OrganiGram Holdings Inc

TSX:OGI

Earnings Call Transcript 2021-Q2

[Operator]

Good morning. My name is Jack, and I will be your operator today. At this time, I would like to welcome everyone to Organigram Holdings, Inc. Second 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 Amy Schwalm, Vice President of Investor Relations.

[Amy Schwalm, Vice President of Investor Relations]

Thank you, Jack. Joining me today are Organigram's Chief Executive Officer, Greg Engel; Chief Financial Officer, Derrick West; and our Chief Strategy Officer, Paolo De Luca. Before we begin, I 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 those 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 meeting under IFRS, and our approach to calculating these measures may differ from that of other issuers. And so, these measures 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.

[Gregory Engel, CEO & Director]

Thanks, Amy. Good morning, and thank you for joining us today. Here we are over a year into this pandemic and despite challenging times currently. There's a light at the end of this tunnel as vaccines start to be administered across the country and worldwide, and we couldn't be more excited about the prospects for the cannabis industry and Organigram. Before going into more detail, I want to take a moment to thank our employees for their commitment and dedication to the company over the last 12 months, which have been challenging for all of us. This morning, we reported our second quarter fiscal 2021 results for the period ended February 28, 2021. As we expected and indicated in our last quarter's disclosure, Q2 continues to be a transition period while we were ramping up operations and hiring the requisite staff such that operations are anticipated to be better supported in Q3. Our Q2 results were also further impacted by production disruptions on 2 occasions related to COVID-19 as well as market dynamics due to COVID-19 restrictions. As we continue to be laser-focused on execution in a very competitive Canadian market, our team has been busy with some significant recent developments, which we believe have meaningfully strengthened Organigram's near and long-term competitive profile and potential. We've positioned the company for more near-term revenue growth with the acquisition of The Edibles and Infusions Corporation and believe our collaboration with BAT will be transformational over time. I will spend a moment on these 2 transactions before I comment more on the quarter. A hallmark over Organigram has been our focus on R&D and innovation. Our efforts and intentions have been and continue to be about delivering innovative, differentiated products with the most consumer appeal. We were 1 of the first 2 cannabis companies to invest in biosynthesis and we believe this technology has the potential to change the cannabis landscape. Another example is our in-house R&D team's development of a proprietary nano-emulsification technology to allow for faster absorption of cannabinoids when compared to traditional edibles. It is our view that the cannabis industry is still in the nascent stages of product development and a continued investment in innovation in R&D is necessary to secure a long-term competitive advantage. BAT, a leading consumer goods business with innovative product platforms, an impressive dedication R&D and deep consumer insight chose to collaborate with us after extensive discussions, workshops and in-depth due diligence. A Center of Excellence, or CoE, is being established on our Moncton facility. At the CoE, we will work on developing the next-generation of cannabis products, IP and technologies and also can now also draw upon our R&D capabilities and license facility in Winnipeg to augment and diversify our product development efforts. Both Organigram and BAT are contributing scientists, researchers and product developers to the CoE. Initially, the focus will be on CBD products. Both companies have access to certain of each other's intellectual property and subject to certain limitations, have the right to independently globally commercialize the products, technologies and IP created by the Center of Excellence. Through the CoE and BAT's representation on our Board of Directors we intend to leverage BAT's expertise for our wider operations. There's 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 2 BAT to nominees to Organigram's Board of Directors. At closing, we welcome Mr. Jeyan Heper, to our Board, and the other nominee is expected to be appointed in the near term. Mr. Heper, who is a group category Director at BAT has over 23 years of diverse management strategic leadership and M&A experience at global companies, including Procter & Gamble, Danone and most recently, Lifestyles Healthcare. Not only is this collaboration with BAT going to accelerate and strengthen our research and product development activities, it is also expected to be instrumental in establishing the foundation for our U.S. and international strategy. As part of the transaction, BAT invested approximately CAD 221 million 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. Under the product development collaboration agreement, we will be granted a worldwide royalty-free sub licensable perpetual license to exploit IP developed under the collaboration. This license, which is non-exclusive outside of Canada and sold in Canada, will also enhance Organigram's ability to enter markets outside of Canada, including through sublicensing arrangements with established operators. Approximately $30 million of BAT's investment is being reserved for our portion of funding obligations under a mutually agreed initial budget for the CoE and cost will be funded equally by Organigram and BAT. Now turning to our most recent transaction announced last week. We acquired The Edibles and Infusions Corporation, or EIC, for short, a soft chew manufacturer with other specialized confectionery capabilities and backed by leadership from a company with 100 years of confectionery operations. The EIC management team also has experience in supplying confectionary products to over 20,000 locations throughout North America. James Fletcher, CEO of Cavalier Candies, joins Organigram as President of EIC. James has deep CPG and confectionery expertise and experience and a proven track record of delivering to some of the world's biggest retailers, such as Costco and Walmart. The acquisition positions us for more near-term revenue growth from the largest edible category, soft chews or gummies, and [ diversify ] our R&D and manufacturing capabilities with an operational footprint in Western Canada. EIC currently holds a standard processing license, it is in the process of obtaining its sales license. Until it receives its sales license, it can manufacture products in bulk for further processing, review and sale by us or other third-party license producers for white label opportunities. Importantly, the acquisition also strengthens our R&D capabilities with its research laboratory and research license. EIC constructed and leases are purpose-built highly automated 51,000 square foot manufacturing facility in Winnipeg, Manitoba, with state-of-the-art equipment designed to produce highly customizable, precise and scalable cannabis-infused products, including edibles. We now have 2 facilities dedicated to Rec 2.0 products, both designed under EU GMP standards. We believe that a strong presence in both cannabis 1.0 and 2.0 markets is crucial to sustain a significant share of the Canadian market. While cannabis 1.0, drug flower, pre-rolls and oils, still accounts for more than 70% of the overall Canadian market, 2.0 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 rec market compared to 12% to 15% in U.S. markets. In fact, we note that in Colorado, which is the most mature U.S. market, edibles account for about 17% of the total cannabis sales. To date in Canada, edibles are one of the fastest-growing segments of Rec 2.0 products. We now have specialized capabilities in the 2 largest edible subcategories, gummies and chocolates. The largest subcategory is gummies or soft chews. With our acquisition of EIC, we can enter this market quickly backed by proven confectionery experience. The EIC equipment is designed to produce craft and large-scale nutraceutical grade cannabis edibles, including, pectin, gelatin and sugar-free gummies, coffee and caramel with novel capabilities such as infusion, striping and the possibility of using fruit purees. Chocolates are the second most popular edible category and our Moncton facility houses our world-class chocolate production and packaging line. Concentrates are another subcategory of Rec 2.0 that has see meaningful growth and appear to have a lot of upside when you look at the popularity of these products in the U.S. We have plans for in-house hydrocarbon extraction for the production of concentrates and other unique products. Currently, we expect to begin commissioning this equipment in Q4 fiscal 2021. In the interim, we've continued to revitalize our product portfolio with 63 new SKUs launched since July 2020, and and up to 31 more SKUs still to come in Q3 fiscal 2021. Ontario SKU rationalization mandate has not negatively impacted us to date. As a result of us revamping our portfolio, we were able to trade up some of our slower moving older products, and we're ready to replace them with new listings. I'll take a moment now to highlight some of our new key listings and launches. As we discussed during last quarter's earnings call, we are very focused on revamping our higher-margin Edison portfolio. After launching 3 new Edison Indica strains in late December 2020, we introduced these strains, Black Cherry Punch, I.C.C. and Slurricane in 3 packs of 05.g pre-rolls. We expect to launch more high THC strains under the Edison brand in Q3 2021. Edison was among the most searched brands on the Ontario Cannabis Store website in November 2020 as well as January and February of this year. Also, in late March, we introduced a new brand called Indi one of Canada's only cannabis brands dedicated exclusively to indica cultivars. Skyway Kush is the first strain in the company's Indi portfolio and currently offers THC in the range of 20% to 23%. And in the popular value segment, we leveraged our successful SHRED brand by launching Jar of Joints, the convenient jar of 14.5g pre-rolls of SHRED’s Tropic Thunder. SHRED has been the #1 most search brand on the OCS website for the last 5 consecutive months. In terms of Rec 2.0 products, we introduced milk chocolate Trailblazer SNAX bars; the third flavor to be added to the initial launches, of mint and mocha flavors. We also plan to launch further Edison Byte Truffle products in the next few quarters after success of our seasonal Gingerbread offering last fall. We look forward to improving revenue from our Vapes portfolio with the launch of 2 new products with higher THC concentrations. These include an Edison + Feather disposal of vape pen at a very competitive price point, as well as a new 1g Edison cartridge for the 510 vaporizer. Both products will be based on our popular Limelight strain. These 2 additions will add to our portfolio, which already includes the value segment offering of Trailblazer Spark, Flicker and Glow, 510-thread Torch cartridges in 0.5g and 1g formats and the premium Edison + PAX ERA distillate cartridges. With last quarter's results, we indicated that we were scaling operations. We've made good progress hiring more staff and ramping cultivation, which we expect will improve demand fulfillment and drive higher net revenue in Q3 as compared to Q2. We do caution that net revenue could be negatively impacted, should we identify any positive COVID-19 cases in the future and need to take similar measures to Q2. We essentially shut down the Moncton facility on 2 occasions in Q2 sending employees home to isolate. As well, Ontario announced its third state of emergency last week shuttering cannabis retail stores to foot traffic and limiting purchases to online shopping -- online shopping, click and collect and local delivery, which could also impact Q3 revenue. Beyond Q3, we're targeting first sales of soft chews in fiscal Q4 2021, subject to certain progress, including, but not limited to, the receipt and commissioning of certain equipment. The completion of QA documentation, the hiring of requisite staff and obtaining listings for provincial boards. Also, we expect to resume shipments to Canndoc in Israel in the near term. We're seeking Good Agricultural Practice certification from the Control Union Medical Cannabis Standard to comply with Israel's updated standards for imported cannabis. Subject to successful completion of a required inspection, likely to be conducted remotely, we anticipate being certified as early as the end of our fiscal third quarter. Shipments to Canndoc are expected to resume in fiscal Q4 2021, contingent upon regulatory approval from Health Canada, including obtaining an export permit and availability of the desired product mix. In terms of gross margins, we see the potential for significant upside here. We have identified a number of opportunities to improve levels over time. We expect to gain economies of scale and efficiencies as we continue to scale up cultivation. There's potential for greater contribution from higher-margin products and formats, including new strains under the Edison and Indi brands. International sales to Canndoc as well as from multi-pack pre-rolls and 1g vapes, which attract higher margins in singles and 0.5g dates. We also continue to invest in automation to drive cost efficiencies and reduce our reliance on manual labor. For example, our new pre-rolled machine has been up and running since March, consistently churning out 25 to 30 pre-rolls per minute over time. With the potential for further improvement. Over the last week alone, we've seen it consistently churning out 40 pre-rolls per minute. And finally, we are looking at more cost-efficient packaging as part of our packaging task force mandate. I'll now pass the call over to Derrick to go through the financials in more detail before I wrap it up.

[Derrick W. West, Chief Financial Officer]

Thanks, Greg. As I usually do, I will start with our financial position. Last week, we repaid our entire term loan balance of $58.5 million such that no amounts are owing under our credit agreement. And at the present time, we intend to terminate the credit agreement and discharge of the related securities. The term loan repayment amounts to $2.7 million in annual interest savings. In terms of balance sheet liquidity, the company currently has $232 million in cash and short-term investments. Q2 2021 net cash used in operating activities of $10.4 million was similar to the $10.9 million used in Q2 2020. The current quarter had a lower gross margin, but this was offset by nominal changes to working capital as compared to the cash outlay in the comparative period, which was largely due to scaling operations just ahead of Rec 2.0 launches. Turning to our results for Q2. Net revenue declined to $14.6 million from $23.2 million in the prior year quarter. This change was primarily due to a decrease in wholesale revenue and a lower average net selling price impacting all product lines. It should also be noted that the higher wholesale revenues in the prior year's quarter were opportunistic in nature and largely consist of sales to a single license producer. Net revenue from the rec market decreased from Q2 2020 due to lower volumes as a result of the prior year quarters being the first quarter for Rec 2.0 sales and a lower average selling price as well as higher proportion of value products being sold in the current quarter. As Greg mentioned, Q2 2021 net revenue was also impacted by temporary shutdowns of the facility and isolation of certain staff after the identification of positive COVID-19 cases. In total, we were unable to fulfill approximately $7 million of demand for our products in Q2 2021 due to various production and processing constraints. As we have heard from other LPs recently, many of the provinces have been reducing their inventory levels to free up working capital. Alberta is 1 such example. This also had an impact on net revenue during the quarter. Q2 2021 cost of sales increased to $31.1 million from $15.8 million in Q2 2020, primarily due to the current quarter's higher inventory provisions, a higher cost of production and a charge related to unabsorbed fixed overhead as a result of lower production volumes in Q2 of 2021. As we expected and indicated in our Q1 2021 disclosure, this charge declined sequentially from last quarter and is expected to decline further in Q3 2021 as we continue to ramp operations. We harvested 5,028 kilos of cannabis during the quarter compared to 5,023 kilos in Q1 2021. During Q1, we were using 40% of our growing rooms on average and during Q2, this was increased to an on average of 54%. As of the date of our MD&A, we are currently using 69% of our growth. Also encouragingly, during the quarter, we achieved higher plant yields and a meaningful sequential decrease in the cultivation cost per gram. As a result of optimizing the density of plants per room and decreasing the time spent in vegetation, the average yield per plant increased. This lower cultivation cost during the quarter lowers the cost of inventory compared to earlier quarters such that when this inventory is sold, this will positively impact gross margins. Note that the overall level of Q3 adjusted gross margins compared to Q2 will also depend on other factors, including but not limited to, product category and brand sales mix. Adjusted gross margin decreased to a negative $0.7 million compared to a positive Q2 2020 gross margin of $8.4 million, largely due to lower net revenue as described above and value segment offerings comprising a larger proportion of total revenue in Q2 2020. Negative IFRS gross margin of $17.2 million declined from a positive gross margin of $11.3 million, largely due to lower net revenue and higher cost of sales, as just described, as well as net noncash fair value changes to biological assets and inventory sold and other charges in Q2 2021 versus positive changes in the prior year's quarter. Q2 2021 SG&A, excluding noncash share-based compensation, decreased to $11.1 million from $14 million in Q2 2020, largely due to higher professional and consultant fees in the prior year's quarter related to project-specific work, including the launch of Rec 2.0 products. Q3 2021 SG&A is expected to be higher than Q2 2021 largely due to an increase in staffing related to the EIC and BAT transactions. The net loss of $66.4 million or negative $0.29 per share on a diluted basis during the quarter compared to a net loss of $6.8 million or negative $0.04 per share in the prior year quarter was primarily due to the current period's negative change of $37.7 million in the fair value of the derivative warrant liabilities and the negative gross margin. That concludes my remarks, so I'll pass the call back to Greg.

[Gregory Engel, CEO & Director]

Thanks, Derrick. After a 13% decline from 2020 to February 2021, rec retail sales have rebounded in March, according to Hifyre data, a widely used digital retail platform that tracks and estimates national retail sales. March recreational sales reached an all-time high of $305 million, implying an annualized run rate of $3.7 billion. Retail stores continue to open with Ontario driving the growth and targeting 1,000 stores opening in the province by the end of the summer. Since July, the store count in the provinces grew by 87% to just over 1,790 stores currently driven by Ontario, growing 468% to nearly 580 stores. In mid-February, Ontario announced it is authorizing 20 to 30 stores per week or up to 120 per month. Longer term, the Brightfield Group estimates Canadian adult rec sales closer to $8 billion by 2026. Other analysts have estimated as high as $10 billion by that time frame. This is expected to be driven by retail store footprint expansion and the introduction of new product formats. And there is room for more upside depending on regulatory amendments, starting with the mandatory review of the Cannabis Act, which starts in October of this year. In closing, we are laser-focused on operational execution to drive top line growth and greater economies of scale and cost efficiencies. Our team is benefiting from increased staffing and expects to leverage the experienced leadership, technical capabilities and resources obtained via the recent BAT and EIC transactions. And of course, we're investing in the future of innovative cannabis products for the long-term competitive advantage in the industry. We are doing all this against a backdrop of solid industry growth. And one of the strongest balance sheets in the company's history.So that concludes my prepared remarks. Operator, if you'd like to go ahead and open up the line for questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Andrew Partheniou with Stifel.

[Andrew Partheniou, Analyst]

Maybe just to start off with -- you have a strong balance sheet. You guys recently announced the acquisition of EIC and strengthening your edibles offering. Do you see any more white space in Canada? And if not, could you also provide a little bit of color on your international expansion strategy? Just trying to get a sense of what are your focus and priorities on deploying this cash?

[Gregory Engel, CEO & Director]

Yes, Andrew. Thanks. It's Greg here. I'll take the question. So I mean, certainly, as you saw and mentioned, our EIC acquisition was really about entering a category with a kind of an entry point with a proven operator that has potential to really scale up and proven ability to produce very high-quality products and get those to market in the near term. I think when we look at other white space for us as an organization, I mentioned earlier in the call, we're not playing in and participating in some of the concentrates areas or some of the more advanced products. So certainly, our hydrocarbon extraction equipment, which has been delayed in terms of getting it fully operational due to some of the certification processes, but we do expect in Q4 to have that hydrocarbon extraction equipment up and running and being able to begin production of those products. So that's -- again, that's a category we're not playing in today. I think we, as a company, are very focused on continuing to drive and improve the quality our flower in the facility. And as you can see from the recent launches. And if you look at the reviews online, there is improvements there. We still are contemplating how do we play in the ultra-premium area, which is an area that we're not participating in, but we certainly are seeing the strength of our flower production and the new cultivars we're bringing to market continuing to improve and drive kind of responses there. So that may be 1 area we would continue to look at is how do we continue to expand into that area. I think on the international front, I mean, we've been vocal before and open about the fact that we continue to look at primarily the CBD market in the near term because that is a more larger, more addressable market, even with our collaboration and product development collaboration with BAT, the initial focus on products is on CBD-based products because it's a larger global addressable market, whether or not that's in the U.S. or in Europe or elsewhere. With THC markets, I mean, we've been exporting to Australia for a few years now, a few years now, and we are working towards recertification to be able to export into Australia, which also has the potential to serve as an entry point through Canndoc in Australia into other markets. So I think as we kind of work through that process, it will give us an opportunity for continue and growth in the international sales market potentially with that certification.

[Andrew Partheniou, Analyst]

Maybe just switching gears and talking about your outlook. You guys already mentioned next quarter, revenue should be up versus this quarter. Absent any kind of COVID risk further shutdowns of your facility and things like that. Is it possible to give any kind of indication as of magnitude of what you could expect maybe tying into the recent SKU launches and more SKU launches that you guys are planning to do in the quarter? Should we be thinking about Q3 returning to Q1 levels or potentially Q4 levels? Any kind of further color would be very useful.

[Gregory Engel, CEO & Director]

I guess, I'll answer it by saying, I mean, as you said, Andrew, we do expect revenue to be higher in Q3 over Q2. And there are a number of risk factors, which you outlined some of them certainly COVID related and/or even the state of emergency we've seen in Ontario and the impact that could have, and we could see that roll into other provinces. I think it's -- we're not in a position to give guidance on what that quarter is going to look like fulsomely. But I think the key things for us is, as you said, great response to our new genetics that we've seen. We've got 31 new SKUs launching before the end of this quarter. We have seen the market growth kind of bouncing back up in March based on the Hifyre data. And I think we've ramped up operations. I think our biggest challenge in Q2 was a combination of not enough supply or not enough processing capacity to respond to the response from the market. So we did leave significant revenue on the table, as Derrick outlined. So ramping up production and ramping up, call it processing staff and our packaging ability is one of the key aspects for us. And I think I mentioned this slightly. We are focused on operational efficiency. So some of the key things that are really improving for us is our packaging costs on a per unit basis for many of the products have gone down. I mean, I've mentioned on our previous earnings call, for example, that with the automation and pre-roll equipment that we have, we went down from 20-22 operators to 5 in staff kind of running that line, with a consistent, constant output. And things like that will help margin overall, but that also improves the top line because you're able to significantly increase the product availability for that market segment, which allowed us, again, to launch the 14g Jar of Joints under the SHRED brand, which has been extremely well received.

[Operator]

Your next question comes from the line of David Kideckel with ATB Capital Markets.

[David M. Kideckel]

I just want to go back, Greg and team for a second. With the $7 million in unfulfilled demand just due to the COVID closures, just wondering if you could provide us any color with respect to what that demand was for, for example, was it 1.0 products, 2.0 products. And at 2.0, what product segment was that in. And also what measures do you think you can take, so as to prevent something like this again, especially given we're already 1.5 months into Q3.

[Gregory Engel, CEO & Director]

Yes. I mean I can answer and -- I mean, it was predominantly 1.0 products in terms of -- so again, it was a combination of reduced staffing and/or the shutdowns, because it wasn't just the shutdown of the facility for a couple of days. In both instances, there were significant staff that had to self isolate for up to 14 days, right? So -- but it was predominantly 1.0 products, there were some 2.0 products in the demand there. I think for us, I would say, we have put very strong and stringent measures in place. And I think one of the key aspects of one of the cases, for example, was identified by us in our screening, right? And then we urged that individual to be tested and went and got tested and was pretty asymptomatic. And I think, again, we're working closely with the provincial government in New Brunswick and our facility and collaborate, and we immediately took it upon ourselves to do a thorough deep clean in the facility. And a testament to our staff to -- wasn't just cleaning sanitation staff that were part of that, we had levels of management and a lot of volunteers helping out with that, that people said, let's get this done as quickly as possible, so to then get reopened. So preventing -- going forward, we are very confident in our own activities. We certainly have no reason to believe, nor does the province have any reason to believe these cases were linked to the facility. They just happen to be individuals that work there. And more than likely contracted COVID out in the marketplace.

[David M. Kideckel]

Okay. That's very helpful. Moving along here as well. I think, Greg, you mentioned in your prepared remarks, with your early investment into Hyasynth, the biosynthesis play here. I'm just wondering, especially with the investment now from BAT. Are you able to provide any sort of general color with respect to what products or category of products you expect biosynthesis to play in Organigram? And any indication of timing when that can occur, especially just given to Derrick's remarks with net selling price going down even further this quarter?

[Gregory Engel, CEO & Director]

Yes, David, it's a good question. And I know we spend a lot of time about [ synthesis ]. I think when we look at that market potential and the segmentation, I mean, you have to look at it 2 ways, as we've outlined before, there's major cannabinoid production and doing that at large-scale for CBD or THC or different versions of those 2 major cannabinoids. I think that as well as the potential for minor cannabinoids as a key driver in our investment, we certainly was one of the reasons that BAT, one of the many reasons that BAT was excited and interested in this collaboration agreement was that we're 1 of only 2 cannabis companies to really be at the forefront of investing there. And I think when we look at the novel minor cannabinoids, I think that is the one where future products where you can bring those novel cannabinoids into product mixes for both medical and recreational use, I think, is going to be the exciting part. So and again, when we talked about the collaboration and under the CoE, a big part of that collaboration is product development and then making sure that those products are tested at a very high level into a high standard, and I think that's going to be important. So yes, I mean, you'd have to speak to Hyasynth direction directly to get an indication of kind of their timing and plans, but we're certainly optimistic in the future that we'll see both potential for major cannabinoids, but more importantly, minor cannabinoids that could be utilized in some of these products.

[Operator]

Your next question comes from the line of Tamy Chen with BMO.

[Tamy Chen, Analyst]

First is, I wanted to go back to on the production side. So Greg, you've talked about this a number of quarters ago where the company has been doing a pivot to change what you've been growing. So it's more in line with consumer demand. So I'm just wondering first, where the company is at with respect to climbing up the learning curve of these new strains. Because we're sort of continuing to see inventory provisions, I think there was last quarter, and now there's additional this quarter. So I'm just trying to understand, like is that a result of you're still going up the learning curve of these new strains and will these write-downs continue?

[Gregory Engel, CEO & Director]

Yes maybe I'll -- thanks, Tamy, for the question. I'll start off and then maybe turn to Derrick to answer part of the question. But so the majority of inventory provisions were related to when you think on the product side, were related to extract and/or extractable material, right? We've got sufficient inventory of extract that carries us out for a significant amount of time going forward based on that demand on 2.0 products at this point. Although, again, with hydrocarbon will produce uniquely new products in the future. And there were certainly packaging and even some vape hardware that was part of those provisions. So certainly, always including provisions is discounts that are taken with the provincial boards, if something is a slow-moving SKU. And one of the things I outlined in our prepared remarks was that we've been very very active in working with the provincial boards to ensure we don't get into return situation, looking to, a, reduce SKU average selling price, if it's not moving -- and then more importantly, for us, transition and flip that SKU to a newer product. So -- and the last element of it is the there is some R&D work that happens. So certainly, as part of the growing process, you're going to get to 3-star strains or 5-star strains, you're producing 15 or 20. So you do have some losses. That's not a significant number. But I think very optimistic with what we're seeing and very good numbers in terms of, a, what we're seeing from a production capacity perspective. As Derrick indicated, when you look at where we were 2 quarters ago, we were only producing kind of on average in about 40% of our rooms. We're now at 67%. So we've increased production capacity significantly. And we are seeing no question, better yields, better THC numbers coming out. So we expect to see good progress. Derrick, I don't know if you want to add any color to that.

[Derrick W. West, Chief Financial Officer]

I guess the only thing I would add to what Greg has outlined would be that when we look at our overall carrying value of the inventory, we have to take a look at each bucket and forecast out and utilize the latest pricing in the marketplace as well, which -- and that considers -- the markets pivot more towards value from mainstream pricing. And when you apply some of that lowered pricing against the existing carrying value of the inventories that are valued at fair value, it does end up with a noncash carrying value adjustment that's required, and that's also embedded into the numbers that negatively impacting the quarter, which would be the only item in addition to what Greg has already outlined.

[Tamy Chen, Analyst]

Okay. And my follow-up is, I'm wondering if you could talk a bit about the -- your different brands in flower, primarily between Edison and SHRED. Are you seeing over the last little bit? And now are you seeing more velocity, more demand on the value side? So your SHRED products? Or are you seeing some more relative velocity and more traction on some of the more mass premium products like your Edison brand?

[Gregory Engel, CEO & Director]

Yes. Tamy, it's a good question. I think -- so certainly, one of our challenges, I mean, SHRED has been an extremely successful launch for us, as I indicated, #1 searched product or brand on the OCS website for 5 months in a row. So the demand is there. We have not been able to fulfill the demand for it because of the demand being so much higher than we had expected. Although, again, we did launch the SHRED Jar of Joint as a way to kind of supplement that as well. So it's -- certainly, demand is very high there. I don't know what the cap on the demand is because we're not -- we have not been able to consistently supply that historically. On Edison, that is where we're continuing to improve and increase our product mix with the new -- the 3 new indicates I mentioned earlier and getting new products to market. We've got another 3 new products coming and coming up in the quarter new strains. And I think we are seeing -- again, it's -- when you get the product out in market, there is good demand. So for example, one of our strains in that mix is Black Cherry Punch, there's a few other companies that have Black Cherry punches. But our Edison Black Cherry Punch outsells them from the data that I have seen. So there is strong demand there. And I think by launching recently Indi, which is an indica-focused brand, it diversifies our brand portfolio a little bit in terms of specifically saying going forward, this is going to be kind of an indica brand and I think, again, our challenge has been -- it's been an inability to fulfill, in part because of production levels and what we're growing because, as you know, it takes 12 to 16 weeks kind of the growth cycle and then another month to get product processed in out the door. So when you make a decision to pivot, it doesn't have an immediate impact. So again, we are seeing continued demand and as I outlined, it means a big part of those missed POs was simply not having either the product or the ability to process it. But I mean, we've made big changes in our facility on operational efficiency to really improve our packaging throughput, and we are continuing to add in automation on some of the areas with minimal investments to improving the lines.

[Operator]

Our next question comes from the line of John Zamparo with CIBC.

[John Zamparo, Associate]

I wanted to ask about the recent EIC deal. And I just would like to get a sense of what you think the reason is that edibles in the category is any larger than it is currently? And assuming that part of the reason is regulatory restrictions on potency or quantity, however you want to describe it. Is there any reason you would expect Health Canada to liberalize regulations on edibles as part of the upcoming mandatory review?

[Gregory Engel, CEO & Director]

Yes, John, it's a good question. I think initially or for certainly part of the since 2.0 has been launched. It feels like part of the lower revenue versus a comparative state data. But certainly -- and so -- but that's caught up. I mean, certainly, there is a good supply and a good mix of products. I think, again, still like any category, there's a different quality of products there and consumers make choice over time. And it's one of the reasons we're very excited about EIC is we're confident in the quality of the product they're going to produce and be able to produce it at a very low cost based on kind of the equipment they have and the proven history of manufacturing. But to your point, how do we -- if U.S. state data is 12% to 15% and Canadian data is just over 4%, how do we improve that? I think one of the key drivers has to be this change to get away from the 10-milligram maximum per package. I think in the marketplace, one of the important things is going to be as well as better differentiation between the products, right? Many of the products that we've seen to date are very similar in terms of the quality and the experience for consumers has to continue to evolve. And if you go into a Canadian retail store versus a U.S. dispensary, the diversity of products is extremely different there. So I think it is a combination of the packaging limitation. I think it's a combination of the kind of limited scope of some of the products, many of them are kind of me-too type products. And again, our investment in EIC is one where we believe it has potential to produce some very differentiated products based on the type of proven confectionery products. We've already seen test runs with the equipment to understand what the equipment can do and produce, and it's a pretty diverse range of products. So we're excited about it.

[John Zamparo, Associate]

Okay. That's helpful. And then my second question is on the margin side, and I'd just like to better understand the expectations for margin expansion. And certainly, increased utilization seems like a positive driver. But if we think about SHRED being a bigger proportion of your flower revenues and you're leading more into 2.0, that category hasn't been the margin driver. Some of the industry thought it would be, and it probably needs more start-up costs in the near term. So should we interpret the commentary on improved margins to be more likely as a longer-term development rather than something we'll see over the next 12 months?

[Gregory Engel, CEO & Director]

And John, maybe I'll let Derrick to answer that question.

[Derrick W. West, Chief Financial Officer]

Yes. I would say generally that margins is a -- we would expect to see gradual improvements over time with a long-term look. One of the things that did occur during the quarter is that we have lowered our production costs in terms of the dollar per gram to create the flower and flower is still the largest product category. And most of those costs would then be into our inventory. And so as we sell it during Q3, that would -- as it relates to that component. By decreasing our current run rate of production costs, we would achieve a level of savings, but I would note that the amount of our margins will be dependent on product categories and brand sales mix. And we are focused on continuing to ensure that we can place as much product as we can into higher-margin areas. And while we're also focused on improving our cost and efficiencies at the facility so that we could continue to achieve lower cost per unit metrics that we achieved in Q2.

[Operator]

Your next question comes from the line of Rupesh Parikh with Oppenheimer.

[Madeleine Marie Stone, Associate]

This is actually Madeleine Stone on for Rupesh. So just first on some of the industry headwinds out there. So how long do you currently see some of these COVID-19 related industry headwinds lasting?

[Gregory Engel, CEO & Director]

Yes, madeleine, it's a tough question to answer. I mean, certainly, Canada is in the midst of a third wave right now. And certainly, we're seeing Ontario, Quebec, Alberta B.C., Manitoba, in particular, being at hard and we're seeing kind of stay-at-home orders and restrictions. So on one hand, though, we did see during the previous shutdown. I mean, cannabis is -- cannabis stores have been allowed to remain open for curbside pickup and local delivery, click and collect type. And certainly, it did blunt we believe, some of the sales and maybe shifted more sales to the online purchases as well. But without that in-store experience, some consumers may have reduced their -- may have reduced their purchasing habits. At this point, as far as we know, for example, in Ontario, there's still more than 3 weeks to go in that existing state-of-home order. I think this is more of a larger question, I mean, Canada is accelerating its vaccination programs. And was far behind many other parts of the world, but sort of more recently is in a catch-up. So as that starts to improve, we would expect at some point, this summer to things to start to return to some level of normalcy. But I mean the focus right now is just on blunting or reducing the current third wave that is hitting many parts of Canada so.

[Madeleine Marie Stone, Associate]

Okay. Great. That's helpful. And then just switching gears to the EIC acquisition. So how should we think about the near-term revenue opportunity for the business? And then just anything else you can share for longer-term margin dynamics of acquisitions such as accretion or anything like that, that would be great.

[Gregory Engel, CEO & Director]

Yes. I mean, certainly, we look at EIC. It has 2 levels of manufacturing equipment. One is more kraft focus and another large-scale production capacity. And again, part of our rationale for this acquisition is that we see that -- versus what we've seen in the market to date with soft chews in particular, but other categories in confection that the amount of throughput and the automation that's there is very high so that definitely the ability to produce product at a low cost. So I think, certainly, you're going to see some unique and interesting products come out of EIC, hopefully, in our Q4 this year. Again, that is dependent upon licensing and commissioning of equipment and everything. But certainly, we do expect them to be strong in terms of what their cost of goods is going to be relative to the competition. The thing you can't control is the market dynamic in terms of where pricing is. So we're excited about EIC. It's why we made the investment. We certainly think that they're going to be able to do things that the majority of other companies cannot do from a costing basis and a consistency basis. So that should definitely be a big contributor to how that product contribution looks like.

[Operator]

Your next question comes from the line of Aaron Grey with Alliance Global Partners.

[Aaron Thomas Grey, MD & Head of Consumer Research]

So quickly [ unmute ], given the drop in the average price per gram and the higher mix from SHRED that was attributable to. I just wanted to know if you had any kind of goal in terms of the mix value of your portfolio and what you expect it to be kind of going forward? Whether or not you look for that to be more in line with the industry, below the industry because you did speak to demand for SHRED still remaining very high. So just curious as to how that plays into your own cultivation plans and think about flower that are coming out in the next 2 months because you've also mentioned kind of the desire for more high-THC Edison products be coming out too?

[Gregory Engel, CEO & Director]

Yes. I mean our goal, Aaron, and thanks for the question, is very much to continue to drive more higher THC product, higher differentiated product in terms of new and interesting strains or are kind of star strains that have had good response in the marketplace. And SHRED was really created as a way, there was a white space there and certainly in terms of the marketplace, where we had seen some blends in the past, but they weren't curated and we look at SHRED stains kind of curated where a unique mix of 2 strains to get up with a premium flavor profile. And again, the demand is very, very high and strong. Ultimately, we are -- our production is shifting more and more to the higher THC and higher-margin products with Edison, as Derrick alluded to earlier. And I think it's important for us because there is strong market demand there. There is strong demand not only in Canada, but internationally and even B2B in Canada. Because we've seen it recently, for example, with the announced acquisition of Supreme by Canopy, where Canopy in the past had shuttered numerous facilities. So they're not -- my assumption certainly as the purchase wasn't based on cultivation capacity. It was based on improved higher-quality product in terms of how product is perceived. And I think we have the advantage with our Moncton facility and the way it's designed to continue to kind of drive and improve the quality of what we're producing, where as we've seen, at least in this 1 case where companies had to go out and do an acquisition to backfill some of their own production capacity.

[Aaron Thomas Grey, MD & Head of Consumer Research]

Okay. Great. That's helpful. And then second one for me is just on the expected return of shipments to Canndoc, I think you expected in the fourth quarter of the fiscal year. I just wanted to get your take on kind of how to expect sales for that. The ramp you still expect to be lumpy on a quarter-to-quarter basis, but how -- or how should we kind of look at the growth of those sales internationally, for Israel.

[Gregory Engel, CEO & Director]

Yes, Aaron, it's still tough to predict. I mean, certainly, the initial shipment that we made to Israel, 2 of the 3 strains sold out within a matter of weeks very quickly. So a very good response, and they were ready to purchase certainly make additional purchases pretty quickly after those first shipments went out. So -- but understanding there's a process with import permits from Israel and export permits being issued by Health Canada. But the demand is there and certainly, it's, first of all, getting through with CUMCS, the GAP certification process so that we're able to begin importing to Israel again. And then again, getting through the process for every shipment because you do have to kind of go through it each shipment.But we certainly expect to return at this point by the end of Q4 to shipping, again, based on product availability to shipping there. And it's going to depend -- the market response has been very strong to our products in Israel. And I think Canndoc is very excited to get our products back in inventory. We're not the only supplier, but we are the only indoor supplier for them, and they've certainly noted that that's a big differential in quality in the market in terms of the consumer response.

[Operator]

Your next question comes from the line of Graeme Kreindler with Eight Capital.

[Graeme Kreindler, Principal]

Greg, I wanted to follow-up on your comments earlier about M&A. And there's been a number of your competitors turning to M&A to drive growth and consolidate market share. I'm wondering if that's been a strategic consideration for Organigram, clearly, as it's a very difficult landscape to drive incremental share in adult-use impacted by both the competitor and provincial level. But there's a lot of initiatives going on to rebalance the product portfolio and cater to consumer needs. But I'm wondering if the general consolidation of that market share is something where you see an opportunity to consolidate some share in the adult-use market there.

[Gregory Engel, CEO & Director]

Yes. Graeme, I think when we look at the marketplace, again, it's been key for us is, again, as I've talked about on the call and previously is continue to improve our quality and hitting the product specs and getting the product out the door, that the market demand is there. I think one of the things we've done and to look to expand with the recent launch of Indi is to expand our own brands in-house that we can target a different consumer with that. I think certainly, we are always open to looking at M&A. And when we look at targets for ourselves, I mean, as you saw with EIC, we focus on 2 things. One is, is there kind of innovation and technology or something unique that comes with it? Or secondly, as in any consumer packaged goods area, if co-acquiring brands, which we've seen Canopy do with both our acquisitions recently has been more of a brand play and I think that's something you need to be open to. Are there strong brands out there? I think 7 acres is a relatively strong brand. So that was an acquisition that made sense, but there's not a lot of them out there, which is the challenge, right, when you look at consolidation targets. I mean, there's a couple that could be of interest. But at this time, they're not necessarily interested in discussion. So I think it's something you need to always be evaluating because if you can expand through innovation technology or acquire brands that really resonate with consumers, those are the 2 key things that we focus on.

[Graeme Kreindler, Principal]

Okay. Understood. Appreciate the color there. Then as a follow-up, based on your comments on brand and creating the products that consumer wants. When we think about the CBD market, which is going to be the focus of initial product launches with the BAT deal, that's a highly competitive market where there's thousands of brands and regulations can make it difficult to get Tier 1 shelf space when looking at the market on a global scale. So I'm wondering if the strategic plan to launch products in that market, has any expectation of some sort of regulatory reform? Or is this something that you think presents a bit of a challenge in the near term, and it's more of a longer-term opportunity there?

[Gregory Engel, CEO & Director]

Yes. Graham, it's a great question. I think both ourselves and BAT, I mean our perspective and the reason -- and I've stated it repeatedly, the reason we're investing heavily in this Center of Excellence in product development is that we believe there are going to be new standards, right? For example, if you look at the U.S. market today, very limited regulations on CBD, right? There are limitations on what you can source the product from, so it has to be hemp with THC less than 0.3, and there are limitations on health claims that you can't make and the FDA has gone after people for making health claims. But beyond that, there's very little or no restrictions or oversight. We do expect there to be a regulatory regime on CBD products in the future. And I think it's important that when you're developing CBD products that you develop them to a rigor that the current products are not developed to, right? And I think that's one of the key aspects from an investment in that marketplace is. CBD is metabolized in the liver. So it's not without potential effects. And so I think it's important that through this collaboration and the way we operate, that we -- our goal is to set new standards, right, and be at a level above, and I think that's where there's a competitive advantage that we will have with the products that are developed through this collaboration is that they're going to go through more rigor and at a higher standard that competitors can't meet. And then it's not if, but when stricter regulations come into place, these products are -- meet the standards that are required and it could put other companies and this very wide range of products around market today into a difficult situation, and that carries over to Canada when we expect new regulations are going to happen here. In Europe, there is movement towards some changes as well. So I think it's important when you think globally in terms of the CBD market about setting the standard and being the leader there.

[Operator]

Our next question comes from the line of Rahul Sarugaser with Raymond James.

[Rahul Sarugaser]

So I'd like to focus on the BAT partnership. Given organic ground strength in the edible segment of the market and the company now doubling down on the segment with the acquisition of EIC. I guess there's a bit of asymmetry with BAT. We can -- it's probably fair to see it more inhalation focused, I wanted to ask whether the IP sharing deal would potentially benefit both sides the edible and inhalable format?

[Gregory Engel, CEO & Director]

Yes. So again, we did disclose in our announcement that the focus of the product types is both on vapor and oral, and oral is a pretty broad category. It doesn't -- it's not just -- it could be -- and again, I'm not -- I can't -- I'm not in a physician to disclose all the products specifically, but you think of oral consumption, whether that's edible or tincture, or it's an oral mucosal, oral buccal form. So there is a pretty comprehensive list of potential products there. So both parties, including -- we did contribute intellectual property into this as well. So it's kind of a pretty broad product development agreement.

[Rahul Sarugaser]

Terrific. And so further to the BAT and their channels, will there be any opportunity for Organigram to leverage BAT's distribution, particularly some international channels as you begin to broaden your footprint outside of Canada, also given the other partnerships that we see in the space do leverage the distribution networks of their partners?

[Gregory Engel, CEO & Director]

Yes. So at this point, the collaboration does not contemplate that necessarily. Each party is both ourselves and BAT are having the ability to commercialize and launch all of or any of the products that are developed through the collaboration under our own brands in any markets. They can be even sublicensed to some degree with some restrictions in those markets. So at this point, that's not what the collaboration is focused on. It's really focused on the product development side of things.

[Operator]

Your next question comes from the line of Douglas Miehm with RBC Capital Markets.

[Douglas Miehm, Analyst]

Yes. Greg, just a quick question with respect to the strategy going more upmarket, better strains and those sorts of things. We're hearing the same thing from almost every single company out there. Can you tell us how you're going to be able to differentiate yourself? And if you think there's going to be any pricing pressure as people all start to move in that direction. And it's not so much that this market is going to change overnight, but it seems that within the next quarter or 2, people are going to have multiple streams available in this marketplace.

[Gregory Engel, CEO & Director]

Yes, Doug, it's a good question. And again, I would point to the Canopy acquisition of Supreme, right, where companies are focusing on it, they're looking to do it, but they may not, with their in-house capabilities to be able to do it. I mean, if we look at some of our peers who have closed facilities, the reason they've closed those facilities is they were not either cost-efficient or more importantly, they weren't capable of producing kind of products in that range, right? So I think that's an advantage of our facility. And again, a key part of -- it's not just the facility, it's the staff and the people we have overseeing things, but it's also been the genetic acquisition, right? I mean, getting access with once kind of the Nurse Reprograms were open in these licenses, allowed us to really obtain a very deep bank of genetics. And also bring back some of the genetics we had in our own reserve to market and work on the conditions for them. So while a lot of companies might be indicating they're moving in that direction, we have not seen that from some companies as of yet. And I think, again, we're certainly optimistic based on the data we're seeing right now in the products we're growing and what's coming off harvest, that we have moved products up into those categories. So people are talking about it, but I'm not sure everyone is able to execute on it.

[Douglas Miehm, Analyst]

Okay. That's fine. And then with respect to that $7 million, and maybe you answered this already, but what was the breakdown? Was it primarily SHRED or what did you miss out specifically on?

[Gregory Engel, CEO & Director]

Yes, we wouldn't give a full breakdown on it, but I mean, certainly, you can imagine that value products because they have made up a significant portion of our revenue was significant part of it. But it was also demand for Edison strains and new products and some of our 2.0 products as well, so it was a mix. And certainly, again, as I said, it was a combination of what product was available, but also the processing and packaging capacity with some of the impacts we had from COVID staffing reductions.

[Operator]

Our next question comes from the line of Matt Bottomley with Canaccord Genuity.

[Matt Bottomley, Analyst]

I just wanted to go back to that $7 million that Doug was just talking about. With respect to, I guess, relationships with the provinces and the ability to carve out additional market share in these various SKUs, are there any near-term implications for not being able to fill certain orders? As I know there's a very strict fulfillment policy that many of the provinces, particularly Ontario have. So just any color on how that may or may not impact relationships with these buyers?

[Gregory Engel, CEO & Director]

Yes. So I think, first of all, I'd start off and answer the question, Matt, that we and our sales team have very strong relationships with the provincial boards. And I think when we talk about missed opportunities here, certainly -- and what you're alluding to is Ontario and Alberta, in particular, that have and Ontario is implementing very strict kind of guidelines in terms of listings is you've got to manage that relationship and manage against future. So the way that it works in a couple of provinces is you kind of get a rolling PO within a window, and you have to fulfill within the time line. So when we talked about missing it, part of it part of that miss happened in the quarter, part of it would have rolled into the next quarter, right? So it's not necessarily -- but again, it was issued and was we could have fulfilled it in the quarter if we'd had the product available at that time. So I think we're not concerned at this point. I think we've done an excellent job, our sales team of transitioning out slower selling SKUs for new listings and new SKUs. And I think that's critical. But again, as you say, it's going to be even more important going forward. With the fulfillment demands that you focus on what your core listing are and make sure that you're hitting those numbers, right? So it is a shift for the industry. It's a shift for the company. And to be honest, it may have a detrimental effect on -- across the industry on some of the other provinces as people are rushing to fulfill Ontario because of penalties that are there, not that other provinces don't also have kind of commitment levels, but just one thing in general trend in the industry to be cognizant of.

[Matt Bottomley, Analyst]

Great. That's helpful. And then just one more question for me on sort of market share. And just tying back to some of your comments, you mentioned that the, I guess, pool of brands to be purchased like a supreme or like some of those that we've seen, isn't as deep where there'd be sort of mass M&A expected in the near-term just for brands. So if you kind of look at where your market share is today and how much growth is left, in the sector, which is still quite a bit. But we are, like you said, I think, $3 billion-plus on a run rate. What's the best way to, in your view, to gain that incremental share, if not through M&A, obviously, you guys are focused a lot on the edibles and chews, and maybe that's an undersized proportion of the market today versus where it is at maturity. But just any color that ex M&A, how market share can be gained in your view in the coming months and quarters?

[Gregory Engel, CEO & Director]

Yes. I think it stems down to 3 key things, Matt. One is continue to focus on improving the quality and the product offerings that you have, right, just in terms of what the consumer demand is. I mean, you can spend 5 minutes on Reddit and see what the comments people are making on product reviews. And they're consistent when you [ regard those ] if it's flower or pre-roll or an edible, it's about quality. So companies, and we're very much focused on improving that quality. I think the second is diversifying your own in-house brands. As I said, recently, we launched Indi, and we have a select target group of consumers that, that product is targeted for SHRED was a new launch for us. And I think as you continue to look at how do you diversify and really do more targeted segmentation for consumers. And so far, again, with those product launches, we've seen good response. And so that's another way to grow organically. And I think the third is still -- and I mentioned this a few times, it's just innovation, right, bringing new innovative products. We're very excited about the EIC acquisition in terms of some of the products and the product quality we can bring to the market because, as I said, what you see today in the soft chews, for example, is majority of the products are quite similar. And we're excited about bringing some unique and innovative products to market through EIC and then the more midterm products through the collaboration with BAT and that's going to be important as the market evolves, so.

[Operator]

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