OrganiGram - Q2 2020

Transcript

Operator (participant)

Good morning. My name is Lisa, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Organigram Holdings Inc.'s second quarter twenty twenty 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 requeue if further questions. As a reminder, this conference call is being recorded, and a replay will be available on Organigram's website. At this time, I would like to introduce Amy Schwalm, investor relations. Ms. Schwalm, you may begin.

Amy Schwalm (Head of Investor Relations)

Thank you, operator. Joining me today are Organigram's Chief Executive Officer, Greg Engel; Chief Financial Officer, Derrick West; and our Chief Strategy Officer, Paolo De Luca. Please bear with us today as we are all doing this call remotely from our homes. 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. 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 may not be directly comparable. Please see today's earnings report for more information about these measures. 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 results from our second quarter of fiscal twenty twenty, ended February twenty-nine, twenty twenty. Before I begin, I would like to welcome Derrick to his first earnings call as our Chief Financial Officer and Paolo as our Chief Strategy Officer.

I'll provide some overall remarks on the quarter as well as on current developments, and then Derrick will take you through our financials in more detail. All three of us will be available to answer questions before we close the call by no later than 9:00 A.M. Eastern Time. First of all, stepping back, I have two important messages I want to come through clearly this morning.

First, we are pleased with our continued execution in the second quarter and with demand for our new products in the market today, including Rec 2.0 SKUs as well as new core strains being introduced across the country. And secondly, we believe we are well positioned with our plans to manage through these uncertain, very uncertain times for a number of reasons, which I'll go through shortly, so turning to the quarter.

Adult-use recreational revenue was up 16% sequentially, driven by the launch of our first Rec 2.0 products, despite total revenue being down on lower wholesale revenue. The adult-use rec market is our core business and represents the most significant growth opportunity for us. We also continue to introduce new strains after these sold exceptionally well as limited time offers in the past.

Limelight, which averages about 20-25% THC, was available in Alberta, BC, Quebec, Nova Scotia, and New Brunswick in mid to late February and is launched in the remainder of the provinces, including Ontario in Q3. El Dorado, a recent addition to our hybrid category, averages about 18-20% THC and had distribution to all provinces in Q2, with the exception of Nova Scotia and BC, both of which are expected to come in Q3.

We expect to continue to see wholesale market demand for our indoor grown product over the next couple of quarters, but it is not our primary focus and more of an opportunity for us in the near term. We have continued to diversify our revenue streams. During the quarter, Rec 1.0 products represented about 52% of net revenue.

Rec 2.0 products, including chocolates and vapes, represented 13% of net revenue. Wholesale revenue from other large Canadian LPs represented 24%, with Canadian medical sales representing 10% and international sales representing 1%. The company continues to actively seek opportunities to expand its product mix and customer base. The second quarter marked a milestone for us, the launch of our initial Rec 2.0 products.

We began shipping Trailblazer Torch vape cartridges on December seventeenth, 2019, and right before the quarter closed, we made our first shipments of Edison vape pens and Edison Bytes, our premium cannabis-infused chocolates. Powered by Feather technology, Edison vape pens are ready-to-use, inhalation-activated pens that are designed to offer a simple and intuitive user experience. Feather is a cannabis vape pen company currently selling products in Colorado, and we have secured exclusivity with them in the Canadian market.

Edison Bytes are premium truffles in both milk and dark chocolate formulations and available as a single chocolate containing 10 milligrams of THC each and a set of two truffles containing five milligrams of THC each. PAX Era cartridges, our third and final vape offering for the premium segment of the market, are expected to launch before the end of calendar Q2 2020. Notably, we've secured listings in all provinces that allow edibles and vapes for our Rec 2.0 products.

Along with our license renewal received this month, we also obtained licensing approval for the remainder of phase V of our facility, which houses a dedicated edibles and derivative product facility. The market continued to see price compression for Rec 1.0 products, but our average net selling price held up well and remained above CAD 5 per gram, excluding wholesale.

Our cost of cultivation remained one of the lowest in the industry, which better positions us against pricing headwinds. In fact, our cost of cultivation decreased from the previous quarter to CAD 0.53 per gram on a cash basis and to CAD 0.75 per gram all in. Q2 gross margin before fair value changes to biological assets and inventories sold declined somewhat from Q1 as we launched a number of Rec 2.0 products for the first time.

Importantly, we see opportunity to drive improved gross margin as we continue to scale and optimize Rec 2.0 products and packs. Adjusted EBITDA was negative in Q2, primarily due to a large brand campaign for Edison that ran during the quarter and higher costs related to the launch of 2.0 products.

As I've said before, prudent cost management is deeply embedded in our culture at Organigram. We've seen most of our competitors announce executive turnover and/or complex cost restructuring plans, where we've been able to stay focused on execution and have not faced these same disruptions. However, we are all facing even more challenging times today with COVID-19 global pandemic. Our priority is to protect the health and well-being of our employees.

It was clear many facility staff were not comfortable coming into work, particularly if they weren't able to practice sufficient physical distancing, even with the additional measures we put in place. It was no longer possible to continue to operate our facility in a business-as-usual approach. We know we are not alone, and other LPs are also experiencing employee absences and reduced operational activity for the same reasons.

As such, we developed a plan intended to help protect the health of our employees and maintain business continuity to service our medical patients and customers. We offered temporary voluntary layoffs to facility staff, and those that accepted made up the majority of those temporarily laid off. Lump sum payments equating to approximately two weeks' worth of work have been paid to the affected employees to help bridge the gap to government programs.

In addition, we will absorb the employee pay portion of health, dental, and short-term disability premiums for all employees during this difficult time. The impact of these temporary layoffs will result in a one-time charge of approximately CAD 0.6 million. We have maintained an experienced group of employees at the facility with skills flexible enough to work on various production and packaging lines as demand dictates.

There were also a select number of administrative and other employees who were temporarily laid off as a result of reduced operations and/or deemed non-essential in the short term. To be clear, we did not make these changes because we had any employees that tested positive for the virus, nor have we made these changes because New Brunswick is any worse off than any other parts of the country.

In fact, even though New Brunswick is reported to conduct about 10% less testing than the national average to date, the province is reported to have 78% fewer confirmed cases per capita than the national average. We applaud the actions the government has taken in an effort to contain the virus in New Brunswick.

By prioritizing the health of employees and being proactive in our containment efforts, we believe this puts us in a better position in the medium to long term, while still being able to manage our operations in the near term. We continue to closely monitor the evolving situation and are prepared to make decisions in the best interest of our employees, balanced with the long-term sustainability of our business.

We have no current plans to reduce medical production, as we intend to continue to serve our patients who have come to rely on our products. In fact, just last week, we expanded our distribution with our first shipment to Shoppers Drug Mart under a distribution agreement we previously announced in February.

With reduced capacity, we are focusing on the most automated and efficient lines of production and packaging and are able to supplement with finished goods inventory on hand in an effort to meet demand in the short term. A good example is our Edison Bytes chocolate truffles with our automated production and packaging equipment. Also, we recently started operating a T0 trimming machine since we received licensing approval for the remainder of phase V in mid-March.

The T0 does the same work as 12 T4s and requires significantly less manual labor to clean than multiple T4 machines. It also means that we have to deprioritize certain products with lower margins and/or those reliant on more manual processes in this temporary period. Where possible, we also shift our production mix to larger format SKUs, as online purchasers tend to prefer those.

We are also evaluating new brand and product launches during this time. We are no longer providing guidance as to the launch timing of our new powdered beverage product and Ankr, our recreational organic dried flower product. Although there has been great interest in our powdered beverage from our provincial partners, it is still estimated to comprise a smaller percentage of sales relative to vapes and chocolates.

Similarly, despite having an Ankr product ready to package, we need to assess priorities in light of a reduced workforce and current consumer demand. Dried flower vape pens and chocolates will be our mainstays for the foreseeable future. Now turning to current demand. We've seen an uptick in March sell-through, as well as more orders from provinces have happened.

Consumers continue to have access to purchase cannabis across the country, with most retail stores remaining open or offering Click and Collect or Curbside Pickup. In addition, online sales run by the provincial cannabis bodies and private retailers, where applicable, are experiencing surges in sales as purchasers adhere to stay-at-home directives.

As a company, we are actively monitoring these trends, but still need more time and data to evaluate just how much is due to pantry loading versus a steady, a sustained change to purchasing habits. While it remains to be seen, there is evidence to support cannabis demand is just as inelastic as demand for alcohol. A survey of 1,005 U.S. consumers by MKM Partners found that media, alcohol, and cannabis were the categories that showed the highest indications of discretionary spending as a result of the pandemic.

There are factors that tend to support increased consumption, even in light of an economic downturn. As consumers pare back spending on higher-ticket items, such as dining out and travel, cannabis is relatively less expensive and still provides a recreational experience. Stay-at-home and physical distancing directives offer more opportunity to consume cannabis in private settings, which is what our own market research indicate is to be expected, particularly for edibles.

I would now like to turn to our ability to supply this demand. As we announced last week, we believe we have sufficient inventory levels to supplement reduced harvest plans and enough contingency staff to keep packaging intact to meet anticipated demand in the short term. We also remain comfortable with our current inventory from external suppliers, such as vape product hardware and packaging materials, and have not experienced any significant disruptions to date.

We provide some detail on the breakdown of inventory in note seven of our financial statements, so I'd ask you to please turn to that to review. Our finished goods, dried flower inventory is largely comprised of higher THC product and our most popular strains. Further, the majority of upcoming harvests are comprised of strains in higher demand, including Limelight and El Dorado. As we have been saying, we attribute this to the benefit of our early views on retail sell-through, allowing us to shift our production mix starting last year. With that, I will now turn the call over to Derrick.

Derrick West (CFO)

Thank you, Greg. Since I joined early last month, it has certainly been an eventful time in the industry and globally, to say the least. In any event, I am very happy to be here and look forward to meeting many of you on the call virtually and eventually in person when it is safe to do so. I have been getting up to speed quickly, and it has helped to have had the vantage point from previously being on the company's board and chair of the audit committee.

I will begin with some comments on our financial position. As at quarter end, our remaining estimated capital spend on phase V was CAD 11 million, largely related to the installation of certain equipment in the edibles and extraction area. We expect to spend at a slower pace to balance near-term priorities with respect to COVID-19.

Our remaining estimate to spend on phase IV is quite marginal at about CAD 2 million. We are pleased to see our capital expansion nearing completion. We believe we have built an impressive indoor facility capable of producing high quality, low-cost flower, as well as premium chocolates and other derivative products. We ended the quarter with CAD 41 million in cash and short-term investments.

As of today, there is CAD 30 million undrawn on our term loan and a CAD 25 million revolver available to be drawn against specified receivables. As at quarter end, working capital declined to CAD 97 million from CAD 152 million at fiscal 2019 year-end. This was largely due to an IFRS requirement to classify the long-term portion of the term loan to current liabilities, because we were in violation of our fixed charge coverage ratio covenant.

We obtained a waiver from our lenders that waives compliance until May thirtieth, 2020. We are currently negotiating an amendment to the credit facility agreement in an effort to provide flexibility as a result of the impact of COVID-19. We reported approximately CAD 85 million in current and long-term debt as at quarter end, which primarily represents the carrying value of the term loan in our credit facility with BMO and a syndicate of lenders.

In December of 2019, we announced an at-the-market offering, or ATM program, which allowed us to issue 55 million or its USD equivalent of common shares from treasury. We issued approximately 16.2 million common shares pursuant to the ATM program in Q2 for gross proceeds of approximately CAD 55 million at a weighted average price of CAD 3.39 per common share.

Although the price per share I just quoted was in Canadian dollars, approximately two-thirds of the shares issued were on the NASDAQ exchange, with the remaining on the TSX. Net proceeds were CAD 52.9 million after agents, commissions, regulatory, and legal and professional fees. We have used and intend to continue to use the net proceeds to fund capital projects, for general corporate purposes, and to repay indebtedness. The ATM program was completed before quarter end. Moving to our quarterly results. Q2 net revenue of CAD 23.2 million, compared to CAD 26.9 million the prior year quarter.

The decline from 2019 was largely due to a decrease in adult use recreational sales volumes as a result of the timing of the large pipeline fill orders in Q2 2019, which was to fulfill supply shortages in Alberta and Ontario following the legalization of adult use recreational cannabis. A lower average net selling price from increased competition, a provision for returns and price adjustments largely related to cannabis oil, which has seen less than anticipated demand in the industry and other slow-moving product.

This decline was partially offset by the launch of our initial Rec 2.0 product and continued wholesale revenue in Q2 2020. Q2 2020 net revenue of CAD 23.2 million compared to Q1 2020 net revenue of CAD 25.2 million. Adult use recreational sales were up approximately CAD 2.1 million, or 16%, offset by a decrease in wholesale revenue.

Q2 2020 net revenue of CAD 23.2 million was largely comprised of CAD 15 million in sales to the adult use recreation market, CAD 2.4 million sales to the medical market, and CAD 5.6 million and CAD 0.2 million in wholesale and international sales, respectively. This compared to Q1 2020's net revenue of CAD 25.2 million, which was largely comprised of CAD 12.9 million in sales to adult use recreation market, CAD 2.7 million in sales to the medical market, and CAD 9.2 million and CAD 0.3 million in wholesale and international sales, respectively.

As Greg mentioned, Q2 cash and all-in cost of cultivation were CAD 0.53 and CAD 0.75 per gram, respectively, and decreased from CAD 0.61 and CAD 0.87 per gram in Q1 2020. As more economies of scale were realized with increased cultivation capacity and as our yield per plant increased from 150 grams in Q1 to 155 grams in Q2 2020. Q2 2020 cost of sales of CAD 15.8 million, compared to Q2 2019 cost of sales of CAD 10.8 million. Higher cost of sales in Q2 of 2020 was primarily due to more staffing for increased cultivation and post-harvest capacity without the benefit of full economies of scale.

Inventory provisions and write-offs primarily related to legacy packaging, and thirdly, higher costs associated with the launch of rec 2.0 products as the company scales and optimizes production and packaging. Q2 gross margin before fair value changes to biological assets and inventory sold was $7.4 million, or 32% of net revenue.

As we have said in the past, we focus on gross margin before fair value change to biological assets and inventories as one of the key measures to assume underlying performance, and generally find this to be what the investment community tends to track. The Q2 IFRS gross margin was $11.3 million, largely due to a net non-cash fair value gain on biological assets and inventory sold of $3.9 million, versus a net non-cash fair value loss of $8.1 million in Q2 2019.

Q2 2020's SG&A, excluding share-based compensation, was CAD 14 million, compared to CAD 5.7 million in Q2 2019, as the company increased staffing and sales and marketing efforts, including a significant brand marketing campaign and higher costs related to the launch of our new Rec 2.0 products. We reported negative Adjusted EBITDA of CAD 1.1 million in Q2 versus positive Adjusted EBITDA in Q1, due to the combination of higher cost of sales and higher SG&A, as just described.

Our Q2 net loss was CAD 6.8 million, or CAD 0.041 per share on a diluted basis compared to our Q2 2019 net loss of CAD 6.4 million, or CAD 0.049 per share, largely due to higher SG&A in Q2 2020. I will now turn the call back to Greg for closing remarks.

Greg Engel (CEO)

Thanks, Derrick. To wrap up our formal remarks, I'd like to summarize why we believe we are well positioned during this temporary period and beyond. First of all, we believe we have developed brand loyalty, and there's strong demand for our Rec 2.0 products, and we are rolling out new, higher THC popular strains across the country.

Secondly, we have forged excellent partnerships and have strong relationships with suppliers, regulators, and our provincial and private retail customers. Third, we maintain a lean cost structure and a relentless focus on prudent discretionary spending. Fourth, we have further strengthened our executive team with the addition of another experienced finance executive and a Chief Strategy Officer, who's intimately familiar with the business. Fifth, we can supplement reduced production capacity with existing inventory, as well as leverage our investments in automation to meet demand in the short term.

And lastly, we remain committed to focusing on disciplined capital allocation to generate sustainable value for our shareholders. I'd like to expressly thank the regulators as well as government authorities for including cannabis in stimulus packages and subsidies in this challenging period. I would also like to thank our customers, patients, investors for their support, and last but not least, the entire Organigram team and our board of directors. With that concludes my formal remarks. Operator, if you could go ahead and open up the line for questions.

Operator (participant)

Thank you. As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound or hash key. Please stand by while we compile a Q&A roster. And our first question comes from the line of Tamy Chen from BMO Capital Markets. Your line is open.

Tamy Chen (Consumer Analyst)

Yeah, thanks. First question is, just wanted to understand, is it, at this point, your intention to rehire back the temporary laid-off workers after the COVID-19 developments go past us? Or, do you intend to wait and see how quickly, you know, for example, stores open in Ontario before bringing back those workers?

Greg Engel (CEO)

Yeah, it's Greg here, Amy, Tammy, that's a good question. So, certainly in the intent and the way we structured this is a temporary layoff. So, you know, this was structured in that manner that we can bring and plan to bring employees back. But I think the timeframe and the cadence of how we bring employees back is going to be dependent on kind of the growth of the market back into play. So it is our intention to bring them back, and that's why we've structured it this way.

Tamy Chen (Consumer Analyst)

Got it. Okay, thanks. And, my second question is, so I noticed your Rec 1.0 sales were flat to slightly down sequentially. But I believe in Ontario, the provinces, I think, almost doubled their store count, over this sort of period and into March. So I would have thought you would have experienced some shelf filling during this period and increased your Rec 1.0 sales sequentially. So just any color there would be helpful. Thank you.

Greg Engel (CEO)

Sure. In Q2, we were still drawing down on inventory that we had placed in Ontario in Q1, and as well as a move to kind of the more high-velocity strains, as we said, Limelight and El Dorado, and ensuring we moved inventory there. So it was a bit of a combination of both. So we did have sufficient inventory. So certainly for the majority of Q2, Ontario revenue was still ticking through inventory from Q1.

Tamy Chen (Consumer Analyst)

Got it. Thank you.

Operator (participant)

Our next question comes from the line of Andrew Partheniou from Stifel GMP. Your line is open.

Andrew Partheniou (VP of Institutional Research)

Hi, thanks for taking my questions. I'm just curious, how does your cost profile now change with the workforce reduction and especially also the licensing of Phase 5?

Greg Engel (CEO)

Yeah, so, I, you know, start off and maybe ask Derrick to add some color. I mean, so we've had a workforce induction. I think we're still assessing our capabilities and exploring, you know, what impact that's going to have, as we've indicated both in our press release related to the temporary layoffs as well as the current, you know, information in this press release is, we are moving as much as possible to automated lines and system.

And so to make a comment, I think, you know, we can't give guidance yet in terms of what impact that will have, but it is a shift to, as, you know, as much automated systems and higher SKU, higher large format SKUs as well, where possible on flower.

Derrick West (CFO)

Yeah, Derrick here. I would just add that our largest cost is our labor cost, and so you know, we will achieve obviously the savings from the layoffs in terms of our labor costs. And obviously, that will reduce our total production amounts, but we do believe that we're going to get some balance as it relates to the SKUs that we'll be focusing on, the product lines we'll be focusing on. But again, we're not in a position at this time to provide any future guidance on exact amounts.

Andrew Partheniou (VP of Institutional Research)

Okay, thanks. And, well, are you able to provide maybe some kind of a distribution between savings on SG&A versus COGS?

Greg Engel (CEO)

We're not at this point, Paul. So we just... Again, we're still working through kind of. You know, we've only now been running two weeks with kind of the reduced structure, so we're not able to give guidance at this point.

Andrew Partheniou (VP of Institutional Research)

Okay, thanks.

Operator (participant)

Our next question comes from the line of Rupesh Parikh from Oppenheimer. Your line is open.

Rupesh Parikh (Managing Director and Senior Analyst)

Good morning. Thanks for taking my questions. So I wanted to ask a little bit more about gross margins. So as we look out to the balance of the year, how should we think about the gross margin? Should we expect sequential improvement versus what we saw in Q2?

Greg Engel (CEO)

Maybe I'll turn that over to Derrick to answer.

Derrick West (CFO)

Yeah. Yeah, I just don't wanna comment too much about future margins, but I can comment that for the margin that we had, the adjusted gross margin of 32%, that was after we did allowances for packaging and material on certain product lines.

And the impact of that was CAD 1.3 million or 5.5%. So while there's always going to be these types of adjustments, it would probably be a larger than normal adjustment to happen in one quarter, and without that adjustment, the margin would have been, on a pro forma basis, 37.5%. And but I'm not gonna, you know, at this point, provide any kind of future guidance in terms of our margins.

Rupesh Parikh (Managing Director and Senior Analyst)

Great. And then one. I guess one follow-up question, just on pricing, because I know there's some pricing pressures within the marketplace right now. Just wanted more color in terms of what you guys are seeing and if there's any forward commentary in terms of how you're thinking about the pricing pressures going forward.

Greg Engel (CEO)

Yeah, maybe. So thanks, Rupesh. It's Greg Engel answering again. So I think where we've seen, I mean, we've still maintained an average selling price of the product that we're selling into the rec market above CAD 5. And I think, you know, we are seeing pricing pressures, and we, you know, we have always made the assumption that the pricing pressures would come, you know, would come because of large SKUs that were coming into market, and we are seeing that.

And I think it's important to understand that, you know, some of this competition, you know, is being driven out of, you know, short-term needs from companies who have had to move product. You know, when you look at the price they're selling at versus what their production costs are, you know, I'm not sure they're actually even making money on some of these products, so not a sustainable pricing strategy beyond the near term.

I think where we have an advantage, you know, we are looking at larger SKU formats, is that our, you know, our average cost of cultivation and the all-in costs are quite low compared to many of our competitors. So we've got the best of both worlds. I guess when you look at it, we're producing, you know, high-quality product as well as at a very low cost. So I think, you know, I think that's where we're seeing most of the pricing pressure is really on the large SKU formats on the lower end.

Rupesh Parikh (Managing Director and Senior Analyst)

Great, thank you.

Operator (participant)

Our next question comes from the line of Graeme Kreindler from Eight Capital. Your line is open.

Graeme Kreindler (Analyst)

Hi, good morning, and thank you for taking my questions here. I was wondering if you could comment on what the ordering patterns from the provinces are looking like, given the current environment that we're in. I know historically, you know, we went from larger ordering patterns to smaller, more frequent orders. Now that we're in a situation where it looks like there's spikes in demand followed by, you know, a commensurate sort of decline in demand, just wondering if the ordering pattern behavior from the provinces has changed at all and how you're responding to that? Thanks.

Greg Engel (CEO)

Yeah, I think certainly we saw, as kind of stay-at-home orders started to come into place, a pretty significant shift in, you know, in kind of demand and, and, you know, provincial retailers and private retailers were looking to stock up in advance with the demand they were seeing. I think one of the challenges that we have seen for those that operate large warehouses like Ontario and Alberta, is that, they had staffing reductions within those facilities as well. So even though they wanted significant amounts of products, they ended up having to take them over a more pushed out period of time.

So, you know, so while the demand there was a sudden kind of increase in demand, and we still see very strong online sales, and we are still seeing strong cannabis sales, it has been pushed out even more. So the demand was there, but they're, you know, getting the shipments in was kind of spaced out a little more. So, in many ways, it's actually easier to manage for companies like ourselves and others to, you know, to get sequential product in. You know, we continue to see, you know, strong demand, especially for, as I commented, our leading strains and, you know, our Rec 2.0 products, so.

Graeme Kreindler (Analyst)

Okay, thank you. And as a follow-up-With respect to the wholesale market, I was wondering if there's been any increase in demand there, given, you know, I would assume there's a number of operators who are working on a reduced staffing level, which could impact their harvest. And given looking at some of the breakdown of the inventory, that's disclosed on the balance sheet there, is there potential for any more opportunistic sales, moving forward on the wholesale channel?

Greg Engel (CEO)

So I guess the comment I would give on that, Graeme, is we've had additional inbounds. We've expanded who we sell to. So I mean, we do have one additional company that we have been selling wholesale to than previous quarter. And we've had additional inbounds as well.

So the answer is yes, there's demand there, and I think, you know, again, having that inventory and having quality inventory, which we've commented in the past, is a big differentiator. So but I can't necessarily, you know, until you've completed an agreement, until you've made a sale, you know, there, there's inbound interest, but I can't say more than that.

Graeme Kreindler (Analyst)

Okay, appreciate the color. Thank you.

Operator (participant)

Our next question comes from the line of Chris Carey from Bank of America. Your line is open.

Chris Carey (Equity Analyst of Consumer Staples)

Hi, good morning.

Greg Engel (CEO)

Hey, Chris.

Chris Carey (Equity Analyst of Consumer Staples)

So I guess, you know, maybe just one question on the cash flow, then I have a follow-up. But you know, I guess this quarter, you know, cash burn represents about a quarter of the cash on hand. And then I guess when you add the term loan and the credit facility, which is another, you know, CAD 55 million, you have about two quarters of liquidity relative to the cash burn this quarter.

So I wonder if you can help me just understand the cadence of cash flow expectations from here. And I appreciate, you know, that CapEx is likely to step down. Perhaps you can provide some visibility there and maybe how operating cash flow. So just, you know, big picture there, you know, how, you know, this cash used versus cash sourced is likely to move over the next, you know, several quarters.

Greg Engel (CEO)

Yeah. Yeah.

Derrick West (CFO)

Derrick here.

Greg Engel (CEO)

Yeah, go ahead, Derrick. I was going to refer to you, please.

Derrick West (CFO)

Okay. Yeah. For the first six months, you know, a large amount of the reduction in our cash position has related to the CapEx spend. Yes, there is a working capital or cash from operations deficiency of CAD 25 million to the end of February as a consequence of our working capital build that did occur, mostly the consequence of the interim bio asset build.

But I would indicate that as at the end of the second quarter, our cash was at CAD 41 million. We are not required to continue on an aggressive CapEx program. To complete 4C, we're talking about CAD 2 million more that could be spent over the next period, and CAD 11 million as it relates to phase V, which relates to equipment for edible extraction.

But that's not equipment that we'd be looking to put in place right away anyway, because we wouldn't even be able to bring the professionals in to assist to load up the equipment and make it certified because of the COVID-19 impact and social distancing. We have a modest spend going forward of approximately CAD 13 million, and that CAD 13 million spend is going to be done in. It's going to be slowed down dramatically from what we spent in the past.

So when you consider that and the fact that we have CAD 41 million in cash at the end of the second quarter, that we do have CAD 25 million remaining on the term loan for the credit facility, and while there's no guarantee that we'll be successful in amending the credit facility, we do, we do believe that we will be successful.

We just cannot guarantee it at this time. So the combination of that does provide sufficient liquidity and cash that will take us into the future. And we always have, whenever the company's been in a situation where it's wanted to access other sources of capital, it's always done so when it's required, but we don't believe it's required at this time.

Greg Engel (CEO)

Maybe just to clarify, Derrick, you were referring to what we had remaining on the long-term debt. So we have CAD 25 million as revolver, and we have CAD 30 million on the debt itself remaining, so.

Chris Carey (Equity Analyst of Consumer Staples)

Right. Right. Okay. All right. That's helpful. And then I guess, you know, as a follow-up, it just feels, and I think, you know, Tammy mentioned it as well, it just feels like the adult use business, after kind of storming out of the gates last year, and I fully appreciate that that was a pipeline fill. But it does feel like it just has struggled to really regain, you know, that position in the market that it had before.

And you know, I appreciate the comments on, you know, provinces like Ontario are starting to work down the inventory that they have. But it doesn't sound to me, from the answer to the prior question, that, you know, you're at the point where your inventory levels in the channel have now reached kind of a clean level, and that you can start to refill at an area where maybe you start to retake some market share.

And so I wonder, you know, just a high-level question, if you think it's, you know, an unfair assessment that the business has stalled a little bit, and maybe how you might see things starting to develop over the next couple of quarters. And then if I could just sneak one in here. I mean, do you think that the industry can even grow in your upcoming quarter with so many stores going Click and Collect? Or is the Click and Collect and online demand such that, you know, the category, the industry at large, can still grow? So thanks so much for those.

Greg Engel (CEO)

Yeah, so maybe I'll take part of that question, Chris, and then I'll turn things over to Paolo. So I think, you know, when... First of all, to answer the second part of your question, I mean, there's significantly the majority of stores across the country with, you know, and if you include Ontario, are still open. You know, PEI only has four stores, they've closed their stores. They're doing, you know, click and collect, or sorry, online. And then in Ontario, they made a decision to close the stores, as you're aware of, and then within a couple days, reverted back to click and collect and local, and they are going to have local orders.

So, the demand's there, and I think, you know, the comment I made earlier, which is interesting, is that, you know, again, consumers and, you know, the population in general has limited opportunities for spend. You know, we've seen and we look at, you know, I mentioned, some of the survey data from earlier.

We've seen in the past, for example, if you go back, there was a major ice storm in Canada, back in the late 1990s on the whole East Coast, and in Quebec, alcohol sales for the month of February, where the power was out for three weeks, was the highest it had been, you know, for the last couple of years at that point.

With limited availabilities for, you know, spending kind of their entertainment dollars, I think certainly the demand for cannabis continues to be strong. Back to your first question, I think when you look at, you know, I think, look, there was a lot of excitement to Rec 2.0 products, and, you know, that has brought, an expanded consumer base into the legal market.

I think one of the challenges has still been, on the 2.0 products, is product availability, as we saw when 1.0 launched. And secondly, is that, you know, the provinces in some cases didn't expect the demand to be as high as possible, so they were, you know, they wanted to keep their inventory levels down and then make decisions on reorders.

You know, for one of the large provinces, for example, we had reorders happen on our Trailblazer vape pens before it had even hit the store shelves because the strong demand from the stores was very, very high. So I think the, you know, there has been a lot of excitement and brought new consumers in through the 2.0 products, and maybe I'll let Paolo add a little bit. I know he's, that's one of the areas he focuses on.

Paolo De Luca (Chief Strategy Officer)

Hey, can you guys hear me okay?

Greg Engel (CEO)

Yes.

Paolo De Luca (Chief Strategy Officer)

Perfect. Hey, Chris. So, look, this quarter that we're in is a you know, obviously, kind of a once in a lifetime quarter in terms of the uncertainty around COVID. And, you know, we're just learning right now what's happening in terms of consumer behavior, you know, both, you know, kind of in the pantry loading that we saw, you know, last month when people were worried that the stores would close down.

And subsequently, you know, that hasn't been the case for the most part, as Greg alluded to. And, you know, we do have a little bit of a different, you know, world right now where you have click and collect in the province, for example, like, like Ontario or online ordering. So we're monitoring that. We're trying to see what's happening there, but we do see some positive anecdotes where, for example, people are actually shifting to the legal market now because they don't want to interact with their black market dealer, and they don't want to, you know, meet the person physically.

They don't want to exchange cash, which is a concern for people in terms of the virus spreading. So that's all, you know, to be determined, and we know we're gonna obviously respond in whichever way we think is best to take advantage of the opportunity that may present itself as a result of that. In terms of just the logistics of the entire market, you know, we are dependent, obviously, on, you know, the consumer behavior.

We're dependent on the ability of the provinces to have the logistics in place and not to have disruptions there in terms of their ability to stock at the distribution centers and so forth. Our view is that this quarter is, you know, it's difficult to forecast. Could be, you know, there could be opportunities for us to do well in certain products and take advantage of opportunities, but we just don't know. It's a very unknown quarter.

Where we are focused is longer term on our core strengths, which is, you know, to become a leader in the chocolate segment and to become, you know, a leader, obviously, with some of our new strains, like Limelight and El Dorado, which we mentioned in the past. You know, I think one of the things to look at in the way that the rec market has developed over the last, call it six to nine months. We've seen some of our competitors adopt pretty aggressive, you know, pricing strategies and move to larger SKU formats.

There's nothing proprietary in what they've done in those segments, and in fact, we are actually the best positioned to take advantage of some of those opportunities. So if we need to toggle our, you know, our SKU mix and our product offering, to, you know, participate in that market, we can do so. We're gonna do so cautiously and with a lot of thought.

But right now, we're, we really are focused this quarter on our best-performing products and to use our reduced workforce in a manner which can, you know, drive the most revenue for the least amount of cost.

Chris Carey (Equity Analyst of Consumer Staples)

Okay, thanks so much.

Operator (participant)

Our next question comes from the line of John Zamparo from CIBC. Your line is open.

John Zamparo (Equity Research Analyst of Retail & Consumer Products)

Thanks. Good morning. I wanna go back to the questions about sell-through. Greg, maybe you could talk about your market share in the quarter versus the prior quarter, particularly in larger provinces. Were there any notable changes among your different categories, and how about your 2.0 products versus 1.0?

Greg Engel (CEO)

I guess we don't typically share market share information, in part because some of the agreements with the provinces, you know, prohibit you from doing that. So some of the data you see out there is actually a bit of a breach of some of the agreements. I mean, there is public information on a few of them, and I know many of the analysts are kind of accessing or media is accessing some to publish.

You know, I think two comments I would make is I think, you know, in certainly with our 2.0 products launch, you know, our vape portfolio, starting out with Trailblazer and then adding in the Feather Pen, has had a strong position.

You know, there's one company certainly that has went with a price strategy on vapes, and they have a very, they would, you know, in Ontario, for example, they would be the leader. You know, and one of the other key comments I would make on vapes is, you know, we've seen challenges from other companies, right? With leakage and with product returns, and, and that's not an issue we faced, and I think it's important to contemplate that, that we've really focused on very high quality suppliers.

We've vetted our suppliers, you know, we know that there's not performance issues or leakage issues or heavy, heavy metal leaching, and, and those are critical for us. On our chocolates, you know, still early days, we only shipped at the end of the quarter, our first couple shipments.

You know, and in this quarter, we've been getting significantly more product out, but I mean, there were provinces like Ontario that went a few weeks without our chocolates available. So demand's been there, and I think, you know, we are seeing a shift as we alluded to, and then we've allowed, you know, our production capability and capacity, you know, we've really shifted our, you know, production to our core strains.

And you know, it was one of the advantages of being a leader last year in, kind of, in the first couple quarters, is we got information about what those core strains are. So our Rio Bravo and our La Strada are strong strains for us. But then subsequently, we did these one-time offers with Limelight and El Dorado, and we've had really strong response to them.

So we've got additional strains that we're going to do one-time offers with as well, that are, you know, high THC, we believe will be somewhat unique in the market. And, you know, again, the ability to shift again to those products, I think is going to continue to provide assistance for us.

John Zamparo (Equity Research Analyst of Retail & Consumer Products)

Okay, that's helpful. Thanks. Particularly on the LTOs, it seems like that's kind of an untapped part of this market. My follow-up is going back to the balance sheet and cash burn. What do you expect in terms of investment in working capital over the next couple of quarters? And generally, maybe we're fast forwarding to next twelve months, what do you view as a normalized maintenance CapEx number?

Greg Engel (CEO)

Yeah, and first, I mean, it's important to kind of maybe answer the first part of it, like, you know, from a, from a cash flow perspective, I mean, you know, we ended the quarter with CAD 41 million. As Derrick outlined earlier, we have, you know, limited CapEx remaining to spend and, you know, the CAD 2 million on 4C to get it up to fully functional.

And not all of the grow rooms operating, but it's like occupying the space, and then CAD 11 million on phase five, which, you know, as noted, the spend on that will be delayed because of, you know, some of the OEMs and working with them to get kind of equipment certified to be operating. And so, we're really at the end of our CapEx spend, which is one of the most important things.

You know, I think it's. You know, we, we feel we have a strong balance sheet at this point in the market relative to our peers, as personally with, you know, having CAD 30 million of undrawn debt capacity with, with BMO and the, and the syndicate. I mean, there's still no guarantee we can draw that CAD 30 million, but we're certainly working closely with them to be able to do that. But, Derrick, I don't know if you want to add any commentary?

Derrick West (CFO)

Yeah. Thanks, Greg. I just want to add specifically as it relates to the working capital. Even in our receivables, we have government HST refunds from the prior CapEx spend that we've already done, that's being realized during the third quarter. And also with working capital, our inventory and biological assets are already fairly significant on our balance sheet, and we would not where we have done the reduction to our workforce, and we are emphasizing the focus on moving the inventory that's there and producing you know near-term saleable product.

We are not anticipating there to be a cash strain as it relates to further investment into our working capital. Just as a general comment, based upon the reductions to the staff and production levels, combined with some of the near-term realization on the working capital.

Greg Engel (CEO)

And John, maybe just to add to the earlier question, part of your question about maintenance CapEx. So, we don't have a general rule of thumb, because, you know, this is primarily a new facility that's been really built over the last couple of years. We expect it to be low single-digit % against the total CapEx, right? You know, we're the majority of the equipment is new and, you know, other than kind of standard maintenance, I mean, we're not in replacement mode. I think, you know, even on our irrigation systems in the last two years, we've had to replace one pump, and we have redundancies whenever.

Again, I think just based on the age of it, you typically might see a maintenance CapEx that's, you know, in the 4%-5%, but significantly less than that based on, you know, what we're seeing to date and based on the age of the equipment. One thing I didn't comment on earlier, and I think, you know, was in the kind of prepared remarks that we made, but, you know, we have not tapped into any government opportunities. And I, you know, I'd say one of the things that, you know, now that with wage subsidies and that being offered, and the cannabis industry being included in that, and that was a big win for our association.

And I know Cameron Bishop, who is our VP of Government Relations, worked really closely with government on that. You know, I think there's also opportunities for us and for the cannabis industry, both federally and even provincially, to look for some assistance during this period if needed. And I think, you know, I think that's got to be taken into consideration as well. I mean, you know, there are significant funds available, and I think, you know, there's definitely an opportunity to access some of those.

John Zamparo (Equity Research Analyst of Retail & Consumer Products)

Thank you very much.

Operator (participant)

Our next question comes from the line of Matt Bottomley from Canaccord Genuity. Your line is open.

Matt Bottomley (Managing Director of Equity Research)

Yeah, good morning, everyone. Just wondering if you could provide just a little more color on the nature of the fixed charge covenant, and is the plan right now, right, just to negotiate with the lender? Or is there anything that's remedial in the interim that can be done independently?

Derrick West (CFO)

Yeah, Derrick here. It's a standard cash flow covenant in the sense that you need a certain amount of EBITDA to cover the future debt service on the term loan, on the $85 million. And you know, we did not meet our Q2 covenant just looking at the trailing 12 months as a consequence of you know, the EBITDA metric not achieving the standard that had been set.

There were reasons for that, as we've already outlined in our presentation of the information during the call. I would indicate that we've already have been in discussions with the lender, and since it came to our attention that this was going to be an issue for our Q2 filing.

And they very quickly moved forward and obtained the approval of all the lenders in the syndicate to provide the covenant waiver, and for us in a very timely way, and that was part of our disclosures. Going forward, we're still midway through on these negotiations. They've provided the forbearance, which extends until we file our Q3 balance sheet, and so until the May thirty-first period. And as mentioned, we're in discussions with them now. And while I cannot provide any guarantees, based on our working assumption, we don't believe this will be an issue based on the discussions we've had with them to date.

Matt Bottomley (Managing Director of Equity Research)

Great. That's helpful, and there's been a lot of good color on this call as well with respect to some of the you know assumptions and inputs here on the various parts of your income statement. The follow-up I had is more on the SG&A part. So I know you touched on this briefly already, but just with respect to you know paring back not only your operational you know planting and et cetera with your existing facilities but also with some of the paring backs as it relates to COVID. What's the best way for us to look at that SG&A line?

Obviously, there was a ramp-up this quarter, in relation to the launch of 2.0, and then all the things you've been doing with your vape pens, et cetera. You know, maybe the next six months, you know, what's the best way to look at this from a volatility standpoint, given that it seems your existing operations now are right around that breakeven on adjusted EBITDA? So just looking for, you know, what might make it, you know, plus or minus on that breakeven in the next couple of quarters, with respect to your SG&A plan.

Greg Engel (CEO)

Yeah, I think I guess I alluded to this earlier, Matt, is that, you know, it's still early and challenging to give a prediction. I mean, yes, we, you know, we've had temporary reduction in our workforce, and certainly there's savings associated with that. It does impact our operational efficiency, which is why we've moved to, you know, the most automated systems and lines, and focused on those as a way to, you know, best utilize the staff and personnel we have.

And I think that, you know, that is a way for us to, you know, optimize both the inventory we already have in existence, and then going forward, continue to get out products that give us, you know, really the greatest return, for the amount of labor hours that we have available, and that's how we're mapping it. But as, you know, as I said earlier, we're only at a couple weeks into this adaptive workforce.

I think, you know, the one thing we are planning, you know, again, is because, again, as I commented, we have, flexibility, based on, you know, our production costs, is to bring, a larger SKU product into the marketplace, and that's been in the plan for a significant amount of time.

It would have been on the market already had we not hit, you know, some of the challenges around COVID-19. But so I guess I'm not fully answering your question here because it's very challenging for us to predict. I mean, not, you know, at one- in many ways, we've taken savings, and we've also looked at where our spends are and, you know, relative to, for example, marketing programs.

And, you know, we're focusing very much more on kind of digital programs as online increases and less on, some of the other programs we've done historically. So, you know, it wasn't just temporary layoffs, for health and safety. We also, in conjunction with that, looked at our production output and what we could actually get out to market, although we do have significant inventory, so.

Matt Bottomley (Managing Director of Equity Research)

Great, very helpful. Thank you.

Operator (participant)

Our next question comes from the line of Doug Miehm from RBC Capital Markets. Your line is open.

Doug Miehm (Analyst)

Yeah, good morning. I just-

Greg Engel (CEO)

Good morning.

Doug Miehm (Analyst)

wanted to follow up. It's... Yeah, yeah, hi. With respect to something you just said a minute or two ago, and that is, there's no guarantee that we can draw down on that 30 million. Did I hear that correctly?

Derrick West (CFO)

There's no guarantee because it's a future event. I'm just stating a factual comment. We are in discussions with them. However, we have had very positive discussions with our lender group as led by BMO, and they responded very quickly to provide the covenant waiver letter when we had asked for it, and they have indicated you know the willingness to hear from us on what the renegotiated credit facility would look like.

Clearly, as we do this renegotiation, we're going to bear in mind what we believe the EBITDA would be on a go-forward basis, based upon the COVID-19 impact to our business, to the industry, and that'll be factored in. But just indicating the obvious, that until we've done the renegotiation, you know, I cannot guarantee it, but it's reasonable for us to assume that there's not going to be an issue based on all the indications they've provided to us.

Doug Miehm (Analyst)

Okay, perfect. And then when you think about the amount of product that you've harvested in this latest quarter at almost 14,000 kilos, I believe you sold about 4,000 of that, just over 4,000. Is the remainder going for extraction? And maybe you could tell us what your extraction, not capabilities, but the deals you have with your partners, are those fixed in stone? Do you have to continue to extract a large part of what you're harvesting, and what could be the impact of the costs there?

Greg Engel (CEO)

Yeah, so it's a good question, Doug. Greg Engel. So the, you know, so our agreement with Valens, who is our contract extraction facility, doesn't have any minimums or requirements. So we have used them and, you know, have plans to continue to use them in the future for hemp. But, you know, at some point in the future, we will move all of our extraction in-house when the phase V extraction is fully operational and certified.

For the time being, we've got, you know, months worth of many months worth of extract concentrate built up. So we're simply just storing the extractable material before we, you know, and we don't need to send it to Valens, because it certainly will be more cost effective to extract it in-house. But, you know, so to answer the question, I can't give you an exact number on the inventory, you know, that we had, available at the end of the quarter, in terms of what will go.

But, I mean, part of our, you know, what supported our decision-making around, you know, doing temporary layoffs for health and safety reasons, was we knew we had sufficient dried flower inventory that we could, you know, package and get out into the market, and we could reduce kind of our cultivation footprint, temporarily, because we had that inventory. And a lot of that is in, you know, high THC and high volume demand strains, Limelight and Rio Bravo and El Dorado and La Strada. We're in a good position in terms of converting a significant portion or parts of that inventory into sellable product.

Doug Miehm (Analyst)

Okay, perfect. Thanks very much.

Operator (participant)

We have time for one more question today from the line of David Kideckel from AltaCorp Capital. Please limit to one question. Your line is open.

David Kideckel (Analyst)

Hi, good morning, everybody. Congratulations on the quarter, and thanks for taking my question. I just wanted to circle back to one of the points that Graeme made regarding wholesale revenue, just not even necessarily specific to Organigram, but as the industry as a whole. I'm just wondering, given your remarks, Greg, about you know, consumer loyalty and branding in the sector and how they are loyal to Organigram for your products in particular, what are your thoughts about different LPs selling to different LPs through the wholesale revenue metric?

And if a consumer is actually purchasing a product from Organigram but it's actually coming from a different LP or vice versa, how relevant do you think that is for general branding and consumer loyalty across the board?

Greg Engel (CEO)

Yeah, no, thanks for the question, David. So I, I think when we look back and we had not historically before our Q1, sold product wholesale, and we looked at it very opportunistically. We started to get information back in Q2 of last year regarding which of our strains were in higher demand and which ones weren't. But as you know, it takes many, many months to change your production cycle.

So we ended up still having production of some of the lower selling, SKUs, right? In terms of those flowers and what was available. So we, we had been getting inbounds from companies that were not satisfied with the product that was available for wholesale out in the market. So we made a decision to take those products, sell them to another LP.

You know, as to a couple of the comments that were made earlier about that Matt made as well, about kind of one-time offers, we do see that still, you know, there's consumers the same way that, you know, if you're a wine drinker, if you're a beer drinker, you know, there's your kind of wines that you buy consistently, but everybody will try different wines.

I think there in the cannabis space, there's a lot of kind of interest and demand in one-time or what's new. So it's a combination of brand loyalty, but also testing what's new. There have been some opportunities where companies can take product that was not in high demand under our brand. They've taken it and put it out, and it comes out as a new product under their brand. And I think that's where, you know, some of this product's been used.

And that is why, as I said earlier, our plan to kind of introduce new genetics, cycle them through under one-time offers to see what the demand and response is, and if it's really strong, like on our Limelight, to increase it into moving into a core offering. So that's how wholesale really has been structured and government government is that, you know, it's going to other LPs, and they're putting their own brand, but it goes in as kind of a bit of a new product, so.

Operator (participant)

Ladies and gentlemen, this will conclude today's call. We thank you for your participation. You may now disconnect.