OrganiGram Holdings (OGI) Q3 2021 Earnings Call Transcript | The Motley Fool

OrganiGram Holdings (NASDAQ:OGI)
Q3 2021 Earnings Call
Jul 13, 2021, 8:00 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Good morning. My name is Renz, and I’ll be your operator today. At this time, I would like to welcome everyone to the OrganiGram Holdings Inc.’s third-quarter fiscal 2021 earnings conference call. [Operator instructions] 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 Ms. Amy Schwalm, vice president, investor relations.

Amy SchwalmVice President-Investor Relations

Thank you, Renz. Joining me today are OrganiGram’s chief financial officer, Derrick West; and our chief strategy officer, Paolo De Luca. Before we begin, I would 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 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 Paolo.

Paolo De LucaChief Strategy Officer

Thanks, Amy. Good morning, and thank you for joining Derrick and me today. We do not have our permanent CEO in place as we are conducting this call, and I will address that right up front in terms of what we can share with you at this point. That way the questions-and-answers portion at the end of this call can be focused on other questions that you might have.

Speaking on behalf of our board of directors, we know that it is a priority to get the right person in the role as soon as possible. A leading search firm has been hired and the committee responsible for the selection of a new CEO has been busy reviewing candidates from across the CPG sector in North America. They are now in the second stage of the interview process with a shortlist of candidates. In any event, the company is operating very well during this interim period with the management team and board working together more closely than ever to expedite decision-making.

I would also like to point out that our chairman, Peter Amirault, is acting as executive chair, and he brings tremendous experience being the longest-serving board member of the company, as well as deep CPG experience through a series of senior executive roles, including Molson and Cara Foods. We feel very equipped as a management team with the key input and oversight computer and the rest of our board of directors. Many of the senior executives have a strong track record at the company and have contributed to the success we are seeing from our revitalized product portfolio, which I will talk about more in a moment. In addition to some long-standing executives, we also announced two key new hires with deep experience in cannabis and CPG.

Our SVP of marketing and communications, Megan McCrae, as well as our VP of Innovation, Borna Zlamalik. We also onboarded great confectionery management capabilities as part of our edibles and infusions acquisition in James Fletcher, who remains president of EIC. In addition to a better top-line trend, we have seen cultivation ramp with the benefit of increased staffing. And critically, we have seen cultivation cost per gram continue to decline on the back of higher plant yields, as well as the realization of other cost efficiencies and improvements.

We have our newly promoted vice president of operations, Nathalie Batten, to thank for leading these efforts. Again, all of this to reinforce that we feel very good about managing the business through this interim period and continue to benefit from the long track record and expertise of Peter Amirault and the rest of the board. We feel even better about our prospects when we look at the strong outlook for the entire industry and with COVID restrictions being unwind nationwide, a strong seasonal backdrop, and the ongoing expansion of the retail store network in key markets with Ontario. Derrick will go into more specifics on our outlook for our fiscal Q4.

So just to sum up before I continue to discuss the quarter, we won’t be answering any other questions on the CEO search on this call, but look forward to updating you as soon as we are able to. Now I will move along to the fiscal Q3 results that we released earlier this morning. I will talk a little about revenue and new product launches as well as some of our strategic developments, and we’ll leave Derrick to go through detailed financials and our outlook for Q4. As we expected and directionally guided, and I say directionally, as we do not provide specific revenue or earnings guidance.

In our last quarter’s disclosure, Q3 revenue improved from a challenged Q2, which we believe represents a clear inflection point for the company. As I mentioned, we have ramped up operations and staff and such that we were better able to fulfill demand in Q3. We believe Q3 revenue was still negatively impacted by relatively suppressed demand from some provincial boards particularly in the most populous province of Ontario. Strict COVID-19 restrictions in Ontario meant less staffing to enable physical distance and retail stores being limited to 25% capacity for most of March and then closed completely to output traffic for the balance of our fiscal quarter, which ended May 31st, 2021.

However, we did not have the production disruptions related to COVID-19 cases that occurred in our Q2 quarter ending February 28th, which essentially shut down the Moncton facility temporarily on two occasions, sending larger groups of employees home to isolate. Our revitalized product portfolio is resonating with consumers, and this has reflected in revenue growth in Q3. We conduct ongoing consumer research and leverage detailed analysis of our consumer purchasing behaviors to help ensure our offerings are aligned with existing and expected evolutions in consumer preferences. Consumer trends have continued to emerge in coalesce, including ongoing growth in the large format value segment, a desire for higher THC as well as a pension for newness, including new genetic streams and novel products.

Organic ramp began a product portfolio revitalization in mid-calendar 2020 to address these consumer trends and preferences. We have launched 84 new SKUs since July 2020 and up to 20 more SKUs are still to come in Q4 fiscal 2021. Dry flower and pre-rolls remain the first and second-largest categories, respectively, in the Canadian adult-use recreational market of all product form factors, and the company believes these categories will continue to dominate based on the sales history in mature legal markets in certain U.S. states, as well as regulatory restrictions on other form factors, for example, the 10-milligram per package THC limit in the edibles category.

Cannabis consumers continue to want both high THC dried flower products and the cult of our diversity is supported by available sales data. In the Popular Value segment, sales of SHRED continue to impress, almost tripling from last quarter and representing the fastest-growing brand in the country. It has remained the No. 1 most searched brand on the OCS website for the last 8 consecutive months.

There are a number of exciting developments I want to highlight when it comes to this highly demanded product. First, the product margin on SHRED is improving with a pivot in commercial strategy and a declining cost structure as our yields and efficiencies are improving with increased scale. Second, we have had the benefit of being able to leverage SHRED’s extremely strong brand equity to introduce new better-margin products like SHRED Jar of Joints, a convenient jar of 14 half-gram pre-rolls of SHRED’s Tropic Thunder. And we have more to count, so stay tuned.

We will obviously provide more details as these products are rolled out. Late in Q3, OrganiGram officially announced the launch of Big Bag o’ Buds, indoor-grown, stream-specific dry flower in a 28-gram value format. The new Big Bag o’ Buds lineup includes existing cultivars such as the company’s industry-leading Ultra Sour, otherwise known as Limelight in our Edison brand, along with new cultivars and rotation of onetime screen offers. Big Bag o’ Buds contains a minimum of 17% THC and onetime offers or OTO’s will range in strain selections, including Grapefruit GG4; Original Glue, and Lemon Tree strains.

Big Bag o’ Buds doubled its sales in Q3 from Q2, and we see this excellent trend continuing into Q4. As we said last quarter, we are focused on growing our sales mix into our higher-margin dried flower brands. We have made ongoing investments in genetics to support the Edison brand promise an innovation in new and exciting products. We plan to keep the Edison brand revitalized over time with new streams, as well as high potency.

As you have heard, other license producers lament, it is not easy to grow new streams at scale with both high THC and balancing that with high plant yields. But we are increasingly encouraged by our progress and recent results. In Q2 fiscal 2021, the company launched three new Edison Cannabis Co. Indica strains, which included high-potency Black Cherry Punch and Ice Cream Cake, or ICC, as well as Slurricane.

Black Cherry Punch joins Limelight as the top seller of their respective strains among other LPs with similar strains in the market. In late April 2021, the company announced the launch of another two new high-potency Edison dried flower streams, GMO Cookies, and MAC-1, which have a THC range of 20 to 26% and are available in either a three-and-a-half gram format or a package of three half-gram pre-rolls. Both strains feature a distinct phenotypic profile, flavor, and aroma as a result of being grown in one of OrganiGram strain-specific microclimates. We expect to introduce more new cultivars under the Edison brand in the near term.

In late March, the company introduced another high-margin dried flower brand, the market called Indi, one of Canada’s only cannabis brands dedicated exclusively to Indica cultivars. Skyway Kuhs was the first and only stream in the company’s Indi portfolio, offering THC in the range of 20 to 23% until June when we launched two new Indi strains in three-and-a-half gram formats: Biscotti Gelato with a THC range of 20 to 26% and Gelato #33 with a THC range of 17 to 23%. Pre-rolls are the second largest category in the adult-use recreational market and the fastest growing on a quarterly basis this year at about 33% in calendar Q2 over Q1. In late March of this year, we introduced the new Edison streams of Black Cherry Punch, ICC, and Slurricane in a package of three half-gram pre-rolls produced with our new pre-roll machine.

This machine was commissioned in March and is now producing an average of about 40 pre-rolls per minute. We have ordered another machine expected to be delivered to commission in early Q1 fiscal ’22 as pre-rolled demand hasn’t shown any signs of slowing down. Derivative product sales were lower in Q3 than Q2, and we look forward to gaining sales traction in the largest derivative product category, vapes, with the launch of two new vape products with higher THC concentrations. These include an Edison plus Feather disposable vape pen at a very competitive price point, as well as a new 1-gram Edison cartridge for the 510 vaporizer.

Both products are based on Limelight, our top-selling flower stream, and the country’s best-selling Ultra Sour. And we expect our new soft chews or gummies to be available in certain retail stores in early August. To date, in Canada, edibles are one of the fastest-growing segments of derivative products, and the largest product subcategory within edibles is gummies. With our acquisition of Winnipeg-based Edibles and Infusions Corporation, or EIC for short, we enter this market backed by leadership with proven confectionery experience and a track record of delivery to some of the world’s biggest retailers, including Costco and Walmart.

We now have two facilities capable of R&D, product development, and large-scale manufacturing capabilities to deliver derivative products. Our flagship facility in Moncton and our derivatives dedicated EIC facility in Winnipeg, both designed and built with EU GMP specification standards in mind. While flower and related products still account for more than 70% of the overall Canadian market, derivative sales growth is outpacing the overall market as new product formats are launched and consumer preferences evolve. For example, edibles currently represent about 4% of the Canadian market, compared to 12% to 15% in more mature U.S.

markets. Lastly, we have a very innovative derivative product launch still to come in Q4 fiscal 2021. I do not want to give away any more details until we are ready to launch, except to say our team is very excited about the potential of this product. In addition to the acquisition of EIC, we also announced the collaboration with and strategic investment from BAT in March.

I won’t reiterate all the details of the transaction as we covered it in great detail last quarter. However, by way of update, we were pleased to announce the successful launch of the Center of Excellence, or COE, at our Moncton facility as outlined in the PDC agreement with BAT. The COE has been established to focus on developing the next generation of cannabis products with an initial focus on CBD. As the company and BAT refined plans and ramp up on execution for the COE, a number of initial skilled positions have been created, including innovation-focused roles, such as scientists and product developers.

And over time, the employee count is expected to increase as new projects and workstreams are brought online. The COE is governed and supervised by a steering committee consisting of an equal number of senior members of each of OrganiGram and BAT. Under the terms of the PDC agreement, both OrganiGram and BAT have access to certain of each other’s intellectual property and subject to certain limitations of the right to independently and globally commercialize the products, technologies, and IT creative pursuant to the PDC agreement. Approximately 31 million of BAT’s $221 million investment in OrganiGram has been reserved for OrganiGram’s portion of its funding obligations under the initially mutually agreed upon three-year budget.

Costs relating to the COE are being funded equally by OrganiGram and BAT. From a governance perspective, there is a steering committee to supervise and govern the COE activities with an equal number of senior members from both companies, and we also anticipate benefiting from two BAT nominees to OrganiGram’s board of directors. At the closing of the transaction, we welcome to Mr. Jeyan Heper to our board, and the other nominee is expected to be appointed in the near term.

Not only is this collaboration with BAT going to accelerate and strengthen our research and product development activities. It is also anticipated to be instrumental in establishing the foundation for our U.S. and international strategy. As part of the transaction, BAT invested approximately 221 million in us for a 19.9% equity interest.

With the significant capital injection, OrganiGram is well-positioned to expand into the U.S. and other international markets at the right time and subject to applicable law. I will now turn the call over to CFO Derrick West.

Derrick WestChief Financial Officer

Thanks, Paolo. I will start with our strong financial position. As we announced last quarter, we have a balance sheet free of any significant debt after repaying our entire term loan balance of 58.5 million. This elimination of our debt amounts to about 2.7 million in annual interest savings.

In terms of liquidity, including 31 million in restricted funds, the company currently has 220 million in cash and short-term investments. We have made the decision to complete the Phase 4c expansion of our Moncton facility for more production capacity in order to meet the longer-term forecasted demand for our products. We are also making changes to our growing and harvesting methodologies, as well as design improvements to the Moncton campus that are expected to result in higher-quality flower and reduced production costs. The budgeted amount for Phase 4c and this work is estimated to be 38 million and anticipated to be incurred starting in fiscal Q4 2021 with completion targeted during fiscal 2023.

We have sufficient cash and short-term investments to support these expenditures and the corresponding growth to our working capital assets while still maintaining sufficient liquidity and financial flexibility. As you may have noted, we did file a preliminary base shelf perspective just recently, which allows us to move quickly to access even more capital to pursue attractive growth opportunities should they arise. Q3 2021 net cash used in operating activities of 10.8 million, compared to 0.3 million provided by operating activities in the same prior-year period. The change was largely due to the increase in working capital assets as the company ramped up cultivation activities during the current quarter.

Turning to our earnings results for Q3. Gross revenue grew 51% from Q2 2021 to 31% from the same period in fiscal 2020 to 29.1 million. The net revenue grew 39% from Q2 and 13% from the same prior-year period, respectively, to 20.3 million. The revenue growth was primarily due to higher adult-use net revenue, which grew 40% from Q2 and 10% from the same period in 2020, and higher wholesale revenue, which are sales to other licensed producers during Q3 of this year.

Cost of sales decreased 47% to 23.4 million from Q3 of 2020, primarily due to almost 30 million in inventory write-offs reported in Q3 of last year and provisions, as well as charges related to a reduced workforce due to COVID-19, which were all incurred in the prior-year period. The charge related to unabsorbed fixed overhead and included in the cost of sales continues to decline again sequentially this quarter as we expected and indicated in our Q2 2021 disclosures. It is anticipated to decline further in Q4 as we continue to ramp operations. We harvested 8,379 kilos of flower during Q3 compared to 4,741 kilos of flower in Q3 of the prior year.

The increase from the comparative period was primarily related to increased cultivation planting and staffing in Q3 of this year to meet the increased demand for many of the new products as part of the product portfolio revitalization, as well as the increase in industry demand on the back of the ongoing accelerated retail store build-out particularly in Ontario. We were using approximately 80% of our grow rooms in Q3 fiscal 2021 as of — and as of the date of our MDA, we were using 85% of our grow rooms. Once complete, Phase 4c increased our annual capacity for the production of flower from 38,000 kilos to approximately 65,000 kilos. The total capacity of the company’s Moncton campus facility will continue to fluctuate as the company further refines its growing methods and growing utilization.

IFRS gross margin increased to a positive 2.1 million from a negative 50 million in Q3 of 2020, largely due to lower cost of sales, as I just described, as well as net noncash positive fair value changes to biological assets and inventories sold in Q3 of ’21 versus negative changes in the prior-year comparison period. Adjusted gross margin was a negative 0.7 million in Q3 ’21, as compared to a positive $4.1 million in the same prior-year period, largely as a result of the value segment, comprising a larger proportion of total revenues in Q3 of 2021, combined with prior periods’ higher cultivation costs making up the current period as cost of sales. SG&A, excluding non-cash share-based compensation, increased to 13.6 million from 10.3 million in Q3 of 2020, largely due to increased staffing and office costs related to the establishment of the OrganiGram BAT Center of Excellence and the EIC acquisition, higher cultivation-related research, and development costs, as well as higher audit fees in connection with the company’s regulatory requirement to obtain an integrated audit opinion for the first time for fiscal 2021 financial statements. Adjusted EBITDA increased to a negative 10.2 million from a negative 2.1 million in Q3 ’20, largely due to lower adjusted gross margins in Q3 2021 and due to some higher general and administrative costs as I just described.

The net loss in Q3 of 2021 was reduced from Q3 2020 loss of 90 million to 4 million. The improvement in earnings was a result of a higher IFRS gross margin during the current quarter combined with the impairment charge to the property plant and equipment recorded in the prior-year period. I will wrap up with our outlook for our Q4 fiscal ’21. Just a reminder, we won’t be reporting on this Q4 quarter until later in November in accordance with the filing deadlines for financial year end.

First, we are very positive on the outlook for industry growth. According to Hifyre data, Canadawide recreational retail sales are expected to total 309 million in June, which is a slight decline from the Hifyre estimate nearing 322 million in May and flat with 310 million in April, which is the most recent available data from statistics in Canada. Based on the estimates available for Hifyre, the second quarter of calendar 2021 was a record for the Canadian cannabis market with 940 million in total REC retail sales and implied sequential quarterly growth of 12%. This occurred despite the strict COVID-19 restrictions in place.

There are a few factors creating tailwinds for further industry growth. First, the legalization in October of 2019 of many derivative product categories has attractive consumers who are not interested in smoking or vaporizing dried flower, including pre-rolls. New categories such as vape pens, edibles, which is the soft chews and chocolates, beverages, and other ingestible products have significantly expanded the addressable market. Second, retail stores continue to open with Ontario driving the growth and targeting 1,000 stores opening in the province by the end of summer.

Since July, the store accounted in the provinces grew by 131% to 2,221 stores currently driven by Ontario growing 755% to 872 stores. And, of course, these stores in any province have been closed to foot traffic for much of 2021 and limited to delivery in some cases, click and collect. We know that the cannabis consumer wants to be able to go into stores to buy their product. As such, we should see a boost in sales as these stores have recently been permitted to reopen to foot traffic, some of the new stores authorized opening for the first time ever.

Third, the industry as a whole has made a constant considered effort to convert consumers from illicit to legal consumption. The gap between Canada’s legal and illicit cannabis market continues to widen, the latest statistic Canada data suggests. Household spending on adult-use cannabis products and regular channels grew to $918 million in the final quarter of 2020 or 204 million more than the estimated amount spent on illicit cannabis in the same period. Spending on legal, recreational cannabis overtook illegal transactions for the first time in the third quarter of 2020 and when regulated expenditures outpaced approximate illicit sales by only 59 million.

The legal market benefited from the growing retail options in calendar 2020. Regulated sales also benefited from a wider breadth of consistent inventory and improved selection of products. In February of 2021, the province of British Columbia tested the illicit cannabis and found 24 distinct pesticides in 20 samples of dried flower. The samples went to a federally licensed lab for testing, and results show that along with the 24 unapproved pesticides, there were high levels of bacteria, fungi, and heavy metals in many of the samples.

These samples were subject to the same full-panel analysis to test chemical and microbial contaminants as licensed cannabis producers are required to use. We believe the more that knowledge like this becomes better known among consumers, the more we’ll see cannabis consumers shift to the legal market. Against this backdrop of strong industry growth, particularly as COVID-19 restrictions are being removed nationwide in a strong seasonal period, we expect to generate higher sequential revenue in Q4 fiscal ’21 as compared to Q3. We have strong demand for our revitalized product portfolio.

And with increased cultivation and more staffing, we are better equipped to fulfill that demand. Revenues to date and purchase orders from [Inaudible] customers support our expectation for higher revenue in Q4. Beyond Q4, we expect to resume shipments to Canada and Israel in Q1 of fiscal ’22. We received a good agricultural practice certification by the Control Union Medical Cannabis Standard to comply with Israel’s updated standards for imported cannabis in early Q4.

However, the timing of shipments is conditioned upon the regulatory approval from Health Canada, including obtaining an export permit. We also expect to see a sequential improvement in adjusted gross margins in Q4 fiscal ’21 largely due to lower product cultivation costs, as well as other economies of scale as we continue to ramp up cultivation and realize the benefit of ongoing cost-efficiency improvements. The overall level of Q4 fiscal ’21 adjusted gross margins versus Q3 will also be dependent on other factors, including, but not limited to, product category and brand sales mix. Although the sequential improvement to adjusted gross margin is anticipated to be fairly marginal in Q4 of fiscal ’21, the company has identified a number of opportunities, which it believes have the potential to further improve adjusted gross margins over time.

We expect to gain economies of scale and efficiencies as we continue to scale up cultivation. As I noted earlier, we plan to make changes to our growing and harvesting methodologies that should not only enhance the quality of our flower but also reduce production costs over time. The recent launches of newer higher-margin dried flowers strains and our Edison Indi brands were more expected to come have the potential to positively impact gross margin as these products gain traction in the market and comprise a greater proportion of the company’s overall revenue. International sales have historically attracted higher margins and are expected to represent a greater proportion of revenue once we resume shipments to Canada.

Further, we continue to launch more multipack pre-rolls and one-gram cartridges and these higher-volume SKUs attracts — attract generally — generally attract higher margins. The company continues to invest in automation to drive cost efficiencies and reduce dependence on manual labor. Lastly, Q4 fiscal 2001 SG&A is expected to be higher than Q3 primarily due to the R&D work at the Center of Excellence and increased selling and marketing expenses as stores reopened to foot traffic and the retail network expands. In closing, we feel very confident about our prospects and remain focused on operational execution to drive top-line growth and just as importantly, to drive cost reduction and operational efficiencies.

At the same time, we are investing in innovation and research and development, and product development, which we believe is critical to gain and sustain a long-term competitive advantage in the industry. So that concludes the prepared remarks. Operator, if you could go ahead and open up the line for questions. Thank you.

Questions & Answers:


Thank you. We have our first question from the line of David Kideckel from ATB Capital Markets. Your line is now open.

David KideckelATB Capital Markets — Analyst

Hi. Good morning. Congratulations on the quarter. Thanks for taking my questions here.

I want to start, I think in your prepared remarks, you mentioned the revenue mix and you look at margins being increased in Q4 as a result of product category or dependent upon product category and sales mix. I just want to know from OrganiGram’s perspective, now with dispensaries opening, some of — many of the COVID restrictions lifting, to what extent do you view this as a tailwind for you and the industry as a whole, especially when it comes to the derivative products or 2.0 product offerings, just given that we know that many consumers require that in-store or dispensary in-phase experience to actually educate a lot of their decisions with these products. And with that said, are you able to comment at all about what you potentially think that revenue mix could look like from a 1.0 versus 2.0 product category split? Thanks.

Paolo De LucaChief Strategy Officer

Hey, Derrick.

Derrick WestChief Financial Officer

Hey, David. Sorry. Can you hear me OK?

David KideckelATB Capital Markets — Analyst

Yes. Loud and clear.

Derrick WestChief Financial Officer

Perfect. Perfect. Thanks for the question. It’s a great question.

First of all, yes, we do view everything that’s happening in terms of the stores, the available both new stores opening and also in-store foot traffic and also just the seasonality where we are in kind of the summer, the kind of the whole social experience and so forth. We do view that as a tailwind. I think your point on derivative products is bang on. Some of those products require a bit more handholding maybe from bud tenders, I was in a store in Toronto just last week, walked in and I was really taking a back about how much a bud tender can influence a consumer’s purchase decision.

The purchasing person walks into the store, kind of middle-aged man and the bud tender really had a strong influence in terms of — in this particular instance, he was looking to buy edible and really help them navigate to a particular brand and so forth. So when I think of derivative products, when I think of our derivative products, in particular, our power beverage, which I think is a relatively novel and innovative product that will certainly do better in our view in a situation where someone walks into the store and can be navigated by a bartender to a different type of beverage, maybe something that’s not as heavy to carry around, something that they could put in their purse or their back pocket now that they’re able to be more social under better clinical environment. We think the same thing certainly with our gummies which are going to be coming out in August. And I think chocolate is also another great opportunity, which is more geared to the kind of the fall and winter seasons.

So I definitely think that derivatives will be a big beneficiary of in-person store traffic and the expansion of retail stores. Our derivative portfolio in aggregate has probably under-indexed the Canadian market in the last year. That is also by design in our part because with the restrictions of COVID and the limitations that we experienced there for a while in terms of less staffing, we thought it was prudent to pivot to higher bigger categories such as flower and pre-roll. So we’ve over-indexed there even against the 70%, which I said in the prepared comments.

But I think we’ll definitely be shifting more to derivatives going forward and starting with Q4 as well. You’ll see some product launches in the next month to two months that we’re excited about. And, yes, I don’t know, Derrick, do you want to add anything on the margins or the revenue mix?

Paolo De LucaChief Strategy Officer

Yes. I would say that as it relates to [Inaudible], we don’t disclose any exact margins by any of our product categories and brands. But I would say that it’s a mix on all of it in terms of pointing a product category. There is various margins depending on the format and the brand.

I would say that we will benefit, over time, with the economies of scale that we expect to get as we’re lowering the cost per unit, the cost per gram, which positively impacts all of our product categories, including derivatives, although not as [Inaudible] one on one as well with the flower categories. And so with — we’ve essentially doubled the production volume in Q3 compared to Q1. And where a large portion of our costs are fixed, we are benefiting significantly over the last quarter with regards to a lower cost per gram, and we’ll start to see that show up. Most of that benefit ends up into our inventory as to what’s sold, and we’ll start to see that as we look forward to a certain extent and as we continue to move to higher production levels.

We’ll always see a bit of timing, and it’s not always going to be exact, but definitely, with the higher production levels we’re running at along the other efficiencies and operational improvements that we’re making and getting improved yields at the facility. There’s positive wins that are back now as it links to our cost per gram, and that will help margins as we look forward from the categories.

David KideckelATB Capital Markets — Analyst

OK. Thanks, Paolo and Derrick. Very helpful. Last question for me, and then I’ll hop back in the queue.

I just — I know you mentioned in your prepared remarks, the Center of Excellence associated with the British American Tobacco company. Beyond what you’ve said in your prepared remarks, is there any color you can give us, or what type of products you expect to hit the market and potential timing here? For example, are these going to be existing products that you already have that you’re looking to tweak like chocolates or beverages, or are these going to be new product offerings altogether? Thank you, and congrats in the quarter again.

Derrick WestChief Financial Officer

Thanks, David. Yes. Look, for — on the BAT, there’s not a ton that we can really say because we just launched it. I can tell you that we’re extremely happy with the people that are involved in the COE, the hirings that we made.

The launch has gone very well to date, and the teams are — within that group are working on product plans and work plans and so forth. I think the best thing to do in terms of — to kind of talk about where this is heading is, for sure the products will be in derivative type of style products. The focus really is on product innovation and also research, understanding safety, understanding the efficacy of the products. And that will be the foundation to which these derivative products will be developed.

So the idea here is to really develop IP and product — products that are — that can transcend borders though. So — yes. So once we’ve developed them and we have IP supporting them and we’ve got a body of research and testing to support how these products work then we can establish them as products in markets around the world, subject to regulations. And we think that the work that we’re going to do is going to be important.

Regardless of which market you go into, regulators and public health officials are going to be, first and foremost, concerned about safety and again, efficacy and the ability to make product claims is going to be based on that. So derivative products, safety and efficacy, supported by research, supported by science, and with a focus in terms of cannabinoids primarily on CBD. In terms of timing, I think we should be very realistic about expectations. There’s certainly nothing that we’re expecting to bring to market in the next kind of 12 months.

Beyond that, it’ll be subject to which product and how far we are along in progress. And in terms of whether they will be innovations on existing products that we have or completely new products, the answer to that is both. Again, subject to the workstreams and the product plans that our teams put together, which we’re still in the relatively early stages of that. But really excited.

I think the people on both sides are — have been great. We’ve been collaborating great. And I think that’s just going to get a lot better when we’re able to kind of travel more freely and so forth. And I think with COVID kind of hopefully on the downslope, these collaborations will just get amplified going forward, and we’re excited about everything that we’ve done today.

David KideckelATB Capital Markets — Analyst

Thanks very much. Congrats on the quarter. I’ll pass it on.


Thank you. The next one is from Andrew from Stifel GMP. Please go ahead.

Andrew PartheniouStifel GMP — Analyst

Hi. Good morning. Thank you for taking my questions. Maybe I could just discuss profitability a little bit.

You had a big revenue bump this quarter sequentially, but it seems like on a reported adjusted gross margin basis, it was relatively stable, cognizant that you still have some unabsorbed fixed costs in that and you’re continuing to scale. So if your product mix remains stable, could you give us a sense of what kind of revenue level we would need to see in order for you to return to kind of pre-COVID gross margin levels or normalized gross margin?

Derrick WestChief Financial Officer

Yes. I’m not sure I’m going to do a projection and look forward on a breakeven analysis on the margin just because we are offering a large number of product categories and different brands. And there’s always newness in the market. Every quarter, we have a number of launches that are coming up, and that happens every quarter, and that does change.

I guess, the mix in terms of the product. And there’s been pricing compression in the market. We do feel that most of that has been flowed through. I would say that the cost reductions on the flower over the last two quarters have been significant.

Most of it does show up in the inventory balances, some of which did help the current period’s cost of sales, but not to the extent that we would see on an ongoing basis. But there was a larger volume of sales in the current quarter with value formats that did contribute to the increase to the revenue in this period. And so the margin did not move up as much as we would have otherwise targeted, but we would think that with the continued efficiency from both changes in processes at our new VP of Operations as well as the facility, along with just the natural gains that we’re going to achieve through spreading up the cost of the overhead facility and the removal of the drag for this unabsorbed fixed charge that you were referring to, which I think was 1.7 million in the quarter. So I think the combination of all those will lead to it if the volume is the same and the mix is the same.

We are going to have mathematically a better margin just because we’ll be flowing through a lower COGS number. That would just be the mathematical outcome, but we’re targeting revenue growth to continue. And over time, we do believe that we will achieve higher margins, but it’s just not something that is automatic and happens just in one quarter, and but we would expect to see improved margins from our product categories again because of lower cost. And there’s just a fair number of initiatives at play, and we are achieving much better — it’s not just a matter of applying the cost to more production volumes.

We are getting better yields out of the room through various process changes that have been implemented. And so we’re — we will start to see the benefit of that. as we move forward. And of course, having sales fulfillment and having higher sales dollars will help as well on the margin, and it does have our attention and we’re having continuous meetings on it on how we can best improve all the profitability metrics.

But it starts with our margin no question.

Andrew PartheniouStifel GMP — Analyst

OK. Thank you for that color. And maybe just switching gears. Health Canada is expected to start the review of regulations that fall.

Just curious if you have any thoughts around that, more specifically perhaps on CBD and how that plays into the BAT partnership?

Paolo De LucaChief Strategy Officer

Yes. I can take that question. Look. We’re awaiting that review period as well.

We have a view that longer term, we think CVD will, hopefully, be available just beyond just traditional retail stores. But again, we don’t have any insight knowledge on that and can offer a firm opinion one way or the other, but just we think over time that, that will likely happen. I think the CBD market, obviously, is a market that has a lot of opportunity just based on what we’ve seen in other jurisdictions as well. And the only thing I can offer as it relates to BAT is that we’ve signaled through formal communication that is the cannabinoid CBD as a cannabinoid with — which will represent a primary focus to start with.

So we think that’s obviously a bigger addressable market than elective products. So we will obviously make that a priority both organic and independently also in CBD.

I was just going to add to that that we expect the three-year review to result in some incremental changes to regulation and some of the — some of which may be positive to the industry, but we are focused on competing in the playing field that exists now. and we don’t predicate our success on the prospects of a favorable regulatory change. But, obviously, there will be a certain level of change, then we’ll be ready and agile to take advantage of those changes.

Andrew PartheniouStifel GMP — Analyst

OK. Do you have any view on what changes might occur?

Paolo De LucaChief Strategy Officer

No. We don’t have [Inaudible] on that.

Andrew PartheniouStifel GMP — Analyst

OK. Thank you for taking my question.


Thank you. The next question is from the line of Tamy Chen. The line is open.

Tamy ChenBMO Capital Markets — Analyst

Thanks. Good morning. First question I had is on the thinking behind the decision to complete the Phase 4 expansion, I noticed another one of your competitors recently brought on a lot of new capacity on their end. So I just wanted to dig into that a bit further.

You talked about wanting to meet longer-term forecasted demand. But as far as I think we can see, at least in the earlier part of this year, provinces were still rationalizing SKUs. It looks like there have been some share losses among the bigger LP, apparently to some craft growers. So I just wanted to understand what specifically are you seeing that prompted the decision to finish Phase 4? Is it discussions with provinces going forward, or is it that you’re just getting more bullish on more Ontario stores? Just wanted to dig into that a bit more.

Thank you.

Paolo De LucaChief Strategy Officer

Hey, Tamy. It’s Paolo. Great question, and I have a few comments to make on that. So number one, I think we’re bullish on stores.

We’re bullish on growth. We’re also bullish on organic ground. We’ve — I — and all the publicly available information, including from Hifyre, will point to our market shares increasing. And we — we’re not able to even produce what we need to meet the demand now.

So this — that’s part of the decision. Our specific situation at OrganiGram requires us to produce more flower. We also have, as part of the investment initiatives to improve our THC and to improve our efficiency. So when we did the analysis, all the signs pointed to that this was the right decision to make and that we needed to do this to grow our business.

In the context of the macro environment, I would just also mention that when you look at the way the industry has unfolded in the past few years, it never made sense for all of the facilities — all of the production facilities that were built to be put online. And we knew that over time, the best facility is even — and when I just say best, I’m talking about either lowest cost of cultivation or highest quality product or a combination thereof, which survive over the long term. And we’ve seen some of the larger players shutter some of their production facility because it’s either inefficient or cannot produce the right quality flower. And also in M&A situations, we’ve seen companies post-M&A, again, shutter facilities.

So what’s happening now is the best producers in terms of being able to produce at a lower cost or higher THC or combination thereof, and we think we’re certainly in that category, or we’d like to survive and are going to be the ones responsibly providing the cultivation in Canada. So we think that we were needed as a cultivator in Canada, and we needed just for even our own demand. And we are very bullish on Canada as a whole. I think the market still has a lot of room to grow.

We hope to see that growth now that Ontario’s opening in stores and stores are open to foot traffic. And when I look at markets like — more mature markets in the U.S. like Colorado, which is less than 6 million people, they did $2.2 billion in sales in 2020. So if you were to — if Canada follows the trajectory of even a fraction of that, we’re going to meet that cultivation.

So again, for us, there’s demand on the table that we need to satisfy. There’s efficiencies that we need to go after, and there’s THC improvements that we still think we can make, and that’s what’s driving the decision to make that investment and to Phase 4c.

Tamy ChenBMO Capital Markets — Analyst

Got it. OK. That’s very helpful. That was it for me.

Thank you.


Thank you. The next question is from the line of Adam Buckham from Scotiabank. Your line is open.

Adam BuckhamScotiabank — Analyst

Good morning. Thanks for taking my questions. So maybe a question on the back of Tamy’s there. So you talked about your capacity and how it’s grown throughout the last two quarters.

Are you able to give us an idea of what your fill rate is on POs as of Q3 versus your prior quarters?

Paolo De LucaChief Strategy Officer

Yes. I don’t have — I don’t know, Derrick, if you have those numbers handy. I don’t have the exact numbers, but I can tell you directionally speaking, that it’s gone a lot better. And in particular, with the largest province, Ontario, we have, I think — I think most recently, we filled, I think, something like 99% of our POs that were actually cut on some of our bigger SKUs.

So our — a lot of credit to be given to our operations department and Nathalie, in particular. They’ve gotten a lot better at fulfilling POs. And I think our sales operations planning process has gotten way better. We’re really dialing that in.

And I think that’s going to help us on our efficiencies and also not missing on sales opportunities. So I can’t give you exact numbers. for the whole company at this point. But I can tell you it’s gotten significantly better.

We’re very pleased, and I think that gives us a lot of confidence going forward in terms of meeting our purchase order obligations.

Adam BuckhamScotiabank — Analyst

OK. Great. Thanks. So second question for me.

I was wondering if we could get an idea. You guys had pretty strong sales growth in the flower category. Right? Like how much of that velocity from a SKU perspective came from larger format versus smaller format products? And then, I guess, secondly, like how much of that, if you can give us an idea for the newest strains versus some of the more, I guess, legacy products?

Paolo De LucaChief Strategy Officer

Yes. I could tell you that we’ve been we’ve been rationalizing our SKUs to make sure that we’re focusing on higher velocity SKUs. And right now, we’re firing on all cylinders. Our three big brands that I think are worth mentioning, SHRED, Edison, and the Big Bag o” Buds, they’re all moving well.

Big Bag o” Buds is, obviously, a large format SKU. SHRED is also — our Jar of Joints is doing extremely well. So we’re very pleased with our velocity in the — on the flower and pre-rolls, in particular. There’s probably a bit more work to do on the derivative portfolio, but that’s going to be revitalized in the next month or two, and you’ll see that with new SKUs coming to market.

So we’re really excited. I think the biggest kind of limitation we’ve had is just the availability of flower, which again speaks to our commitment to doubling down — or not doubling, but increasing our capacity and finishing off Phase 4c, which is already substantially complete.

Adam BuckhamScotiabank — Analyst

OK. Great. Thanks.


Thank you. The next question is from the line of Rupesh Parikh from Oppenheimer. Please go ahead.

Rupesh ParikhOppenheimer — Analyst

Good morning. Thanks for taking my questions. So, Paolo, I just had a question just on the competitive backdrop out there. So clearly, we’ve seen a lot of consolidation space really in the past few months.

So just curious how you feel about OrganiGram’s position just given some of the developments out there. And then where does consolidation or M&A, where is that a focus going forward for OrganiGram?

Paolo De LucaChief Strategy Officer

Yes. Look. I think when you look at the decision tree between buying market share and being extremely dilutive doing that, which I think has been a trend that some of our peers have demonstrated in the past versus taking that market share with our own internal capabilities and like what we announced today in terms of our commitment to finishing 4c and some process improvements, the math definitely works in terms of build-it-yourself and expand. And we have the confidence to do that now because our forecasting and our planning and our brands, just our Edison brand, and our SHRED brand are so strong.

There’s so much brand equity there, that we have the confidence to do that ourselves. So I think we’re not going to say no to M&A. We’ve had — we’ve looked at a lot of companies, none of them have made sense from a risk-reward perspective. I think if we are going to do something in the M&A space.

It’s going to be much more targeted to either a product category or a segment that maybe need a little boost in or to just go a little faster on. But I think like we’re really excited about the market share we’ve captured the last couple of months. And we think there’s actually quite a bit of runway on that as well. So our focus really is on what’s within our control, which is our two facilities now, one in Moncton, one in Winnipeg.

And we still have a lot of optimization to do there. And we think, like I said, answering Tamy’s question, our facility is going to be one of the winners that survives in Canada. It’s a crown jewel of ours. And I think that’s something that others don’t have, and we’re going to leverage that as much as possible before trying to buy market share with just — with M&A ’cause I think that’s not a winning proposition for our shareholders.

Rupesh ParikhOppenheimer — Analyst

OK. Great. Thank you. I’ll pass it along.


Thank you. We have our last question from the line of John Zamparo from CIBC. Please go ahead.

John ZamparoCIBC Capital Markets-Analyst

Thank you. Good morning. I’d like to better understand the strategy when it comes to how OrganiGram gets to improve margins. And I ask that with the backdrop we’ve all seen the numbers on SHRED.

I think we can all agree it’s pretty remarkable growth, but it’s one of the largest or top-selling brands in Canada already, but it’s — that doesn’t necessarily result in positive margin. So I wonder does this need to get to an even higher level of sales to become a positive margin contributor? Or should we think about it as that is probably not going to be the primary driver of margin expansion and that margin expansion will come from the other categories that you’re focused on?

Paolo De LucaChief Strategy Officer

John, that’s a great question. Look. I think to answer that question, what I would say is SHRED will benefit from increased volume, for sure. SHRED will also benefit from lower cost of cultivation, which we’re already demonstrating.

SHRED will also benefit from line extensions, Jar of Joints is a good example of that. That’s a better margin product example for us than the 7-gram pouches. And we think we can take the brand extension to other products as well. The brand equity that SHRED has is remarkable.

I mean it’s a pleasant surprise for us. And along with Edison, I think we’ve got two real winners to build upon, and getting brand equity in cannabis has been a hard proposition for a bunch of reasons, structural including regulatory and so forth. So like you can advertise and all that other stuff. So I would say, look, we want to, obviously, shift as much as possible to higher-margin brands.

that is happening already, I think, with our new Edison streams. And I think that investment that we made in our facility to bring the THC up will allow us to do that. But we’re keeping a close eye on SHRED. And trust me, it’s a big topic of discussion internally, and we have a plan to take it to a better margin place, and I would just be patient and watch us roll that out in the next couple of quarters.

But I think line extensions would be one answer. Efficiencies on just cost of cultivation and then just general efficiencies in terms of the way we operate. I think we’re going to get there very soon.

John ZamparoCIBC Capital Markets-Analyst

OK. That’s very helpful. Thank you. And then second question, as far as these two parts, they’re both related to margin, though.

First, are there other international markets that you’re potentially going to sell into over the next couple quarters? And then second, in Canada, how would you characterize where we’re at in terms of price compression on the producer side. Is there still room for this to fall forward in your opinion in the next few quarters?

Paolo De LucaChief Strategy Officer

Yes. On international, I think we’re signaling that we’re probably going to restart international sales in our fiscal Q1 of next year. International, while we would like to make it a bigger part of our business, we’re still — we still have a lot of opportunities to deal with in Canada here, and we want to make sure that we’re capturing all that demand. But longer term, I think as part of our strategy, we do have to figure out a way to get more international sales.

And hopefully, we’ll have more news on that again as the — by the time the next quarter rolls around. On price compression, look, that’s a hard one to answer because that requires a forecast of supply and demand. It’s hard to actually get good transparency on what the other producers are producing in terms of kgs. And, again, I think I made the comment earlier on the M&A question is we think that there’s going to be continued rationalization of cultivation facilities.

Obviously, as that cultivation comes offline, that will — the supply will hopefully start to — side of the equation will start to balance a bit better. On the demand side, though, we’re seeing growth. Certainly, the proliferation of stores in Ontario is going to drive a lot of that. And so it’s certainly slowed down if nothing else, so that’s probably a sign that it’s bottoming.

And I think the margins just become impossible at a certain point for LPs if they keep dropping in. So I think rationality will prevail. And the one thing I am encouraged about with M&A is that people will be a bit more rational. I think some of the companies that have done that are going to have to look really closely in the mirror to see and ask themselves the question, is it worth producing in this facility that can’t get the THC to the right level or cost of production is too high, that will get rationalized.

And I think that’s going to help the overall supply demand equation. But on our side, we’re committed to making money at these prices because we have to. It’s within our control to get more efficient, and that’s what we’re driving to. And again, on the THC side, we’ve seen our THC climb, but there’s a little more work to do there.

And I think that’s the way we’re going to deal with it and just making sure that we maximize our THC and keep our costs as low as possible.

John ZamparoCIBC Capital Markets-Analyst

Understood. Thank you very much.


[Operator signoff]

Duration: 62 minutes

Call participants:

Amy SchwalmVice President-Investor Relations

Paolo De LucaChief Strategy Officer

Derrick WestChief Financial Officer

David KideckelATB Capital Markets — Analyst

Andrew PartheniouStifel GMP — Analyst

Tamy ChenBMO Capital Markets — Analyst

Adam BuckhamScotiabank — Analyst

Rupesh ParikhOppenheimer — Analyst

John ZamparoCIBC Capital Markets-Analyst

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