of missed purchase orders or something along those lines?

Greg Engel (CEO)

Yeah, Adam, I mean, you know, internally, we, we do know. Now, some of these purchase orders we were able to fulfill in Q2, so they weren't necessarily completely missed, but we did, you know, we did have, between CAD 5 million and CAD 6 million of POs we were not able to fulfill in the quarter.

Adam Buckham (Associate Director of Equity Research)

Okay, that's, that's great color. Thanks. Secondly, in the prepared remarks, the team indicated that there could be some cooling off in the market given the retail restrictions in Ontario. To date, have you seen any impact to buying patterns from the OCS? And then just a bit of a follow-up to that, the OCS has recently had some comments about potentially rationalizing SKU counts. Obviously, OGI has already gone through this with much of its portfolio, but with this potentially coming, do you think it could eventually be a bit of a tailwind for the products that are left remaining on the OCS?

Greg Engel (CEO)

Yeah, no, it's a, it's a good question, Adam. So to answer your first question, I think certainly, you know, we have not seen a shift in order patterns, but certainly we've been notified by OCS, you know, again, as they are continuing to kind of monitor daily, weekly, the impact of, you know, now going to click and collect and local delivery only will have on retail sales, that they could change. So an existing PO, for example, that's due to be shipped three weeks out could be reduced.

So, we have not seen that happen yet, but they've given us indication that that could happen. Yeah, I mean, to your point, we, we've been probably one of the most active companies in working closely with OCS in terms of, you know, revamping our portfolio, switching out products.

So certainly that's been a big focus for us, and we really see with every province, and, you know, certainly with the two largest provinces, for us and for the market, Alberta and Ontario, we've been active in doing that. So, you know, I think it does. I mean, their strategy, I mean, they've, you know, they're going to 100 core listing products. They expect those products to always be 100% available. And so, you know, there are tailwind opportunities for those products, for core listed products to generate revenue.

Because, again, the commitment from every company will be to, you know, make sure those products are always in stock, and, you know, there's tremendous opportunity.

So retailers know that they will always be able to, you know, access those products and carry them at the retail store. But any listing requirement in the province of Ontario now will require a 98.5% inventory level. And so, you know, it's critical for companies to consistently meet that level, or you run, as you would see in any normal retail environment, you run the risk of being delisted.

So, you know, companies that have in-demand products and are able to consistently supply the market, you know, are in a great position in terms of revenue against those products.

Adam Buckham (Associate Director of Equity Research)

Great. Thanks for the color.

Operator (participant)

Your next question comes from the line of John Zamparo from CIBC. Please go ahead. Your line is now open.

John Zamparo (Equity Research analyst)

Hi. Thanks. Good morning. I want to get a sense of how you feel about the balance sheet at the moment. And, of course, you did the recent equity raise, but there's still some debt on the balance sheet, and industry valuations are pretty robust at the moment. And now there's the prospect, potentially, of entering the U.S. at some stage at least. So just would like to get your thoughts on capitalization levels at this time.

Greg Engel (CEO)

Yeah, look, I mean, we're very comfortable with our balance sheet, as you said. I mean, you know, at the end of the quarter, after using CAD 55 million of proceeds to pay down a portion of the debt facility, you know, we still have CAD 60 million remaining in debt. But we did have, you know, CAD 79 million dollars in cash and short-term investments, plus CAD 8 million dollars of restricted cash. I mean, again, one of the things I would highlight is, you know, we had, for the second of the last three quarters, a positive cash flow from operations.

So, you know, as a company perspective, I think we're, you know, we're in a strong position, you know, on a go-forward basis relative to, you know, our own cash position, and also kind of how we're operating and our operating consistency.

John Zamparo (Equity Research analyst)

Okay, thanks. And then my follow-up is on the gross margin. When you think about getting back to the previous levels, you hit kind of that 35%-40% number. Do you need to get to the same level of net cannabis revenue, kind of that 25 million plus, in terms of sales? Or is your cost structure different now that it wouldn't quite need to be so high? Or is it potentially higher because now you're offering a lot more value products? Just would like to get a sense of what you'd need to hit on the top line to hit that previous gross margin level. Thanks.

Greg Engel (CEO)

Yeah, it's a good question, John. I think, you know, there is a mix there. So certainly on one hand, you know, we have become much more efficient as an operator. You know, I hate to say there was a benefit from COVID, but one of the things that, you know, with reduced staffing it forced us to do was look at, you know, how we operate, how we do things, and we've been able to get much more efficient in a lot of things we do. And then kind of going forward,

as I said, you know, some of the initiatives we've taken on automation or even kind of systems and how we operate. So, you know, do we need to be there?

I mean, yes, the, you know, there's no question, that our mix is, you know... So I, I didn't mean to say, do we need to be there, yes, at the same level of net revenue? I think it's, it's a mix, right? Because we are selling, you know, more value, large volume SKUs. You know, so your average price per gram there, but certainly is lower, but your, you know, your labor costs that go into that and packaging costs are significantly lower as well. But, you know, again, our goal is to, as I spoke to earlier, is to really continue to drive more revenue on the high-margin products.

You know, that's why this investment in the genetics program and what we've been doing over the last twelve to eighteen months is really starting to pay off now. And because that is going to be critically important. You know, we have seen. There's no question, we've seen price compression in many categories, and it's not just value-dried flower categories. It's also been in the vapes category as well.

So, you know, again, I don't want to give a specific forecast, as we don't give guidance on what level we need to hit. But, you know, I guess your comment would be accurate in terms it's a mix between the two.

You know, on one hand, we're selling more of the high volume, lower priced value products, which do have a lower margin. One of our lowest margin products historically has been pre-rolls, so we're looking to improve that dramatically with the automation rate, so.

Graeme Kreindler (Principal and senior equity research analyst)

Okay, that's great color. Thank you very much.

Operator (participant)

Your next question comes from the line of Vivien Azer with Cowen and Company. Please go ahead. Your line is now open.

Vivien Azer (Managing Director and Senior Research Analyst)

Hi, good morning.

Greg Engel (CEO)

Good morning.

Vivien Azer (Managing Director and Senior Research Analyst)

I just wanted to follow up on Aaron's question about the US market and your posturing there around CBD. You know, there hasn't been a lot of evidence around brand equity transferability between CBD and THC, and frankly, the category development in CBD has been quite lackluster. There continues to be regulatory uncertainty around the FDA. So can you just expand on why that's the appropriate pathway to enter the US?

I understand, you know, obviously the regulatory constraints around THC, but why even pursue a CBD strategy? Thanks.

Greg Engel (CEO)

No, it's a great question, Vivien. Ultimately, what you've outlined is why we have not entered the U.S. I mean, we have not seen really an impact. I mean, you know, is there transferability between CBD and THC products? Not necessarily. I think there's only a few areas where that's the case. I think for part of us, our strategy there was, you know, as we've evaluated, entering the market is, you know, simply to get a toehold in the U.S. and look to be a U.S.

operator and kind of, you know, look to hire people potentially or acquire a company that, you know, you could leverage across to the THC market. But I agree with you 100% that to date, we haven't seen that transfer, and ultimately that's why we haven't made the decision.

You know, again, our focus has been, you know, as I outlined earlier in response to Aaron's questions, you know, I think there are technologies and innovations like our dried powder that can be applied in both markets. And one strategy may be to say: Do we look for, you know, for someone to license those to, or do we look to launch those ourselves? I think there is still a level of uncertainty on CBD, you know, in the U.S. with the FDA.

I think there is still gonna be guidance out, where they are going to look at certain forms of, you know, ingestion, for example, oral ingestion products, having to undergo some toxicology work potentially.

The rules still aren't clear on CBD, and there's a number of reasons we have not yet entered the market, but certainly we've looked at it as an opportunity to potentially get a toehold into the US, possibly.

Vivien Azer (Managing Director and Senior Research Analyst)

Understood. Thanks for that color.

Operator (participant)

Your next question comes from the line of Rahul Sarugaser from Raymond James. Please go ahead. Your line is now open.

Rahul Sarugaser (Managing Director of Equity Research)

Okay, thank you. Good morning, Greg, Derrick, and Amy. Thanks so much for including us in Q. So my first question is around market share, and you know, all of your comments earlier are well taken. I guess maybe more speaking at the macroscopic level. You know, we've seen a decline in market share over several quarters. At least in this last quarter, we've seen that, you know, that being attenuated somewhat. So, you know, you are extending that.

Given your earlier comments about increasing appreciation and demand for Organigram's products, do you anticipate that you kind of bottoming out in market share should start to increase over time?

Greg Engel (CEO)

Yeah, you know, it's a great question, Rahul. I think we're, you know, as, as I mentioned, I mean, we had unfulfilled POs in the quarter, there's no question. And I think one of the challenges we've had, truly is, you know, we've had inconsistent supply of many of our products. So even, you know, our Trailblazer Snax, when it was launched in chocolate category, it was not always available.

And, and part of the, you know, part of the challenge you face is that in certain jurisdictions, in terms of how much product they carry at launch, and then if it sells out quickly, you know, our SHRED is very similar to that, right? So SHRED was an overwhelming success. You know, as I said, it was the most searched, number one most searched brand in November, December, in, on the OCS website.

And so we had no idea that was going to be the case. So, you know, again, it's difficult to just look at our share because there's kind of a lost opportunity there where, you know, we've not been able to fulfill the market demand. And I think certainly, you know, we believe with increased production, you know, we are in a great position, you know, to be able to continue to increase share on products like that or some of our core new offerings on Edison.

Because, you know, every time we ship SHRED in, it sells out very quickly right now. And as I said, the search metrics that we've seen on OCS would be an indication of the demand. You know, what you see in terms of share doesn't represent the demand necessarily. We've got to do a better job in kind of meeting the inventory levels to fulfill that demand.

Rahul Sarugaser (Managing Director of Equity Research)

Great, thanks. And then just a quick follow-up, and pivoting a little bit. So, you know, you're one of two companies that has taken a pretty, pretty material bet in biosynthesis, and we're seeing the space really starting to evolve.

And given the bet in Hyasynth, and its specific, somewhat unique strategy of focusing on the major cannabinoids relative to its universe of peers, which are very focused on the minor cannabinoids, do you see this as kind of your, you know, ace in the hole, particularly when it comes to entering the US market as you referred to, specifically around the beverage powders?

Greg Engel (CEO)

Yeah, no. So again, you know, I'd agree in part with what you said. Like, initially, certainly Hyasynth's approach has been, you know, they were the first commercial company that we're well aware of, first biosynthesis company to have a commercial sale of, you know, of a cannabinoid with CBDA produced through biosynthesis. And so, but, I mean, they are focused on minor cannabinoids as well. I mean, they've got a fulsome portfolio of 23 cannabinoids, 19 minor and four major cannabinoids.

You know, again, I think one of the keys of early focus on major cannabinoids is that the process for producing them is somewhat more straightforward and not as complicated. But, you know, in parallel, they are also working on minor cannabinoids, and I think that's going to be critical for the future.

You know, I wouldn't necessarily agree with your comment that, like, every, you know, other companies are all focusing on minor. We've seen other companies, you know, talking about plans to commercialize CBG in the near term and not spend their focus. So, but I think, you know, Hyasynth's focus, you know, they've got a. You know, our investment strategy with them has been, you know, that we believe they have a strong IP portfolio, and that they are working, you know, on dual paths, both with major cannabinoids, but potentially for minor cannabinoids in the future.

And I think that's one of the key aspects where we believe, you know, in the future, minor cannabinoids are gonna benefit greatly from biosynthetic production, because, you know, ultimately, you cannot produce the majority of minor cannabinoids from a plant at any significant level, and the cost would be prohibitive. So the benefits of biosynthetic production, as you know, are much higher with minor cannabinoids than major cannabinoids.

Rahul Sarugaser (Managing Director of Equity Research)

Perfect. Thanks very much.

Operator (participant)

Your next question comes from the line of Pablo Zuanich. Please go ahead. Your line is now open.

Pablo Zuanic (Managing Partner and Chief Compliance Officer)

Good morning. Two quick questions. One, you know, when you see Aphria and Tilray merge, you know, how do you think about that? You know, you have about 3-4% share based on my numbers. You know, as the industry starts to merge, is that a problem for a company like your- like yourselves? Or, you know, how does, how does that manifest itself at the ground level? Or it doesn't make a difference, it's not something that's keeping you awake at night. And the second question: in the case of Israel, with Canndoc, there's been two or three other companies that have also shipped to Israel.

Seems that Canndoc is, I guess, cherry-picking, and they buy something from some companies and other things from other companies. Just talk about that dialogue in terms of what are they buying from you, and what is it that stands out compared to what other people are exporting to Israel? Thank you.

Greg Engel (CEO)

Yeah, no, Pablo, it's great. You know, your first question, in terms of the overall marketplace, I think, you know, you know, we have seen, you know, bigger doesn't necessarily mean better. I mean, some of our larger peers have shuttered multiple facilities, so, you know, a potential merger of an Aphria and Tilray coming together, you know, it, it may be more about international markets from certainly what I've seen written or kind of looking at other markets, than it is about the Canadian market per se.

Certainly, at least that's many analysts', you know, perspective on it. I think for us, the key has to be continue to drive forward with, you know, new and innovative products, differentiated products that there is market demand for.

And, you know, that's going to be one of the critical parts. To answer your question on Israel, you know, certainly for us with Canndoc, you know, we're an indoor producer, and certainly there's a differentiation between, you know, their other supplier at this point, you know, in terms of the marketplace. And certainly, the initial response to the product we did sell in on our first shipment was extremely positive. And, you know, we're working hard to with Canndoc to be able to continue to supply them in Q3.

And again, that will be dependent upon getting the CUMCS certification as well as, you know, having the right product mix for them at the time. But, you know, certainly for them, one of the big advantages that they saw in us is being an indoor producer, so.

Pablo Zuanic (Managing Partner and Chief Compliance Officer)

Got it. Thank you.

Operator (participant)

There are no further questions at this time. Ladies and gentlemen, this concludes today's call. We thank you for your participation, and you may now disconnect.